Question

Internal rate of return: Refer to problem 10.5. Compute the IRR for both production system 1 and production system 2. Which hasa the higher IRR? Which production system has the higher NPV? Explain why the IRR and NPV rankings of systems 1 and 2 are different.

Net present Value: Blanda Incorporated mangement is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. If the firm uses a 9 percent discount rate for their production systems, in which system should the firm invest?

Year	System 1	System 2
0	-13,600	-42,000
1	13,600	30,700
2	13,600	30,700
3	13,600	30,700

Answer 1

1.System 1

Internal rate of return can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$13,600. The initial cash flow is indicated by a negative sign since it is a cash outflow.  
• Cash flow for each of the fifteen years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project is 83.93%.

System 2

Internal rate of return can be calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$42,000. The initial cash flow is indicated by a negative sign since it is a cash outflow.  
• Cash flow for each of the fifteen years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project is 52.48%.

2.Production system 1 has the higher IRR.

3.System 1

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$13,600. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the discount rate of 9%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 9% discount rate is $20,825.61.

System 2

Net present value can be solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$42,000. Indicate the initial cash flow by a negative sign since it is a cash outflow.  
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the NPV button and enter the discount rate of 9%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.  

Net present value at 9% discount rate is $50,100.

Production system 2  has the higher NPV.

3.NPV and IRR ranking are different for system 1 and 2 because the NPV and IRR approaches use different reinvestment rate assumptions so there can be a conflict in project acceptance when mutually exclusive projects are considered.

4.If the two production systems are mutually exclusive, the firm should invest in system 2 since it has the higher net present value.

In case of any query, kindly comment on the solution.