Question

Northern Manufacturing Ltd. is considering the investment of $85,000 in a new machine. The machine will generate cash flow of $14,000 per year for each year of its eight-year life and will have a salvage value of $9,000 at the end of its life. The company’s cost of capital is 10%. Table 6-4 and Table 6-5. (Use appropriate factor(s) from the tables provided. Round the PV factors to 4 decimals.)

Required:

1. Calculate the net present value of the proposed investment. (Ignore income taxes.)
2. What will the internal rate of return on this investment be relative to the cost of capital?

Answer 1

Calculation of the net present value of the proposed investment.
(a)	(b)	(c)	(d)		(e) = (c)*(d)
Year	Cashflow		Discounting Factor @10%		Discounted Cash Flows
Year 0	Outflow	-$ 85,000	1/1.10^0	1	-$ 85,000.00
Year 1	Inflow	$ 14,000	1/1.10^1	0.909091	$ 12,727.27
Year 2	Inflow	$ 14,000	1/1.10^2	0.826446	$ 11,570.25
Year 3	Inflow	$ 14,000	1/1.10^3	0.751315	$ 10,518.41
Year 4	Inflow	$ 14,000	1/1.10^4	0.683013	$ 9,562.19
Year 5	Inflow	$ 14,000	1/1.10^5	0.620921	$ 8,692.90
Year 6	Inflow	$ 14,000	1/1.10^6	0.564474	$ 7,902.64
Year 7	Inflow	$ 14,000	1/1.10^7	0.513158	$ 7,184.21
Year 8	Inflow	$ 14,000	1/1.10^8	0.466507	$ 6,531.10
Year 8	Inflow	$ 9,000	1/1.10^8	0.466507	$ 4,198.57
Net Present Value (-85000+12727.27+11570.25+10518.41+9562.19+8692.90+7902.64+7184.21+6531.10+4198.57)					-$ 6,112

What will the internal rate of return on this investment be relative to the cost of capital?

Internal rate of return will be lower than the cost of capital of 10% as we the Net present value of the project is negative at 10% cost of capital