Question

Clare Company is considering the purchase of some labor saving equipment for its packaging department. The equipment is expected to result in labor cost savings of $50,000 per year for the expected five-year life of the equipment. The cost of the equipment is $120,000 and the desired rate of return is 6%.

1. The NPV of the investment for Clare Company is ___________.

Is the IRR greater than, equal to or less than the desired rate of return?

2. What will the NPV be if the desired rate of return is 4%?

Is the IRR greater than, equal to or less than the desired rate of return?

3. What will the NPV be if the desired rate of return is 8%?

Is the IRR greater than, equal to or less than the desired rate of return?

Answer 1

Solution 1:

Computation of NPV
Particulars	Amount	Period	PV Factor @6%	Present Value
Cash Outflows:
Cost of Equipment	$1,20,000	0	1	$1,20,000
Present Value of Cash Outflows (A)				$1,20,000
Cash Inflows:
Labor Cost Savings	$50,000	1-5	4.21236	$2,10,618
Present Value of Cash Inflows (B)				$2,10,618
Net Present Value (B-A)				$90,618

Since the NPV of investment is Positive that is NPV>0, therefore IRR will be greater than Desired rate of return.

Solution 2:

Computation of NPV
Particulars	Amount	Period	PV Factor @4%	Present Value
Cash Outflows:
Cost of Equipment	$1,20,000	0	1	$1,20,000
Present Value of Cash Outflows (A)				$1,20,000
Cash Inflows:
Labor Cost Savings	$50,000	1-5	4.45182	$2,22,591
Present Value of Cash Inflows (B)				$2,22,591
Net Present Value (B-A)				$1,02,591

Since the NPV of investment is Positive that is NPV>0, therefore IRR will be greater than Desired rate of return.

Solution 3:

Computation of NPV
Particulars	Amount	Period	PV Factor @8%	Present Value
Cash Outflows:
Cost of Equipment	$1,20,000	0	1	$1,20,000
Present Value of Cash Outflows (A)				$1,20,000
Cash Inflows:
Labor Cost Savings	$50,000	1-5	3.99271	$1,99,636
Present Value of Cash Inflows (B)				$1,99,636
Net Present Value (B-A)				$79,636

Since the NPV of investment is Positive that is NPV>0, therefore IRR will be greater than Desired rate of return.