Question

1. a) Would you suggest your firm invest in a new machine that costs $450,000 and generates cash flows of $60,000 per year at the end of each of the next ten years if the appropriate discount rate for the machine is 8 percent? What is the present value of the annuity generated by this machine’s cash flows?

b) Calculate the internal rate of return for a project that has upfront costs of $6 million and cash flows of $2 million per year for each of the next four years. Suppose the risk adjusted borrowing cost of this project is 15 per-cent. Using IRR analysis, would you undertake this project? Confirm your answer by calculating the project’s NPV.

Answer 1

a. Net present value is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0=-450,000
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the tenth cash flow cash flow, press the NPV button and enter the interest rate of 8%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The present value of cash flows is -$47,395.12.

b. This is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$6,000,000
• Cash flow for each year is entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the IRR button to get the IRR of the project.

The IRR is 12.59%.

Net present value is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0=-$6,000,0000
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the tenth cash flow cash flow, press the NPV button and enter the interest rate of 15%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The present value of cash flows is -$290,0432.27.

Using the IRR rule, I would reject the project since its IRR is less than the cost of capital. I would also reject using the project using NPV rule since it results in a negative net present value.