Question

Merrill Corp. has the following information available about a potential capital investment:   

Initial Investment	1,700,000
Annual Net income	190,000
Expected Life	8 years
Salvage Value	250,000
Merills Cost of Capital	10%

Assume straight line depreciation method is used.

Required:

1. Calculate the project’s net present value.

2. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 10 percent.

3. Calculate the net present value using a 15 percent discount rate.

4. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 15 percent.

NET PRESENT VALUE IS NOT 397,220

Answer 1

Initial Investment = $1,700,000
Salvage Value = $250,000
Useful Life = 8 years

Annual Depreciation = (Initial Investment - Salvage Value) / Useful Life
Annual Depreciation = ($1,700,000 - $250,000) / 8
Annual Depreciation = $181,250

Annual Net Cash Flow = Annual Net Income + Annual Depreciation
Annual Net Cash Flow = $190,000 + $181,250
Annual Net Cash Flow = $371,250

Answer 1.

Cost of Capital = 10%

Net Present Value = -$1,700,000 + $371,250 * PVA of $1 (10%, 8) + $250,000 * PV of $1 (10%, 8)
Net Present Value = -$1,700,000 + $371,250 * 5.3349 + $250,000 * 0.4665
Net Present Value = $397,206.63 or $397,207

Answer 2.

Internal rate of return is higher than 10% as NPV is positive at cost of capital of 10%.

Answer 3.

Cost of Capital = 15%

Net Present Value = -$1,700,000 + $371,250 * PVA of $1 (15%, 8) + $250,000 * PV of $1 (15%, 8)
Net Present Value = -$1,700,000 + $371,250 * 4.4873 + $250,000 * 0.3269
Net Present Value = $47,635.13 or $47,635

Answer 4.

Internal rate of return is higher than 15% as NPV is positive at cost of capital of 15%.