Question

Problem 10-09

NPVs and IRRs for Mutually Exclusive Projects

Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Because both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered truck will cost more, but it will be less expensive to operate; it will cost $23,000, whereas the gas-powered truck will cost $17,100. The cost of capital that applies to both investments is 11%. The life for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be $6,500 per year and those for the gas-powered truck will be $4,950 per year. Annual net cash flows include depreciation expenses.

• Calculate the NPV for each type of truck. Do not round intermediate calculations. Round your answers to the nearest dollar. show excel formulas

  Electric-powered truck	$
  Gas-powered truck	$

• Calculate the IRR for each type of truck. Do not round intermediate calculations. Round your answers to two decimal places. show excel formulas

  Electric-powered truck	%
  Gas-powered truck	%

• Which type of the truck should the firm purchase?
• Electric or gas powered?
• 
  
• 
  

Answer 1

Electric-powered truck

Discount rate	11.000%
Year	0	1	2	3	4	5	6
Cash flow stream	-23000	6500	6500	6500	6500	6500	6500
Discounting factor	1.000	1.110	1.232	1.368	1.518	1.685	1.870
Discounted cash flows project	-23000.000	5855.856	5275.546	4752.744	4281.751	3857.434	3475.165
NPV = Sum of discounted cash flows
NPV 0 =	4498.50
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
PI= (NPV+initial inv.)/initial inv.
=(4498.5+23000)/23000
1.2
0
IRR is the rate at which NPV =0
IRR	17.55%
Year	0	1	2	3	4	5	6
Cash flow stream	-23000.000	6500.000	6500.000	6500.000	6500.000	6500.000	6500.000
Discounting factor	1.000	1.175	1.382	1.624	1.909	2.244	2.638
Discounted cash flows project	-23000.000	5529.626	4704.117	4001.847	3404.418	2896.178	2463.813
NPV = Sum of discounted cash flows
NPV 0 =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	17.55%

Gas-powered truck

Discount rate	11.000%
Year	0	1	2	3	4	5	6
Cash flow stream	-17100	4950	4950	4950	4950	4950	4950
Discounting factor	1.000	1.110	1.232	1.368	1.518	1.685	1.870
Discounted cash flows project	-17100.000	4459.459	4017.531	3619.397	3260.718	2937.584	2646.472
NPV = Sum of discounted cash flows
NPV 0 =	3841.16
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
PI= (NPV+initial inv.)/initial inv.
=(3841.16+17100)/17100
1.22
0
IRR is the rate at which NPV =0
IRR	18.49%
Year	0	1	2	3	4	5	6
Cash flow stream	-17100.000	4950.000	4950.000	4950.000	4950.000	4950.000	4950.000
Discounting factor	1.000	1.185	1.404	1.663	1.971	2.335	2.767
Discounted cash flows project	-17100.000	4177.742	3525.965	2975.873	2511.602	2119.763	1789.055
NPV = Sum of discounted cash flows
NPV 0 =	0.000
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor
IRR=	18.49%

c.

Choose Electric as it has higher NPV