Question

(NPV with varying required rates of return​) Big​ Steve's, a maker of swizzle​ sticks, is considering the purchase of a new plastic stamping machine. This investment requires an initial outlay of ​$100,000 and will generate free cash inflows of $18,000 per year for 15 years.

a. If the required rate of return is 5 ​percent, what is the​ project's NPV​?

b. If the required rate of return is 20 percent, what is the​ project's NPV​?

c. Would the project be accepted under part ​(a​) or ​(b​)?

d. What is the​ project's IRR​?

Answer 1

a.Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$100,000.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the required rate of return of 5%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 5% the required rate of return is $86,833.84.

b.Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$100,000.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the required rate of return of 20%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 20% the required rate of return is -$15,841.49.

c.Project with 5% required rate of return should be accepted under part (a) and (b) since it has a positive and highest net present value.

d.Internal rate of return is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$100,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow cash flow, press the IRR and CPT button to get the IRR of the project.

The IRR of the project with 5% required rate of return is 16.08%.

In case of any query, kindly comment on the solution.