Question

Dwight Donovan, the president of Perez Enterprises, is considering two investment opportunities. Because of limited resources, he will be able to invest in only one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of three years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $115,000 and for Project B are $41,000. The annual expected cash inflows are $54,593 for Project A and $17,070 for Project B. Both investments are expected to provide cash flow benefits for the next three years. Perez Enterprises' cost of capital is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Compute the net present value of each project. Which project should be adopted based on the net present value approach? b. Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach? Complete this question by entering your answers in the tabs below. Required A Required B Compute the net present value of each project. Which project should be adopted based on the net present value approach? (Round your intermediate calculations and final answers to 2 decimal places.) Net Present Value Project A Project B Which project should be adopted? Required A Required B >

Answer 1

Requirement A:

Project A:

Initial Investment = $115,000
Annual Cash Inflows = $54,593
Cost of Capital = 8%
Useful Life = 3 years

NPV = -$115,000 + $54,593 * PVA of $1 (8%, 3)
NPV = -$115,000 + $54,593 * 2.5771
NPV = $25,691.62

Project B:

Initial Investment = $41,000
Annual Cash Inflows = $17,070
Cost of Capital = 8%
Useful Life = 3 years

NPV = -$41,000 + $17,070 * PVA of $1 (8%, 3)
NPV = -$41,000 + $17,070 * 2.5771
NPV = $2,991.10

So, the company should accept Project A as its NPV is higher.

Requirement B:

Project A:

Initial Investment = $115,000
Annual Cash Inflows = $54,593
Useful Life = 3 years

IRR Factor = Initial Investment / Annual Cash Inflows
IRR Factor = $115,000 / $54,593
IRR Factor = 2.1065

Using PVA of $1 table values, IRR = 20%

Project B:

Initial Investment = $41,000
Annual Cash Inflows = $17,070
Useful Life = 3 years

IRR Factor = Initial Investment / Annual Cash Inflows
IRR Factor = $41,000 / $17,070
IRR Factor = 2.4019

Using PVA of $1 table values, IRR = 12%

So, the company should accept Project A as its IRR is higher.