Question

Blanda Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. If the firm uses a 9 percent discount rate for production systems projects, System 2 Year System 1 -$13,500 -$44,796 0 1 13,732 30,300 2 13,732 30,300 3 13,732 30,300 Compute the IRR for both production system 1 and production system 2. (Do not round intermediate calculations. Round ans wers to 2 decimal places, e.g. 15.25.) IRR of system 1 is % and IRR of system 2 is %. Which has the higher IRR? has higher IRR Compute the NPV for both production system 1 and production system 2. (Do not round intermediate calculations. Round answers to 2 decimal places, e.g. 15.25 or 15.25%.) and NPV of system 2 $ NPV of system 1 is $ Which production system has the higher NPV? has higher NPV.

Answer 1

IRR is the Rate at which PV of Cash Inflows are equal to PV of Cash Outflows.

System 1:

Year	CF	PVF @85%	Disc CF	PVF @86%	Disc CF
0	$ -13,500.00	1.0000	$ -13,500.00	1.0000	$ -13,500.00
1	$ 13,732.00	0.5405	$    7,422.70	0.5376	$    7,382.80
2	$ 13,732.00	0.2922	$    4,012.27	0.2891	$    3,969.24
3	$ 13,732.00	0.1579	$    2,168.80	0.1554	$    2,134.00
NPV			$        103.77		$        -13.96

IRR = Rate at which least +ve NPV + [ NPV at that Rate / Change in NPV due to 1% inc in Rate ] * 1%

= 85% + [ 103.77 / 117.73 ] * 1%

= 85% +0.88%

= 85.88%

System2:

Year	CF	PVF @45%	Disc CF	PVF @46%	Disc CF
0	$ -44,796.00	1.0000	$ -44,796.00	1.0000	$ -44,796.00
1	$ 30,300.00	0.6897	$ 20,896.55	0.6849	$ 20,753.42
2	$ 30,300.00	0.4756	$ 14,411.41	0.4691	$ 14,214.67
3	$ 30,300.00	0.3280	$    9,938.91	0.3213	$    9,736.08
NPV			$        450.87		$        -91.82

IRR = Rate at which least +ve NPV + [ NPV at that Rate / Change in NPV due to 1% inc in Rate ] * 1%

= 45% + [ 450.87 / 542.70 ] * 1%

= 45% +0.83%

= 45.83%

System 1 is selected as it has higher IRR

NPV = Pv of cash Inflows - PV of Cash outflows

System1:

Year	CF	PVF @9%	Disc CF
0	$ -13,500.00	1.0000	$ -13,500.00
1	$ 13,732.00	0.9174	$ 12,598.17
2	$ 13,732.00	0.8417	$ 11,557.95
3	$ 13,732.00	0.7722	$ 10,603.62
NPV			$ 21,259.74

System 2:

Year	CF	PVF @9%	Disc CF
0	$ -44,796.00	1.0000	$ -44,796.00
1	$ 30,300.00	0.9174	$ 27,798.17
2	$ 30,300.00	0.8417	$ 25,502.90
3	$ 30,300.00	0.7722	$ 23,397.16
NPV			$ 31,902.23

System 2 is selected as it has higher NPV.