Question

(Present value tables are needed.) Somerville Corporation is considering investing in specialized equipment costing $618,000. The equipment has a useful life of 5 years and a residual value of $55,000. Depreciation is calculated using the straight-line method. The expected net cash inflows from the investment are: Year 1 $250,000 Year 2 $190,000 Year 3 $152,000 Year 4 $112,000 Year 5 $95,000 $799,000 Somerville Corporation's required rate of return is 14%. Is the internal rate of return of the investment equal to, higher than, or lower than 14%?

Answer 1

Net present value = Present value of cash inflows + present value of salvage value - Initial investment

= 250000*0.877+190000*0.769+152000*0.675+112000*0.592+95000*0.519 + 55000*0.519 - 618000

= $-5886

Internal rate of return of the investment is lower than 14%.