Summer Company is considering three capital expenditure projects. Relevant data

Question

Summer Company is considering three capital expenditure projects. Relevant data for the projects are as follows.
Project Investment Annual Income Life of Project
22A $240,000 $15,000 6 years
23A 270,000 24,400 9 years
24A 280,000 21,000 7 years


Annual income is constant over the life of the project. Each project is expected to have zero salvage value at the end of the project. Summer Company uses the straight-line method of depreciation.





Determine the internal rate of return for each project.
22A %
23A %
24A %







If Summer Company's required rate of return is 11%, which projects are acceptable?
23A22A and 24A23A and 24A22A and 23A22A, 23A and 24A22A24A

Explanation / Answer

Projects Net Income Depreciation Cash Flow 22A 15000 40000 55000 23A 24400 30000 54400 24A 21000 40000 61000 Depreciation = Investment / Lifetime Project 22A Discounted Discounted Years Cash Flows Discount rate 15% Cash Flow Discount rate 9% Cash Flow 1 55000 0.869565217 47826.08696 0.917431193 50458.7156 2 55000 0.756143667 41587.9017 0.841679993 46292.39963 3 55000 0.657516232 36163.39278 0.77218348 42470.0914 4 55000 0.571753246 31446.42851 0.708425211 38963.38661 5 55000 0.497176735 27344.72044 0.649931386 35746.22625 6 55000 0.432327596 23778.01778 0.596267327 32794.70298 Total Discounted Cash Flows 208147 246726 Invest ment 240000 240000 Net Present Value -$31,853 6726 IRR = L1 + (NPV L1 /( Present value L1 - Present L2)) * L2 - L1 =9%+(6726/(246726-208147))*15%-9% = 9 + 0.95 = 9.95% Project 23A Discounted Discounted Years Cash Flows Discount rate 15% Cash Flow Discount rate 9% Cash Flow 1 54400 0.869565217 47304.34783 0.917431193 49908.25688 2 54400 0.756143667 41134.2155 0.841679993 45787.39163 3 54400 0.657516232 35768.88304 0.77218348 42006.78132 4 54400 0.571753246 31103.37656 0.708425211 38538.33148 5 54400 0.497176735 27046.4144 0.649931386 35356.26741 6 54400 0.432327596 23518.62122 0.596267327 32436.94258 7 54400 0.37593704 20450.97497 0.547034245 29758.66292 8 54400 0.326901774 17783.4565 0.50186628 27301.52561 9 54400 0.284262412 15463.87521 0.46042778 25047.27121 Total Discounted Cash Flows 259574 326141 Invest ment 270000 270000 IRR = L1 + (NPV L1 /( Present value L1 - Present L2)) * L2 - L1 56141 =9+(56141/(326141-259574))*15-9 = 9 + 4.9 = 13.9% Project 24A Discounted Discounted Years Cash Flows Discount rate 15% Cash Flow Discount rate 9% Cash Flow 1 61000 0.869565217 53043.47826 0.917431193 55963.30275 2 61000 0.756143667 46124.76371 0.841679993 51342.47959 3 61000 0.657516232 40108.49018 0.77218348 47103.19228 4 61000 0.571753246 34876.94798 0.708425211 43213.93787 5 61000 0.497176735 30327.78085 0.649931386 39645.81456 6 61000 0.432327596 26371.98335 0.596267327 36372.30694 7 61000 0.37593704 22932.15944 0.547034245 33369.08894 Total Discounted Cash Flows 253786 307010 Invest ment 280000 280000 Net Present Value -26214 27010 IRR = L1 + (NPV L1 /( Present value L1 - Present L2)) * L2 - L1 = 9+(27010/(307010-253786))*15-9 = 9+2.82 = 11.82% Project 24A Discounted Discounted Years Cash Flows Discount rate 15% Cash Flow Discount rate 9% Cash Flow 1 61000 0.869565217 53043.47826 0.917431193 55963.30275 2 61000 0.756143667 46124.76371 0.841679993 51342.47959 3 61000 0.657516232 40108.49018 0.77218348 47103.19228 4 61000 0.571753246 34876.94798 0.708425211 43213.93787 5 61000 0.497176735 30327.78085 0.649931386 39645.81456 6 61000 0.432327596 26371.98335 0.596267327 36372.30694 7 61000 0.37593704 22932.15944 0.547034245 33369.08894 Total Discounted Cash Flows 253786 307010 Invest ment 280000 280000 Net Present Value -26214 27010 IRR = L1 + (NPV L1 /( Present value L1 - Present L2)) * L2 - L1 = 9+(27010/(307010-253786))*15-9 = 9+2.82 = 11.82%
Project 23A&24A are acceptable. Thank you.... Projects Net Income Depreciation Cash Flow 22A 15000 40000 55000 23A 24400 30000 54400 24A 21000 40000 61000 Depreciation = Investment / Lifetime

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