Internal Rate of Return Follow the format shown in Exhibit 14B-1 and Exhibit 148

Question

Internal Rate of Return Follow the format shown in Exhibit 14B-1 and Exhibit 148-2 as you complete the requirements below Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows. a. Cuenca Company is considering the purchase of new equipment that will speed up the process for producing flash drives. The equipment will cost $7,200,000 and have a life of 5 years with no expected salvage value. The expected cash flows associated with the project follow: Year Cash Revenues Cash Expenses $6,000,000 6,000,000 6,000,000 6,000,000 6,000,000 $8,000,000 8,000,000 8,000,000 8,000,000 8,000,000 b. Kathy Shorts is evaluating an investment in an information system that will save $240,000 per year. She estimates that the system will last 10 years. The system will cost $1,248,000. Her company's cost of capital is l0%. c. Elmo Enterprises just announced that a new plant would be built in Helper, Utah. Elmo told its stockholders that the plant has an expected life of 15 years and an expected IRR equal to 25%. The cost of building the plant is expected to be s 2,880,000. Required: 1 Calculate the IRR for Cuenca Company. The company's cost of capital is í 6%. Round your answer to the nearest perm 945 PM

Explanation / Answer

1)

Annual net cash revenues = Cash revenues - Cash expenses = 8000000 - 6000000 = 2000000

Life of equipment = 5 years

Cost of equipment = 7200000

Calculation of IRR:

7200000 = 2000000*Present value annuity factor(r,5)

7200000/2000000 = Present value annuity factor(r,5)

3.6 = Present value annuity factor(r,5)

Now we need to find out the value of "r" which annuity value is 3.6 for 5 years.

Let r be 15%.

Present value annuity factor of 10% for 5 years = 3.79

Present value annuity factor of 12% for 5 years = 3.604

So, annuity value of 12% for 5 years is approximately 3.6

So, IRR = 12%

New equipment should not be purchased because IRR is 12% and cost of capital is 16%. IRR is lower than cost of capital.

2)

Annual savings = 240000

Maturity = 10 years

Cost of system = 1248000

Cost of capital = 10%

Calculation of IRR:

1248000 = 240000*Present value annuity factor(r,10)

1248000/240000 = Present value annuity factor(r,10)

5.2 = Present value annuity factor(r,10)

Now we need to find out the value of "r" which annuity value is 5.2 for 10 years.

Let r be 15%.

Present value annuity factor of 15% for 10 years = 5.0187

Present value annuity factor of 14% for 10 years = 5.216

So, annuity value of 14% for 10 years is approximately 5.2

So, IRR = 14%

3)

Expected life = 15 years

Expected IRR = 25%

Cost of building the plant = 2880000

Let expected annual cash flows from plant be X.

2880000 = X*Present value annuity factor(25%,15)

2880000 = X*3.8592

X = 2880000/3.8592 = 746268.66 i.e. 746269

Expected annual cash flows = 746269

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