EXERCISE 13-11 Basic Net Present Value and Internal-Rate of Return Analysis QT C

Question

EXERCISE 13-11 Basic Net Present Value and Internal-Rate of Return Analysis QT Consider each part below independently. Ignore income taxes.
l. Preston Company's required rate of return is 14% on all investments. The company can purchase a new machine at a cost of $84,900. The new machine would generate cash inflows of $15,000 per year and have a 12-year useful life with no salvage value. Compute the machine's net present value. (Use the format shown in Exhibit 13-l.) Is the machine an acceptable investment? Explain.
2. The Walton Daily News is investigating the purchase of a new auxiliary press that has a projected life of 18 years. It is estimated that the new press will save $30,000 per year in cash operating costs. If the new press costs $217,500, what is its internal rate ofreturn? Is the press an acceptable investment if the company's required rate of return is 16%? Explain.
3. Refer to the data above for the Walton Daily News. How much would the annual cash inflows (cost savings) have to be for the new press to provide the required 16% rate of return? Round your answer to the nearest whole dollar.

Explanation / Answer

l. i = rate of return =14% Purchase of a new machine = CF0 = -$84,900 CF1 to CF12 = cash inflows of $15,000 per year = PMT Net Present Value = CF0+ CF1/(1+i)^1 + CF2/(1+i)^2 + .....+CF12/(1+i)^12 Ie NPV = CF0 + PMT*(PVIFA14%,12) = -84900 + 15000*[1 -(1/(1 + i)^n)]/i ie NPV = -84900 + 15000*[1-(1/(1+14%)^12)]/14% = -84900+15000[1-0.2075]/14% ie NPV = -84900 + 15000*5.66 = 0 As NPV = 0, it means Rate of Return = 14% = IRR. As NPV = 0, this is not a good investment as company is mot making any money from this. activity 2. n= 18 years. CF1 to CF18 = PMT = $30,000 per year CF0 = Cost of Press = -$217,500 Required rate of return is 16% Using Excel Function IRR, we get IRR = IRR(CF0, CF1, ....CF18) = IRR(-217500, 30000,30000,......,30000) = 12% SO IRR = 12% As IRR

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