Well, the merger deal fell through and you are still an Assistant Controller. Th

Question

Well, the merger deal fell through and you are still an Assistant Controller. Things could be worse. Whatever. You have now been asked by your boss to help her choose between two mutually exclusive (due to limited resources) capital investments. Project A is to purchase a robot that can do oil changes on the trucks. The robot is expected to have a useful life of four years and no salvage value. Project B supports a management training program that will improve the skills of current truck maintenance employees.   Initial cash expenditures for Project A are $116,000 and for Project B are $47,000. The annual expected cash inflows are $44,810 for Project A and $14,827 for Project B. Both investments are expected to provide cash flow benefits for the next four years. HZMT’s cost of capital is 6 percent. Present value of $1 and an annuity are available here.

Required

Compute the net present value of each project (round your intermediate and final calculations to 2 decimal places).

Which project should be accepted based on the net present value approach?

Compute the approximate internal rate of return of each project.

Which one should be adopted based on the internal rate of return approach?

Required

Compute the net present value of each project (round your intermediate and final calculations to 2 decimal places).

Which project should be accepted based on the net present value approach?

Compute the approximate internal rate of return of each project.

Which one should be adopted based on the internal rate of return approach?

Explanation / Answer

Solution:

Calculation of Net Present Value:

Conclusion:

Project A should be accepted because it gives the higher net present value of 39,267.

Calculation of Internal Rate of Return:

IRR = Lower Rate + (NPV at Lower Rate/ (NPV at Lower Rate - NPV at Higher Rate) * (Higher Rate - Lower Rate)

= 16 + (9,378/ (9,378 -(-2,813))) * (21 - 16)

= 16 + 4.06

= 20.06%

IRR = 9 + (1,039/ (1,039 - (-1,007))) * (11 - 9)

= 9 + 1.02

= 10.02%

Conclusion:

Project A should be accepted because it gives the higher IRR of 20.06%.

Project A Year Cash flow PV factor @ 6% Discounted Cash flow 0         (116,000) 1                            (116,000) 1 to 4 44,810 3.465                              155,267 Net Present Value                                39,267

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