Wallowa Company is considering a long-term investment project called ZIP. ZIP wi
ID: 2491275 • Letter: W
Question
Wallowa Company is considering a long-term investment project called ZIP. ZIP will require an investment of $104,001. It will have a useful life of 4 years and no salvage value. Annual cash inflows would increase by $82,750, and annual cash outflows would increase by $48,050. The company's required rate of return is 12%. (For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Calculate the internal rate of return on this project and use the table above to complete the answer. (Round answers to 0 decimal places, e.g. 15%.) Determine whether this project should be accepted?Explanation / Answer
Initial investment = $104,001
Increase in annual cash inflows = $82,750
Increase in annual cash outflows = $48,050
Net annual savings due to project = $82,750 - $48,050 = $34,700
Net present value at the required rate of return of 12% is calculated as below:
Year
Cash flows
Present value at 12%
Present value of cash flows
0
-$ 104,001
1
-$ 104,001
1
$ 34,700
0.8929
$ 30,984
2
$ 34,700
0.7972
$ 27,663
3
$ 34,700
0.7118
$ 24,699
4
$ 34,700
0.6355
$ 22,052
$ 1,397
At the required rate of return NPV is positive. To find the IRR, we need to find the rate of return at which NPV is zero. To find the IRR, we will find the NPV at a rate higher than 12%, say 13%.
Year
Cash flows
Present value at 13%
Present value of cash flows
0
-$ 104,001
1
-$ 104,001
1
$ 34,700
0.885
$ 30,710
2
$ 34,700
0.7831
$ 27,174
3
$ 34,700
0.6931
$ 24,051
4
$ 34,700
0.6133
$ 21,282
-$ 786
Hence, IRR is between 12% and 13%.
Yes, the project should be accepted.
Year
Cash flows
Present value at 12%
Present value of cash flows
0
-$ 104,001
1
-$ 104,001
1
$ 34,700
0.8929
$ 30,984
2
$ 34,700
0.7972
$ 27,663
3
$ 34,700
0.7118
$ 24,699
4
$ 34,700
0.6355
$ 22,052
$ 1,397
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