Nowadays Manufacturing is considering an investment proposal with the following

Question

Nowadays Manufacturing is considering an investment proposal with the following information:

Cost $450,000

Useful life 6 years (straight-line depreciation)

Annual Cash inflows $100,000 (estimated per year for 8 years)

Residual value $  20,000

Required rate of return 10%

Answer the following questions concerning this proposal.  Show your work.

a. What is the payback period of this project?

b. What is the NPV of this project?  

c. Is the IRR greater or less than 10%?  Explain your answer

d. Should the project be accepted based on your NPV analysis?  Why or why not?

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Annual Cash Inflows = 100000

Part A:

Payback Period = Initial Investment/Annual Cash Inflows = 450000/100000 = 4.5 Years

Part B:

NPV = -450000 + 100000/(1+.10)^1+ 100000/(1+.10)^2 + 100000/(1+.10)^3 + 100000/(1+.10)^4 + 100000/(1+.10)^5 + 100000/(1+.10)^6 + 100000/(1+.10)^7 + 100000/(1+.10)^8 + 20000/(1+.10)^8 = 92822.77 or 92823

Part C:

To calculate IRR, you need to put the value of NPV as 0 and solve for IRR as follows:

NPV = 0 = -450000 + 100000/(1+r)^1+ 100000/(1+r)^2 + 100000/(1+r)^3 + 100000/(1+r)^4 + 100000/(1+r)^5 + 100000/(1+r)^6 + 100000/(1+r)^7 + 100000/(1+r)^8 + 20000/(1+r)^8

Solving for r, we get IRR as 15.35%

Conclusion: IRR is greater than 10%.

Part D:

The project should be Accepted by the company as the project generates a + NPV.

Thanks.

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