ANSWER THIS QUESTION: Internal Rate of Return Analysis. Heston Farming Company w

Question

ANSWER THIS QUESTION:

Internal Rate of Return Analysis. Heston Farming Company would like to purchase a harvesting machine for $100,000. The machine is expected to have a life of 4 years, and a salvage value of $20,000. Annual maintenance costs will total $28,000. Annual savings are predicted to be $60,000. The company’s required rate of return is 11 percent (this is the same data as the previous exercise).

Required:

Use trial and error to approximate the internal rate of return for this investment proposal.

Should the company purchase the harvesting machine? Explain.

USING THE FOLLOWING TEMPLATE:

i. Internal Rate of Return Analysis a. 15% 17% Cash Flow Present Present Item Description Purchase price (today) Annual maintenance costs In (Out)FactorValue ForValue (years 1-4) Annual savings (years 1-4) Salvage value (end of year 4) Net present value S 2,796 * Because this is not an annuity, use Figure 8.9 in the Appendix **Because this is an annuity, use Figure 8.10 in the Appendix b.

Explanation / Answer

Req A: IRR At 15% At 17% Item Dscription cash flow Factor Present value Factor Present value Purchase price -100,000 1.0000 -100000.00 1.0000 -100000.00 Annual maintenance cost 60,000 2.8550 171300.00 2.7432 164592.00 Annual savings -28,000 2.8550 -79940.00 2.7432 -76809.60 Salvage value 20,000 0.5718 11436.00 0.5337 10674.00 Net present value 2796.00 -1543.60 IRR = Lower rate +( NPV at lowwr rate /Difference in NPV)*Difference in rates 15% + (2796 / 4340)*2% = 16.29% Req B.: Yes, the company shall purchase the machine, as the IRR of machine is higher than rate of return of 11%.

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