Dwight Donovan, the president of Munoz Enterprises, is considering two investmen
ID: 2523805 • Letter: D
Question
Dwight Donovan, the president of Munoz Enterprises, is considering two investment opportunities. Because of limited resources, he will be able to invest in only one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of three years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $103,000 and for Project B are $40,000. The annual expected cash inflows are $40,691 for Project A and $17,229 for Project B. Both investments are expected to provide cash flow benefits for the next three years. Munoz Enterprises’ cost of capital is 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)
Required
Compute the net present value of each project. Which project should be adopted 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
Req a; NPV at 8% Project-A Annual cash innflows 40,691 Annuity at 8% for 3 years 2.577 Present value of inflows 104,861 Less: Initial investment 103,000 Net present value 1,861 project-B: Annual cash innflows 17229 Annuity at 8% for 3 years 2.577 Present value of inflows 44399.13 Less: Initial investment 40000 Net present value 4399 Rreq b: IRR Project-A: Annual cash innflows 40,691 Annuity at 9% for 3 years 2.531 Present value of inflows 102,989 Less: Initial investment 103,000 Net present value 11 IRR of Project A: 9% project-B: Annual cash innflows 17229 Annuity at 14% for 3 years 2.322 Present value of inflows 40005.74 Less: Initial investment 40000 Net present value 5.74 IRR of Project-B: 14%
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