Velma and Keota (V&K;) is a partnership that owns a small company. It is conside

Question

Velma and Keota (V&K;) is a partnership that owns a small company. It is considering two alternative investment opportunities. The first investment opportunity will have a four-year useful life, will cost $13,067.62, and will generate expected cash inflows of $3,600 per year. The second investment is expected to have a useful life of four years, will cost $12,474.38, and will generate expected cash inflows of $3,600 per year. Assume that V&K; has the funds available to accept only one of the opportunities. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Calculate the internal rate of return of each investment opportunity. (Do not round intermediate calculations.) b. Based on the internal rates of return, which opportunity should V&K; select? Internal Rate of Return a. First investment Second investment b. V&K; should select the

Explanation / Answer

(a)Calculation of Internal Rate of Return of each Investment Oppertunity

First Investment.

Internal Rate of return = 4%

Present Value Annuity Factor = Cost / cash inflow

                                                = $13,067.62 / $3600

                                                = 3.629

From the PVA Factor, Table IRR corresponding to 3.629 for 4 years = 4%

Second Investment.

Internal Rate of return = 6%

Present Value Annuity Factor = Cost / cash inflow

                                                = $12,474.38 / $3600

                                                = 3.465

From the PVA Factor, Table IRR corresponding to 3.465 for 4 years = 6%

(b)Which opportunity should V&K Select

V&K should Select Second Investment

V&K should Select Second Investment Since it has a higher Internal Rate of Return (6%) than First Investment (4%)

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