An investment committee is evaluating three proposals with the investment, estim

Question

An investment committee is evaluating three proposals with the investment, estimated annual cash flows, and estimated salvage values shown below. A MARR of 15% and a six year time-span is to be used. Which ones should be approved from a financial perspective if all could fit within the investment budget if they meet investment criteria.? Determine which one(s) should be selected using only the internal rate of return criterion.   Proposal Investment Annual cash flow Salvage in last year A1 ($1,750,000) $400,000 $500,000 A2 ($1,550,000) $400,000 $25,000 A3 ($1,300,000) $370,000 $10,000 MARR Years 15.0% 6 An investment committee is evaluating three proposals with the investment, estimated annual cash flows, and estimated salvage values shown below. A MARR of 15% and a six year time-span is to be used. Which ones should be approved from a financial perspective if all could fit within the investment budget if they meet investment criteria.? Determine which one(s) should be selected using only the internal rate of return criterion.   Proposal Investment Annual cash flow Salvage in last year A1 ($1,750,000) $400,000 $500,000 A2 ($1,550,000) $400,000 $25,000 A3 ($1,300,000) $370,000 $10,000 MARR Years 15.0% 6

Explanation / Answer

NPV of A1 = -1750000 + 400000*present value factor + 500000/1.15^6

NPV of A1 = -1750000 + 400000*(1-1/1.15^6)/15% + 500000/1.15^6= -$ 20,043.12

NPV of A2 = -1550000 + 400000*present value factor + 25000/1.15^6

NPV of A2 = -1550000 + 400000*(1-1/1.15^6)/15% + 25000/1.15^6= -$ 25,398.73

NPV of A3 = -1300000 +370000*(1-1/1.15^6)/15% + 10000/1.15^6=    $104,581.87

Proposal A3 should be approved because it has positive NPV

Calculation of IRR

For IRR, NPV =0

NPV of A1 = -1750000 + 400000*(1-1/(1+IRR1)^6)/IRR1% + 500000/1.15^6= 0

IRR1 = 14.62%

NPV of A2 = -1550000 + 400000*(1-1/(1+IRR2)^6)/IRR2% + 25000/1.15^6=0

IRR2 = 14.39%

NPV of A3 = -1300000 +370000*(1-1/(1+IRR3)^6)/IRR3%   + 10000/1.15^6=0

IRR 3= 17.93%

According to internal rate of return criterion, MARR should be less than IRR to approve the proposal

Only A3 should be approved

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