Davis Industries must choose between a gas-powered and an electric-powered forkl
ID: 2629431 • Letter: D
Question
Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Since both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered truck will cost more, but it will be less expensive to operate; it will cost $21,000, whereas the gas-powered truck will cost $17,230. The cost of capital that applies to both investments is 11%. The life for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be $6,100 per year and those for the gas-powered truck will be $5,300 per year. Annual net cash flows include depreciation expenses.
a. Calculate the NPV for each type of truck. Round your answers to the nearest dollar.
b. Calculate the IRR for each type of truck. Round your answers to two decimal places
Explanation / Answer
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Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Since both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The electric-powered truck will cost more, but it will be less expensive to operate; it will cost $23,000, whereas the gas-powered truck will cost $17,230. The cost of capital that applies to both investments is 11%. The life for both types of truck is estimated to be 6 years, during which time the net cash flows for the electric-powered truck will be $4950 per year and those for the gas-powered truck will be $5,300 per year. Annual net cash flows include depreciation expenses.
a. Calculate the NPV for each type of truck. Round your answers to the nearest dollar.
b. Calculate the IRR for each type of truck. Round your answers to two decimal places
Annual Dep of Electric truck = Total cost/No of years of Life = $22000/6 = $3666.67
Annual Dep of Gas truck = Total cost/No of years of Life = $17500/6 = $2916.67
So Net CF of Electric Truck = Annual CF + Dep added back = $6290+$3666.67=$9956.67
So Net CF of Gas Truck = Annual CF + Dep added back = $5000+$2916.67=$7916.67
Cost of capital is Kd=12%
From annuity tables, PV of annuity of $1 for 6 Yrs at 12% = 4.1114
So PV of CFs of Electric truck = 4.114*$9956.67 = $40,935.85
So NPV of Eletric truck = PV of CFs - Initial Inv = $40935.85 - $22000 = $18,935.85....(A)
IRR = IRR(CFs) = IRR(-22000, 9956.67,9956.67,9956.67,9956.67,9956.67,9956.67) = 38.98%.....(A1)
So PV of CFs ofGas truck = 4.114*$7916.67 = $32,548.60
So NPV of Gas truck = PV of CFs - Initial Inv = $32,548.60 - $17500 = $15,048.60....(B)
IRR = IRR(CFs) = IRR(-17500,7916.67,7916.67,7916.67,7916.67,7916.67,7916.67,) = 38.95%....(A2)
From above, we see than NPV of Electric truck is higher than that of Gas Truck. So we must go for electric truck.
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