Pedro Spier, the president of Spier Enterprises, is considering two investment o

Question

Pedro Spier, the president of Spier 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 four 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 $106,000 and for Project B are $43,000. The annual expected cash inflows are $32,719 for ProctA and $14,157 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Spier Enterprises' cost of capital is 6 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) and PVAof S1) Uent A and $106.00 nd mporees operars and no salte Required a-1. Compute the net present value of each project. (Round your intermediate calculations and final answers to 2 decimal places.) Net Present Value Project A Project B a-2. Which project should be adopted based on the net present value approach? Project B Project A b-1. Compute the approximate internal rate of return of each project. Internal Rate of Return Project A Project B b-2. Which one should be adopted based on the internal rate of return approach? Project B Project A

Explanation / Answer

Project A:

Year

Cash

flow

PV Factor @6%

PV

0

$        (106,000)

1.0000

$ (106,000.00)

1

$             32,719

0.9434

$      30,866.98

2

$             32,719

0.8900

$      29,119.79

3

$             32,719

0.8396

$      27,471.50

4

$             32,719

0.7921

$      25,916.51

NPV

$         7,374.79

Project B:

Year

Cashflow

PV Factor @6%

PV

0

$          (43,000)

1.0000

$    (43,000.00)

1

$             14,157

0.9434

$      13,355.66

2

$             14,157

0.8900

$      12,599.68

3

$             14,157

0.8396

$      11,886.49

4

$             14,157

0.7921

$      11,213.67

NPV

$         6,055.50

a 1) NPV :

Project A=$7,374.79

Project B=$6,055.50

a 2) As Project A has higher npv Project A to be adopted

IRR Computation

Let us use trial and error method .

Let us try with 9%

Year

Cashflow

PV Factor @9%

PV

0

$ (106,000)

1.0000

$ (106,000.00)

1

$      32,719

0.9174

$      30,017.43

2

$      32,719

0.8417

$      27,538.93

3

$      32,719

0.7722

$      25,265.07

4

$      32,719

0.7084

$      23,178.96

NPV

$                  0

As NPV is zero IRR = 9%

Project B:

Let us try with 12%

Year

Cashflow

PV Factor @12%

PV

0

$    (43,000)

1.0000

$    (43,000.00)

1

$      14,157

0.8929

$      12,640.18

2

$      14,157

0.7972

$      11,285.87

3

$      14,157

0.7118

$      10,076.67

4

$      14,157

0.6355

$         8,997.03

NPV

$                0

As NPV is zero IRR = 12%

b 1)

IRR

Project A:9%

Project B:12%

b 2) As Project A has higher IRR Project B to be adopted

Year

Cash

flow

PV Factor @6%

PV

0

$        (106,000)

1.0000

$ (106,000.00)

1

$             32,719

0.9434

$      30,866.98

2

$             32,719

0.8900

$      29,119.79

3

$             32,719

0.8396

$      27,471.50

4

$             32,719

0.7921

$      25,916.51

NPV

$         7,374.79

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