NPV and IRR, Mutually Exclusive Projects For discount factors use Exhibit 128-1

Question

NPV and IRR, Mutually Exclusive Projects For discount factors use Exhibit 128-1 and Exhibit 128-2. Hunt Inc. intends to invest in one of two competing types of computer-aided manufacturing equipment: CAM X and CAM Y. Both CAM X and CAM Y models have a project life of 10 years. The purchase price of the CAM X model is $3,600,000, and it has a net annual after-tax cash inflow of $900,000. The CAM Y model is more expensive, selling for $4,200,000, but it will produce a net annual after-tax cash inflow of $1,050,000. The cost of capital for the company is 10%. Required: 1. Calculate the NPV for each project. Round present value calculations and your final answers to the nearest dollar. CAM X: CAM Y Which model would you recommend using NPV? 2. Select the IRR for each project CAM X: CAM Y Which model would you recommend using IRR? Check My Work Previous Next

Explanation / Answer

NPV is sum of present value of all cash flows

Present value = cash flow/(1+r)n?, where r is cost of capital and n is number of years

r = 10%

For CAM X,

Purchase price = $3,600,000

Annual after tax cash flow = $900,000

Project life = 10 years

NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + ............................ + CF9/(1+r)9 + CF10/(1+r)10

?NPV = -3600000 + 900000/(1.1)1 + 900000/(1.1)2 + .......................... + 900000/(1.1)9 + 900000/(1.1)10? = $1,930,110 (negative sign indicates cash outflow)

For CAM Y,

Purchase price = $4,200,000

Annual after tax cash flow = $1,050,000

Project life = 10 years

NPV = CF0 + CF1/(1+r)1 + CF2/(1+r)2 + ............................ + CF9/(1+r)9 + CF10/(1+r)10

?NPV = -4200000 + 1050000/(1.1)1 + 1050000/(1.1)2 + .......................... + 1050000/(1.1)9 + 1050000/(1.1)10? = $2,251795 (negative sign indicates cash outflow)

We would choose the project with higher NPV

CAM Y has higher NPV so we will choose that

IRR is the rate of return that will make the present value of all cash flows equal to NPV

For project CAM X,

1,930,110.40? = -3,600,000 + 900,000/(1+r)1 + 900,000/(1+r)2 + .......................... + 900,000/(1+r)9 + 900,000/(1+r)10

?Solving this we get r as 21.41%

For project CAM Y

2,251795.46? = -4,200,000 + 1050,000/(1+r)1 + 1050,000/(1+r)2 + .......................... + 1050,000/(1+r)9 + 1050,000/(1+r)10

?Solving this we get r as 21.41%

Both project has same IRR so we can choose any of the project as IRR is more tha cost of capital

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