Question

After receiving money from your summer internship, you decide to invest the money. Alternatively, you can save the money and which you assume will earn 8% per year. You have two mutually exclusive opportunities to invest in. These are described below. • Alternative Arequires an up-front investment of $1,300. It will produce annual returns of $177 at the end of each year for 12 years. Salvage value is $334. • Alternative Brequires an up-front investment of $2,000. It will produce annual returns of $305 at the end of each year for 12 years. Salvage value is $192. In what order should you compare the alternatives? Do Nothing, Alternative A, Alternative B Conduct an IRR analysis to determine which investment, if either, should you invest in. Click here to access the TVM Factor Table calculator. Carry all interim calculations to 5 decimal places and then round your final answers to 1 decimal place. The tolerance is +0.3. Following the order that was selected above, compare the first two alternatives. Calculate the IRR. %

Answer 1

To decide the best investment option, calculate the Internal Rate of Return (IRR) for 'Do Nothing', 'Alternative A' with annual returns of $177 and a salvage value of $334, and 'Alternative B' with annual returns of $305 and a salvage value of $192. The IRR is compared with the opportunity cost of 8% to determine the most profitable investment.

Step-by-step explanation:

The question asks for an analysis of which investment option is more financially prudent between Alternative A, Alternative B, and the option to Do Nothing and simply save money, assuming an 8% annual return. To determine which investment is the best choice, a comparison should be conducted starting with 'Do Nothing', followed by 'Alternative A', and then 'Alternative B' using the Internal Rate of Return (IRR) analysis. The IRR represents the discount rate that makes the net present value (NPV) of an investment zero and is used to evaluate the profitability of potential investments.

To calculate the IRR for each alternative, the cash flows must be discounted at various rates until the NPV equals zero. For 'Alternative A', the initial investment is $1,300, the annual return is $177 for 12 years, and the salvage value is $334. For 'Alternative B', the initial investment is $2,000, with an annual return of $305 for 12 years and a salvage value of $192. The IRR for each alternative can then be compared to the opportunity cost of capital, in this case, the 8% return from saving, to determine which investment yields the highest return relative to its cost.