Question

NPV Versus IRR Covington Pharmacies has decided to automate its insurance claims process. Two networked computer systems are being considered. The systems have an expected life of two years. The net cash flows associated with the systems are as follows. The cash benefits represent the savings created by switching from a manual to an automated system. Year System I System II 0 $(120,000) $(120,000) 1 - 76,628 2 162,708 76,628 The company's cost of capital is 10 percent. The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems. Required: 1. Compute the NPV and the IRR for each investment. If required, round intermediate calculations and NPV to the nearest dollar and round IRR percentages to one decimal place (for example, 15.68% rounds to 15.7% and should be entered as "15.7" in the answer box).

Answer 1

The NPV and IRR for each investment can be calculated using the formula for the present value of future cash flows. For System I, the NPV is -$52,299.09 and the IRR is approximately 45.4%. For System II, the NPV is -$38,826 and the IRR is approximately 9.3%.

Step-by-step explanation:

To compute the NPV and IRR for each investment, we will use the formula for calculating the present value of future cash flows. We will discount each cash flow at the company's cost of capital, which is 10%.

For System I, the net cash flows are: -$120,000, -$76,628, and $162,708 for years 0, 1, and 2 respectively. We will discount each cash flow using the formula: NPV = CF / (1 + r)^t, where CF is the cash flow, r is the discount rate, and t is the number of years.

Calculating the NPV for System I, we get: -$120,000 / (1 + 0.1)^0 - $76,628 / (1 + 0.1)^1 + $162,708 / (1 + 0.1)^2 = -$120,000 - $69,662.73 + $136,363.64 = $-52,299.09.

The IRR for System I is the discount rate that makes the NPV equal to zero. Using the formula for IRR, we find that the IRR for System I is approximately 45.4%.

For System II, the net cash flows are: -$120,000, $76,628, and $76,628 for years 0, 1, and 2 respectively. Using the same approach as above, we calculate the NPV for System II as follows: -$120,000 / (1 + 0.1)^0 + $76,628 / (1 + 0.1)^1 + $76,628 / (1 + 0.1)^2 = -$120,000 + $69,662.73 + $62,424.29

= -$(120,000 - 69,662.73 - 62,424.29)

= -$(38825.98)

= $-38,826.

The IRR for System II is approximately 9.3%.