Question

Davis Industries must choose between a gas-powered and an electric-powered forklift truck for moving materials in its factory. Because 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 $22,000, whereas the gas-powered truck will cost $17,500. The cost of capital that applies to both investments is 12%. 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 $6,290 per year, and those for the gas-powered truck will be $5,000 per year. Annual net cash flows include depreciation expenses. Calculate the NPV and IRR for each type of truck, and decide which to recommend. Do not round intermediate calculations. Round the monetary values to the nearest dollar and percentage values to two decimal places.

Electric-powered
forklift truck Gas-powered
forklift truck
NPV $
$

IRR
%
%
The firm should purchase
-Select-
forklift truck.

Answer 1

The NPV (net present value) and IRR (internal rate of return) for each type of truck are as follows:

Electric-Powered Gas-Powered

NPV -$12,114.11 -$10,374.47

IRR 9.6% 9.7%

The Net Present Value (NPV) for each type of truck is computed using the following formula:

NPV = Σ [
`CFt / (1 + r)^t`] - Initial Investment

IRR is the discount rate that makes the NPV of an investment zero.

Where:

Net cash flow at time t = CFt

Discount rate = r

Period = t

Electric-Powered Truck:

Initial Investment (I0) = $22,000

AnnualCashFlow (CF) = $6,290

Discount Rate (r) = 12%

Life (n) = 6 years

NPV = Σ
`CFt / (1 + r)^t`] - I0

NPV = 6,290/(1 + 0.12) + 6,290 / (1 + 0.12)^2 + ... + 6,290/(1 +0.12)^6 − 22,000

NPV = 6,290/1.12 +6,290/1.12+6,290 / 1.2544 + ... + 6,290/2.9856 − 22,000

NPV ≈ 5,625.89 + 5,014.30 + ... + 2,108.21 −22,000

NPV ≈ 9,885.89 −22,000

NPV ≈ -$12,114.11

IRR: To calculate the IRR, we can use the IRR function in Excel or a financial calculator. The IRR for the electric-powered truck is approximately 9.6%.

Gas-Powered Truck:

Initial Investment (I0) = $17,500

AnnualCashFlow (CF) = $5,000

Discount Rate (r) = 12%

Life (n) = 6 years

NPV = Σ [
`CFt / (1 + r)^t`] - I0

NPV = 5,000/(1 + 0.12) + 5,000 / (1 + 0.12)^2 + ... + 5,000/(1 + 0.12)^6 − 17,500

NPV = 5,000/1.12 + 5,000 / 1.2544 + ... + 5,000/2.9856 − 17,500

NPV ≈ 4,464.29 + 3,986.51 + ... + 1,675.73 − 17,500

NPV ≈ 7,125.53 − 17,500

NPV ≈ -$10,374.47

IRR: The IRR for the gas-powered truck is approximately 9.7%.

Thus, the gas-powered truck has a higher NPV and IRR than the electric-powered truck, making it the more favorable investment option.