Question

Dwight Donovan, the president of Jordan 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 three 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 $115,000 and for Project B are $31,000. The annual expected cash inflows are $45,431 for Project A and $13,353 for Project B. Both investments are expected to provide cash flow benefits for the next three years. Jordan Enterprises’ cost of capital is 6 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required Compute the net present value of each project. Which project should be adopted based on the net present value approach? Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach?

Answer 1

Based on the NPV, project A would be chosen because its NPV is higher compared to that of project B.

Based on the IRR, project B would be chosen because it has an higher IRR when compared with project A.

Step-by-step explanation:

Net present value is the present value of after tax cash flows from an investment less the amount invested.

Internal rate of return is the discount rate that equates the after tax cash flows from an investment to the amount invested.

Both npv and IRR can be calculated using a financial calculator.

For project A,

Cash flow in year 0 = - $115,000

Cash flow each year from year one to three = 45,431

I = 6%

NPV = $6,437.61

IRR = 9%

For project B,

Cash flow in year 0 = -$31,000.

Cash flow each year from year one to three = $13,353

I = 6%

NPV = $4,692.73

IRR = 14%

Based on the NPV, project A would be chosen because its NPV is higher compared to that of project B.

Based on the IRR, project B would be chosen because it has an higher IRR when compared with project A.

To find the NPV using a financial calacutor:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. After inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.

3. Press compute

To find the IRR using a financial calacutor:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. After inputting all the cash flows, press the IRR button and then press the compute button.

I hope my answer helps you