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Chapter 26: Q26RQ (page 1464)
How is IRR calculated with equal net cash inflows?
By subtracting the anticipated future cash flows from the initial beginning value, dividing the result by the actual value, and multiplying the result by 100, one can determine the internal rate of return.
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Hudson Manufacturing is considering three capital investment proposals. At this time, Hudson only has funds available to pursue one of the three investments.
Equipment A | Equipment B | Equipment C | |
Present value of net cash inflows | \(1,647,351 | \)1,969,888 | \(2,064,830 |
Initial investment | (1,484,100) | (1,641,573) | (1,764,812) |
NPV | \)163,251 | \(328,315 | \)300,018 |
Which investment should Hudson pursue at this time? Why?
Refer to the Hunter Valley Snow Park Lodge expansion project in Short Exercise S26- 4. What is the project鈥檚 NPV (round to nearest dollar)? Is the investment attractive? Why or why not?
What is net present value?
Henry Hardware is adding a new product line that will require an investment of \(1,512,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of \)310,000 the first year, \(270,000 the second year, and \)240,000 each year thereafter for eight years. Compute the payback period. Round to one decimal place.
Using payback, ARR, and NPV with unequal cash flows
Hughes Manufacturing, Inc. has a manufacturing machine that needs attention. The company is considering two options. Option 1 is to refurbish the current machine at a cost of \(2,600,000. If refurbished, Hughes expects the machine to last another eight years and then have no residual value. Option 2 is to replace the machine at a cost of \)3,800,000. A new machine would last 10 years and have no residual value. Hughes expects the following net cash inflows from the two options:
Year | Refurbish current machine | Purchase new machine |
1 | \(1,760,000 | \)2,970,000 |
2 | 440,000 | 490,000 |
3 | 360,000 | 410,000 |
4 | 280,000 | 330,000 |
5 | 200,000 | 250,000 |
6 | 200,000 | 250,000 |
7 | 200,000 | 250,000 |
8 | 200,000 | 250,000 |
9 | 250,000 | |
10 | 250,000 | |
Total | \(3,640,000 | \)5,700,000 |
Hughes uses straight-line depreciation and requires an annual return of 10%.
Requirements
1. Compute the payback, the ARR, the NPV, and the profitability index of these two options.
2. Which option should Hughes choose? Why?
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