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# Finance: Calculate IRR, NPV, Cost of Capital

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1. You purchase machinery for \$23,958 that generates cash flow of \$6,000 for five years. What is the internal rate of return on the investment?

Chapter 22: Capital Budgeting 429
2. The cost of capital for a firm is 10 percent. The firm has two possible investments with the following cash inflows:

A B
Year 1 \$300 \$200
2 200 200
3 100 200

a. Each investment costs \$480. What investment(s) should the firm make according to net present value?

b. What is the internal rate of return for the two investments? Which investment(s) should the firm make? Is this the same answer you obtained in part a?

c. If the cost of capital rises to 14 percent, which investment(s) should the firm make?

3. A firm has the following investment alternatives:

Cash Inflows
A B C
Year1 \$1,100 \$3,600 ?
2 1,100 ? ?
3 1,100 ? \$4,562

Each investment costs \$3,000; investments B and C are mutually exclusive, and the firm's cost of capital is 8 percent.

a. What is the net present value of each investment?

b. According to the net present values, which investment(s) should the firm make?Why?

c. What is the internal rate of return on each investment?

d. According to the internal rates of return, which investment(s) should the firm make? Why?

e. According to both the net present values and internal rates of return, which investments should the firm make?

f. If the firm could reinvest the \$3,600 earned in year one from investment B at 10 percent, what effect would that information have on your answer to part e? Would the answer be different if the rate were 14 percent?

g. If the firm's cost of capital had been 10 percent, what would be investment A's internal rate of return?

h. Payback method of capital budgeting selects which investment? Why?

#### Solution Preview

1) Given that,
Initial investment in machine \$23,958
Yearly cash flow \$6,000
Time 5 years

Now,
Year Cash flow
0 -\$23,958
1 \$6,000
2 \$6,000
3 \$6,000
4 \$6,000
5 \$6,000
IRR 8.00%

2) Given that,
Cost of capital 10%

Year A B
1 \$300 \$200
2 \$200 \$200
3 \$100 \$200
(a) Initial investment for each investment \$480

Therefore,
Year A B PV Factor @ 10% PV of Cash flow (A) PV of Cash flow ...

#### Solution Summary

This solution provides a detailed and thorough discussion of a series of finance questions.

\$2.19