# NPV & IRR

1. Mesa Products Inc. requires a new machine to produce a part for a solar air conditioner. Two companies have submitted bids, and you have been assigned the task of choosing one of the machines. Cash flow analysis indicates the following:

Year Machine A Machine B

0 -1,000 -1,000

1 0 417

2 0 417

3 0 417

4 1,938 417

If the cost of capital for Mesa is 5%, which one of the following statements is the most valid?

a. Project B because of higher NPV

b. Project A because of higher NPV

c. Project A because of higher IRR

d. Project B because of higher IRR

e. Neither, because both projects have IRRs less than the cost of capital

https://brainmass.com/business/internal-rate-of-return/npv-irr-cash-flow-analysis-mesa-products-109460

## SOLUTION This solution is **FREE** courtesy of BrainMass!

Please see the attached file.

HOMEWORK PRACTICE PROBLEM

1. Mesa Products Inc. requires a new machine to produce a part for a solar air conditioner. Two companies have submitted bids, and you have been assigned the task of choosing one of the machines. Cash flow analysis indicates the following:

Year Machine A Machine B

0 -1,000 -1,000

1 0 417

2 0 417

3 0 417

4 1,938 417

If the cost of capital for Mesa is 5%, which one of the following statements is the most valid?

a. Project B because of higher NPV

b. Project A because of higher NPV

c. Project A because of higher IRR

d. Project B because of higher IRR

e. Neither, because both projects have IRRs less than the cost of capital

Please show all work.

ïƒ Step 1: Compute the NPV for both the machines. Note that r = 0.05 or 5%

NPV (machine A) = Year 0 cash flow + Year 1 cash flow/(1+r) + Year 2 cash flow/(1+r)2 + Year 3 cash flow/(1+r)3 + Year 4 cash flow/(1+r)4

NPV (machine A) = -1000 + 0/(1+0.05) + 0/(1+0.05)2 + 0/(1+0.05)3 + 1938/(1+0.05)4

NPV (machine A) = -1000 + 1594.397

NPV (machine A) = $594.397

NPV (machine B) = Year 0 cash flow + Year 1 cash flow/(1+r) + Year 2 cash flow/(1+r)2 + Year 3 cash flow/(1+r)3 + Year 4 cash flow/(1+r)4

NPV (machine B) = -1000 + 417/(1+0.05) + 417/(1+0.05)2 + 417/(1+0.05)3 + 417/(1+0.05)4

NPV (machine B) = -1000 + 417* 0.95238 + 417* 0.90702 + 417* 0.86383 + 417* 0.82270

NPV (machine B) = $478.661

Step 2: Compare: Select the machine with higher NPV.

For machine A NPV is greater than machine B.

Also, it can be shown that IRR for both the machines is higher than cost of capital

Answer is b.

https://brainmass.com/business/internal-rate-of-return/npv-irr-cash-flow-analysis-mesa-products-109460