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    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

    © BrainMass Inc. brainmass.com December 24, 2021, 6:22 pm ad1c9bdddf
    https://brainmass.com/business/internal-rate-of-return/npv-irr-cash-flow-analysis-mesa-products-109460

    SOLUTION This solution is FREE courtesy of BrainMass!

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    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.

     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.

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    © BrainMass Inc. brainmass.com December 24, 2021, 6:22 pm ad1c9bdddf>
    https://brainmass.com/business/internal-rate-of-return/npv-irr-cash-flow-analysis-mesa-products-109460

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