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Calculating IRR and NPV

Scalia's Cleaning Service is investigating the purchase of an ultrasound machine for cleaning window blinds. The machine would cost $136,700, including invoice cost, freight, and training of employees to operate it. Scalia's has estimated that the new machine would increase the company's cash flows, net of expenses, by $25,000 per year. The machine would have a 14-year useful life with no expected salvage value.

Required:
(Ignore income taxes)

1)Compute the machine's internal rate of return to the nearest whole percent.

2)Compute the machine's net present value. Use a discount rate of 16%.Why do you have a zero net present value?

3)Suppose that the new machine would increase the company's annual cash flows, net of expenses, by only $20,000 per year. Under the conditions, compute the internal rate of return to the nearest whole percent.

Solution Preview

Solution:

1) Compute the machine's internal rate of return to the nearest whole percent.
Annual Cash flow=$25000
Period=14 year
Since cash flow is same throughout 14 years.
It is equivalent to an ordinary annuity with R=$25000, n=14.
PV factor=Initial outlay/annual cash flow=136700/25000=5.468
Refer PV factor of ordinary annuity tables for n=14, and PV factor=5.468, we get discount rate=16%
IRR=16%

2) Compute ...

Solution Summary

Solution describes the steps for calculating internal rate of return and net present value of an investment proposal.

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