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Calculating NPV, Profitability Index and IRR

1.TLC Corp. is considering purchasing one of two new diagnostic machines. Either machine would make it possible for the company to bid on jobs that it currently isn't equipped to do. Estimates regarding each machine are provided below:

Machine A Machine B
Original Cost $78,000 $190,000
Estimated life 8 years 8 years
Salvage value 0 0
Estimated annual cash inflows $20,000 $40,000
Estimated annual cash outflows $5,000 $9,000

Calculate the net present value and profitability index of each machine. Assume a 9% discount rate. Which machine should be purchased.

2.Kendra Corporation is involved in the business of injection molding of plastics. It is considering the purchase of a new computer-aided design and manufacturing machine for $425,000. The company believes that with this new machine it will improve productivity and increase quality, resulting in an increase in net annual cash flows of $95,000 for the next 6 years. Management requires a 10% rate of return on all new investments.

Calculate the internal rate of return on this new machine. Should the investment be accepted?


Solution Preview

Please refer attached file for complete solution for better clarity of tables and formulas.

1. Solution
PV = FV/(1+r/100)^n where FV is future value of cash flow, r is discount rate in %, n periods
Machine A
Year End Cost Cash inflow Cash outflow Net Cash Flow PV @9%
0 -78000 -78000 -78000.00
1 20000 -5000 15000 13761.47
2 20000 -5000 15000 12625.20
3 20000 -5000 15000 11582.75
4 20000 -5000 15000 10626.38
5 20000 -5000 15000 9748.97
6 20000 -5000 15000 8944.01
7 ...

Solution Summary

There are two problems. The solution describes the steps in determining NPV, profitability index and rate of return for given proposals.