question archive EXERCISE 13-10 Internal Rate of Return and Net Present Value [LO1, LO2] Scalia’s Cleaning Service is investigating the purchase of an ultrasound machine for cleaning window blinds
EXERCISE 13-10 Internal Rate of Return and Net Present Value [LO1, LO2] Scalia’s Cleaning Service is investigating the purchase of an ultrasound machine for cleaning window blinds
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EXERCISE 13-10 Internal Rate of Return and Net Present Value [LO1, LO2]
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 these conditions, compute the internal rate of return to the nearest whole percent.
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Question 1
Looking in annuity of PV factor table and scanning along the 14-period line, a factor of 5.468 represents an internal rate of return of 16%. Hence the IRR = 16%
Question 2
From the computations above it can be observed that, NPV is Zero.
The reason for the zero net present value is that 16% (the discount rate) represents the machine's internal rate of return. The internal rate of return is the rate that causes the present value of a project's cash inflows to just equal the present value of the investment required.
Question 3
Looking in annuity of PV factor table and scanning along the 14-period line, the 6.835 factor is closest to 6.982, the factor for the 11% rate of return. Thus, to the nearest whole percent, the internal rate of return is 11%.
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