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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
BuyFindarrow_forward

Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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NPV and IRR, Mutually Exclusive Projects

Hunt Inc. intends to invest in one of two competing types of computer-aided manufacturing equipment: CAM X and CAM Y. Both CAM X and CAM Y models have a project life of 10 years. The purchase price of the CAM X model is $3,600,000, and it has a net annual after-tax cash inflow of $900,000. The CAM Y model is more expensive, selling for $4,200,000, but it will produce a net annual after-tax cash inflow of $1,050,000. The cost of capital for the company is 10%.

Required:

  1. 1. Calculate the NPV for each project. Which model would you recommend?
  2. 2. Calculate the IRR for each project. Which model would you recommend?

1.

To determine

Compute NPV for each project and recommend a model to be chosen.

Explanation

Net Present Value:

The remaining balance of the present value of a project’s inflows and outflows is known as net present value (NPV). It is a discounting model of capital investment decision. A project with a positive NPV increases the wealth of a firm whereas a project with a negative NPV decreases the wealth of a firm.

Use the following formula to calculate NPV for Model CX:

NPV=Presentvalueofcashinflow(P)Presentvalueofcashoutflow(I)

Substitute $5,530,1131 for P and $3,600,000 for I in the above formula.

NPV=$5,530,113$3,600,000=$1,930,113

Therefore, net present value for Model CX is $1,930,113.

Use the following formula to calculate NPV for Model CY:

NPV=Presentvalueofcashinflow(P)Presentvalueofcashoutflow(I)

Substitute $6,451,7992 for P and $4,200,000 for I in the above formula.

NPV=$6,451,799$4,200,000=$2,251,799

Therefore, net present value for Model CY is $2,251,799

2.

To determine

Compute IRR for each project and recommend a model to be chosen.

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