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Managerial Accounting: The Corners...
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Managerial Accounting: The Corners...
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. Calculate the NPV for each project. Which model would you recommend?
- 2. Calculate the IRR for each project. Which model would you recommend?
1.
Compute NPV for each project and recommend a model to be chosen.
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:
Substitute $5,530,1131 for P and $3,600,000 for I in the above formula.
Therefore, net present value for Model CX is $1,930,113.
Use the following formula to calculate NPV for Model CY:
Substitute $6,451,7992 for P and $4,200,000 for I in the above formula.
Therefore, net present value for Model CY is $2,251,799
2.
Compute IRR for each project and recommend a model to be chosen.
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