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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

Techno Inc. intends to invest in one of two competing types of flexible manufacturing systems: FLEX-1K and FLEX-2Z. Both systems have a project life of 10 years. The purchase price of the FLEX-1K system is $9,600,000, and it has a net annual after-tax cash inflow of $2,400,000. The FLEX-2Z is more expensive, selling for $11,200,000, but it will produce a net annual after-tax cash inflow of $2,800,000. The cost of capital for the company is 12%.

Required:

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

1.

To determine

Compute NPV for each System and recommend a system 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 System F1K:

NPV=Presentvalueofcashinflow(P)Presentvalueofcashoutflow(I)

Substitute $13,560,5281 for P and $9,600,000 for I in the above formula.

NPV=$13,560,528$9,600,000=$3,960,528

Therefore, net present value for System F1K is $3,960,528.

Use the following formula to calculate NPV for System F2Z:

NPV=Presentvalueofcashinflow(P)Presentvalueofcashoutflow(I)

Substitute $15,820,6162 for P and $11,200,000 for I in the above formula.

NPV=$15,820,616$11,200,000=$4,620,616

Therefore, net present value for System F2Z is $4,620,616

2.

To determine

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

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