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.
Compute NPV for each System and recommend a system 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 System F1K:
Substitute $13,560,5281 for P and $9,600,000 for I in the above formula.
Therefore, net present value for System F1K is $3,960,528.
Use the following formula to calculate NPV for System F2Z:
Substitute $15,820,6162 for P and $11,200,000 for I in the above formula.
Therefore, net present value for System F2Z is $4,620,616
2.
Compute IRR for each project and recommend a model to be chosen.
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