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Internal Rate of Return
Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows.
Cuenca Company is considering the purchase of new equipment that will speed up the process for producing flash drives. The equipment will cost $7,200,000 and have a life of 5 years with no expected salvage value. The expected cash flows associated with the project follow:
Kathy Shorts is evaluating an investment in an information system that will save $240,000 per year. She estimates that the system will last 10 years. The system will cost $1,248,000. Her company’s cost of capital is 10%.
Elmo Enterprises just announced that a new plant would be built in Helper, Utah. Elmo told its stockholders that the plant has an expected life of 15 years and an expected IRR equal to 25%. The cost of building the plant is expected to be $2,880,000.
Required:
Calculate the IRR for Cuenca Company. The company’s cost of capital is 16%. Should the new equipment be purchased?
Calculate Kathy Short’s IRR. Should she acquire the new system?
What should be Elmo Enterprises’ expected annual cash flow from the plant?
1.
Compute IRR for Company C. Also recommend that the equipment should be purchased or not.
Internal Rate of Return:
An interest rate at which the present value of an investment’s cash inflows is equal to the present value cost of the investment is known as internal rate of return. The value of NPV is 0 in case of an internal rate of return.
Use the following formula to calculate discount factor:
Substitute $7,200,000 for investment and $2,000,0001 for annual cash flow in the above formula.
2.
Compute IRR of Person KC. Also recommend if new system should be acquired.
3.
Calculate annual cash flow of Enterprise E.
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