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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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Section
BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Net present value method, internal rate of return method, and analysis

 The management of Style Networks Inc. is considering two TV show projects. The estimated net cash flows from each project are as follows:

Year After Hours Sun Fun
1 $320,000 $290,000
2 320,000 290,000
3 320,000 290,000
4 320,000 290,000

 After Hours requires an investment of $913,600, while Sun Fun requires an investment of $880,730. No residual value is expected from either project.

Instructions

 1.    Compute the following for each project:

 a.    The net present value. Use a rate of 10% and the present value of an annuity of $1 table appearing in this chapter (Exhibit 5).

 b.    A present value index. Round to two decimal places.

 2.    Determine the internal rate of return for each project by (a) computing a present value factor for an annuity of $1 and (b) using the present value of an annuity of $1 table appearing in this chapter (Exhibit 5).

 3.        What     advantage     does the internal rate of return method have over the netpresent value method in comparing projects?

1. a.

To determine

Net present value method:

Net present value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value, the interest rate is desired by the business based on the net income from the investment, and it is also called as the discounted cash flow method.

Present value index:

Present value index is a technique, which is used to rank the proposals of the business.  It is used by the management when the business has more investment proposals, and limited fund.

The present value index is computed as follows:

Present value index =Total present value of net cash flowAmount to be invested

Internal rate of return method:

Internal rate of return method is one of the capital investment method which determines the rate of return wherein the net present value of all the cash flows (both positive and negative) from an investment is zero. This method also called as the time-adjusted rate of return method, and it used to evaluate the different proposal’s expected rate of return.

To calculate: The net present value of the investment of SN Incorporation.

Explanation

Calculate the net present value of the investments with 10% rate of return as follows:

b.

To determine

To determine:  The present value index for each proposal.

2.

To determine
The internal rate of return for the given project

3.

To determine

To compare: The both projects, and discuss the advantages of internal rate of return over the net present value.

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