Capital Budgeting Techniques in Finance: NPV and IRR

School: La Cité - Collège d'arts appliqués et de technologie - Course: ACC 2234 - Subject: Accounting

ACC 2234 Hand-In Assignment 5 QUESTION 1 Net Present Value Method The management of Threader Company, a wholesale distributor of cracker products, is considering the purchase of a $30,000 machine that would reduce operating costs in its warehouse by $5,000 per year. At the end of the machine's eight-year useful life, it will have no scrap value. The company's required rate of return is 11%. Required: (Ignore income taxes.) 1.Determine the net present value of the investment in the machine. NPV = [-30000/ (1+.11)^0] + [5000/(1+.11)^1] + [5000/(1+.11)^2] etc... for the life of the machine -30000 + 4504.5 + 4058.11 + 3655.96 + 3293.65 + 2967.26 + 2673.30 + 2408.29 + 2169.63 NPV = -4269.39 2.What is the difference between the total undiscounted cash inflows and cash outflows over the entire life of the machine? (5000 x 8) - 30000 40000 - 30000 10000 QUESTION 2 Internal Rate of Return Billy Brown, owner of Billy's Ice Cream On-the Go is investigating the purchase of a new $45,000 delivery truck that would contain specially designed warming racks. The new truck would have a six-year useful life. It would save $5,400 per year over the present method of delivering pizzas. In addition, it would result in the sale of 1,800 more litres of ice cream each year. The company realizes a contribution margin of $2 per litre. Required: (Ignore income taxes.)

1.What would be the total annual cash inflows associated with the new truck for capital budgeting purposes? Annual Cash Flow = savings in Annual expense + increase in annual contribution 5400 + (1800*2) 9000 2.Find the internal rate of return promised by the new truck to the nearest whole percent point. IRR is rate when NPV is Zero NPV = Cash outflow + Present Value of Inflow for 6 years 0 = -45000+8000 *(1+R)^6 Using Excel - The IRR is 5.47% 3.In addition to the data above, assume that due to the unique warming racks, the truck will have a $13,000 salvage value at the end of six years. Under these conditions, compute the internal rate of return to the nearest whole percentage point. (Hint: You may find it helpful to use the net present value approach; find the discount rate that will cause the net present value to be closest to zero. IRR is the Rate when NPV is Zero, with Salvage Value considered -45000 + 9000 * (1+R)^6 + 13000 * present Value Factor There was a lot of trial calculations to find the NPV closest to zero which are omitted due to redundancy NPV @ 12% -45000 +9000*1.12^6 +13000*0.5066 = -1411.13 NPV @ 11% -45000 + 9000 * 1.11^6 + 13000 * 0.5346 = 25.17 45025.17 - 43588.87 = 1436.3 25.17/1436.3 = 0.01750 IRR = 11% + 0.0175 IRR 11.0175%