Cornerstone Exercise 14-25 NPV and IRR, Mutually Exclusive Projects Follow the f

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Cornerstone Exercise 14-25

NPV and IRR, Mutually Exclusive Projects

Follow the format shown in Exhibit 14B-1 and Exhibit 14B-2 as you complete the requirements below.

Hardy Inc. intends to invest in one of two competing types of computer-aided manufacturing equipment: CAM X and CAM Y. Both CAM X and CAM Y models have a project life of 10 years. The purchase price of the CAM X model is $3,000,000, and it has a net annual after-tax cash inflow of $750,000. The CAM Y model is more expensive, selling for $3,500,000, but it wil produce a net annual after-tax cash inflow of $875,000. The cost of capital for the company is 10 percent.

1. Calculate the NPV for each project. Round present value calculations and your final answers to the nearest dollar.

CAM X: $   

CAM Y: $   

Which model would you recommend?

2. Calculate the IRR for each project.

CAM X:

CAM Y:

Which model would you recommend?

Explanation / Answer

Hi,

Please find the answer as follows:

Part A: NPV

CAM X = -3000000 + 750000/(1+.10)^1 + 750000/(1+.10)^2 + 750000/(1+.10)^3 + 750000/(1+.10)^4 + 750000/(1+.10)^5 + 750000/(1+.10)^6 + 750000/(1+.10)^7 + 750000/(1+.10)^8 + 750000/(1+.10)^9 + 750000/(1+.10)^10 = 1608425.33 or 1608425

CAM Y = -3500000 + 875000/(1+.10)^1 + 875000/(1+.10)^2 + 875000/(1+.10)^3 + 875000/(1+.10)^4 + 875000/(1+.10)^5 + 875000/(1+.10)^6 + 875000/(1+.10)^7 + 875000/(1+.10)^8 + 875000/(1+.10)^9 + 875000/(1+.10)^10 = 1876496.22 or 1876496

Part B:

CAM X (IRR) = 21.41% or 21% (rounded off)

CAM Y (IRR) = 21.41% or 21% (rounded off)

Based on the above calculations Model Y should be selected as it offers a higher NPV and same IRR as CAM X.

Thanks.

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