Division D is considering two possible expansion plans. Plan A would expand a cu
ID: 2479067 • Letter: D
Question
Division D is considering two possible expansion plans. Plan A would expand a current product line at a cost of $8,550,000. Expected annual net cash inflows are$1,625,000, with zero residual value at the end of 10 years. Under Plan B, Division D would begin producing a new product at a cost of $8,000,000. This plan is expected to generate net cash inflows of $1,090,000 per year for 10years, the estimated useful life of the product line. Estimated residual value for Plan B is$1,200,000. Division D uses straight-line depreciation and requires an annual return of 9%.
Calculate the IRR of Plan A and B.
Explanation / Answer
Plan A Plan B Project cost 8550000 8000000 Cash inflows 1625000 1090000 Residual value 1200000 Useful life years 10 10 PV of Cumulative factor 13.00% 5.426 PV of Inflows for 10 years(5.426*1625000) 13.00% 8817250 PV of Cumulative factor 14.00% 5.216 PV of Inflows for 10 years(5.216*1625000) 8476000 NPV at 13%(PV of Inflows-Out flows) 13.00% 267250 NPV at 14% 14.00% -74000 IRR= R1%+(NPV1*(R2-R1)%)/(NPV1-NPV2) IRR= 13%+((267250*(14-13)%)/(267250-(-74000))) 0.7831501832 IRR=13%+.78%=13.78% Plan B Project cost 8000000 Cash inflows 1090000 Residual value 1200000 Useful life years 10 PV of Cumulative factor 9.00% 6.418 PV of Inflows for 10 years(6.418*1090000) 6995620 Residual value end of 10th year(1200000*0.422) 506400 Pv of inflows 7502020 PV of Cumulative factor 7.00% 7.024 PV of Inflows for 10 years(7.024*1625000) 7656160 Residual value end of 10year(1200000*0.463) 555600 Pv of inflows 8211760 NPV at 9%(PV of Inflows-Out flows) 13.00% -497980 NPV at 7% 14.00% 211760 IRR= R1%+(NPV1*(R2-R1)%)/(NPV1-NPV2) IRR= 9%+((-497980*(7-9)%)/(-497980-(211760))) -1.4032744385 IRR= 9%-1.40% IRR= 7.60%