Net present value method, internal rate of return method, and analysis The manag
ID: 2498803 • Letter: N
Question
Net present value method, internal rate of return method, and analysis The management of Heckel Communications Inc. is considering two capital investment projects. The estimated net cash flows from each project are as follows: The radio station requires an investment of $1,598,800, while the TV station requires an investment of $3,401,440. No residual value is expected from either project. Compute the following for each project: The net present value. Use a rate of 10% and the present value of an annuity of $1 table appearing in this chapter. A present value index. Round to two decimal places. 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. What advantage does the internal rate of return method have over the net present value method in comparing projects?Explanation / Answer
1
a)
Radio Station :
NPV = - Initial Investment + Annual Cash Flow*PVIFA(10%,4)
NPV = -1598800 + 560000*3.170
NPV = $ 176,400
TV Station :
NPV = - Initial Investment + Annual Cash Flow*PVIFA(10%,4)
NPV = -3401440 + 1120000*3.170
NPV = $ 148,960
b)
Radio Station :
Present value Index = (1+ NPV/Initial Investment)
Present value Index = (1+ 176400/1598800)
Present value Index = 1.11
TV Station :
Present value Index = (1+ NPV/Initial Investment)
Present value Index = (1+ 148960/3401440)
Present value Index = 1.04
2)
Radio Station :
As per IRR
Present value of Cash Inflow = Present value of Cash outflow
560000*PVIFA(rate,4) = 1598800
PVIFA(rate,4) = 1598800/560000
PVIFA(rate,4) = 2.855
Using Table We get
rate = 15%
IRR = 15%
TV Station :
As per IRR
Present value of Cash Inflow = Present value of Cash outflow
1120000*PVIFA(rate,4) = 3401440
PVIFA(rate,4) = 3401440/1120000
PVIFA(rate,4) = 3.037
Using Table We get
rate = 12%
IRR = 12%
3)
As once we have calculated internal rate of return we can know the Project is viable or not if the discount rate changes but in NPV method we have to perform once again and analyse the project is viable . As per IRR if IRR is greater than Discount rate than the project is viable.