Merrill Corp. has the following information available about a potential capital
ID: 2525109 • Letter: M
Question
Merrill Corp. has the following information available about a potential capital investment: Initial investment Annual net income Expecled life Salvage value Mermill's cost of capita $1,200,000 $ 120,000 8 years $ 130,000 10% Assume straight line depreciation method is used. Required: 1. Calculate the project's net present value. (Future value of?1. Present Value of $3. calculations. Round the final answer to nearest whole dollar) Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate 2. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 10 percent Greater than 10 Percent O Less than 10 Percent 3. Celculate the net present velue using a 13 percent discount rate. Future Value of $1, Present Value of $1, intermediate calculations. Round the final answer to nearest whole dollar.) of $1,Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round 4. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 13 percent. More than 13 percent O Less than 13 percent Equal to 13 percentExplanation / Answer
Merill Corp
Net present value = present value of expected cash inflows – present value of initial investment
Initial investment = $1,200,000
Annual net income = $120,000
Salvage value = $130,000
Useful life = 8 years
Cost of capital = 10%
Net present value = - ($1,200,000) + $120,000 (P/A, 10%, 8) + $130,000 (P/F, 10%, 8)
= -1,200,000 + 120,000 (5.335) + 130,000 (0.4665)
= -1,200,000 + 640,200 + 60,645 = -$499,155
The net present value of the project discounted at 10% for 8 years = -$499,155
The project earns a negative net present value.
At internal rate of return, the net present value of all cash flows equals to zero. In other terms, at internal rate of return, the net present value of cash inflows equals to the net present value of all cash outflows.
In the given situation, the net present value is negative. The values get negative at higher discount rate and at lower discount rates the present values are relatively higher. Hence, the cost of capital 10% is not the internal rate of return for the company. The internal rate of return should be less than 10% to make the net cash outflows equal to net cash inflows.
Net present value = present value of expected cash inflows – present value of initial investment
Initial investment = $1,200,000
Annual net income = $120,000
Salvage value = $130,000
Useful life = 8 years
Cost of capital = 13%
Net present value = - ($1,200,000) + $120,000 (P/A, 13%, 8) + $130,000 (P/F, 13%, 8)
= -1,200,000 + 120,000 (4.799) + 130,000 (0.3762)
= -1,200,000 + 57,588 + 48,906 = -$1,093,506
The net present value of the project discounted at 13% for 8 years = -$1,093,506
Net present value = -$1,093,506
The internal rate of return is less than 13%
At internal rate of return, the net present value of all cash flows equals to zero. In other terms, at internal rate of return, the net present value of cash inflows equals to the net present value of all cash outflows.
In the given situation, the net present value is negative. The values get negative at higher discount rate and at lower discount rates the present values are relatively higher. Hence, the cost of capital 13% is not the internal rate of return for the company. The internal rate of return should be less than 13% to make the net cash outflows equal to net cash inflows.