Merrill Corp. has the following information available about a potential capital
ID: 2580953 • Letter: M
Question
Merrill Corp. has the following information available about a potential capital investment:
Initial investment $ 2,000,000
Annual net income $ 210,000
Expected life 8 years
Salvage value $ 220,000
Merrill’s cost of capital 10 %
Assume straight line depreciation method is used.
Required:
1. Calculate the project’s net present value. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round the final answer to nearest whole dollar.)
2. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 10 percent.
Greater than 10 Percent
Less than 10 Percent
3. Calculate the net present value using a 15 percent discount rate. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round the final answer to nearest whole dollar.)
4. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 15 percent.
More than 15 percent
Less than 15 percent
Equal to 15 percent
Explanation / Answer
Initial Investment = $2,000,000
Salvage Value = $220,000
Expected Life = 8 years
Annual Depreciation = (Initial Investment - Salvage Value) / Expected Life
Annual Depreciation = ($2,000,000 - $220,000) / 8
Annual Depreciation = $222,500
Annual Cash flows = Annual Net Income + Annual Depreciation
Annual Cash flows = $210,000 + $222,500
Annual Cash flows = $432,500
Answer 1.
Cost of Capital = 10%
NPV = -$2,000,000 + $432,500 * PV of an Annuity of $1 (10%, 8) + $220,000 * PV of $1 (10%, 8)
NPV = -$2,000,000 + $432,500 * 5.3349 + $220,000 * 0.4665
NPV = $409,974
Answer 2.
IRR is greater than 10%
Answer 3.
Cost of Capital = 15%
NPV = -$2,000,000 + $432,500 * PV of an Annuity of $1 (15%, 8) + $220,000 * PV of $1 (15%, 8)
NPV = -$2,000,000 + $432,500 * 4.4873 + $220,000 * 0.3269
NPV = $12,675
Answer 4.
IRR is equal to 15% becuase NPV will be negative if Cost of capital is greater than 15%