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Phoenix Company can invest in each of three cheese-making projects: C1, C2, and C3. Each project requires an initial investment of $228,000 and would yield the following annual cash flows.

C1 C2 C3
Year 1 $12,000 $96,000 $180,000
Year 2 108,000 96,000 60,000
Year 3 168,000 96,000 48,000
Totals $288,000 $288,000 $288,000

Assume that the company requires a 12% return from its investments. Using net present value, determine which projects, if any, should be acquired.

Required:
Compute the internal rate of return for project C2.

Sagot :

Answer:

c3 should be acquired

8.52%

Explanation:

Net present value is the present value of after-tax cash flows from an investment less the amount invested.  

Only projects with a positive NPV should be accepted. A project with a negative NPV should not be chosen because it isn't profitable.  

When choosing between positive NPV projects, choose the project with the highest NPV first because it is the most profitable.

Internal rate of return is the discount rate that equates the after-tax cash flows from an investment to the amount invested

NPV and IRR can be calculated with a financial calculator

C1

Cash flow in year 0 =  $-228,000  

Cash flow in year 1 = $12,000

Cash flow in year 2 = $96,000

Cash flow in year 3 = $180,000

I = 12%

NPV = -12,634.66

C2

Cash flow in year 0 =  $-228,000  

Cash flow in year 1 = 108,000

Cash flow in year 2 = $96,000

Cash flow in year 3 = 60,000

I = 12%

NPV = -12,334

IRR = 8.52%

C3

Cash flow in year 0 =  $-228,000  

Cash flow in year 1 = 168,000

Cash flow in year 2 = $96,000

Cash flow in year 3 = 48,000

I = 12%

NPV = 32,696.06

It is only c3 that has a positive NPV. Thus, it is the only profitable project. Only C3 should be accepted

To determine the NPV using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.  

3. Press compute  

To determine the IRR using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. After inputting all the cash flows, press the IRR button and then press the compute button.  

c2 = 12,334

c3 = 32,696.06

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