Question

Merrill Corp. has the following information available about a potential capital investment: Initial investment $ 1,700,000 Annual net income $ 190,000 Expected life 8 years Salvage value $ 250,000 Merrill’s cost of capital 10 % Assume straight line depreciation method is used. Required: 1. Calculate the project’s net present value. 2. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 10 percent. 3. Calculate the net present value using a 15 percent discount rate. 4. Without making any calculations, determine whether the internal rate of return (IRR) is more or less than 15 percent.

Answer 1

Answer:

1./

INITIAL INVESTMENT

= $1600000

ANNUAL NET CASH FLOW

= NET INCOME + DEPERICATION

= $250000 + [($1600000 - $350000) / 8]

= $250000 + $156250

= $406250

SALVAGE VALUE

= $350000

NPV

= -$1600000 + $406250 * PVIFA 10%, 8 PERIODS + $350000 * PVIF 10% *PERIOD

= -$1600000 + $406250 * 5.3349 + $350000 * 0.4665

= -$1600000 + 2167303.13 + $163275

= $730578.13

2./

AS THE NPV IS GREATER THAN 0 OR POSITIVE THE IRR IS GREATER THAN 10%

3./

INITIAL INVESTMENT

= $1600000

ANNUAL NET CASH FLOW

= NET INCOME + DEPERICATION

= $250000 + [($1600000 - $350000) / 8]

= $250000 + $156250

= $406250

SALVAGE VALUE

= $350000

NPV

= -$1600000 + $406250 * PVIFA 20%, 8 PERIODS + $350000 * PVIF 20% *PERIOD

= -$1600000 + $406250 * 3.8372 + $350000 * 0.2326

= -$1600000 + $1558862.5 + $81410

= $40272.5

4./

AS THE NPV IS GREATER THAN 0 OR POSITIVE THE IRR IS GREATER THAN 20%

Explanation: