Question

The management of Advanced Alternative Power Inc. is considering two capital investment projects. The estimated net cash flows from each project are as follows:
Year Wind Turbines Biofuel Equipment
1 $280,000 $300,000
2 280,000 300,000
3 280,000 300,000
4 280,000 300,000
The wind turbines require an investment of $887,600, while the biofuel equipment requires an investment of $911,100. No residual value is expected from either project.
Present Value of an Annuity of $1 at Compound Interest
Year 6% 10% 12% 15% 20%
1 0.943 0.909 0.893 0.870 0.833
2 1.833 1.736 1.690 1.626 1.528
3 2.673 2.487 2.402 2.283 2.106
4 3.465 3.170 3.037 2.855 2.589
5 4.212 3.791 3.605 3.353 2.991
6 4.917 4.355 4.111 3.785 3.326
7 5.582 4.868 4.564 4.160 3.605
8 6.210 5.335 4.968 4.487 3.837
9 6.802 5.759 5.328 4.772 4.031
10 7.360 6.145 5.650 5.019 4.192
1a. Compute the net present value for each project. Use a rate of 6% and the present value of an annuity of $1 in the table above.
1b. Compute a present value index for each project.
2. 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 in the table above.

Answer 1

Answer:

Wind turbine

NPV = $82,629.57

IRR = 10%

PVI = 1.09

Biofuel

NPV = $128,431.68

IRR = 12%

PVI = 1.14

Explanation:

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

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 using a financial calculator

Wind Turbine

Cash flow in year 0 = $-887,600,

Cash flow in year 1 - 4 = 280,000

I = 6%

NPV =   $82,629.57

IRR = 10%

Biofuel

Cash flow in year 0 =  $-911,100

Cash flow in year 1 - 4 = $300,000

I = 6%

NPV = $128,431.68

IRR = 12%

present value index = 1 + (NPV / initial cost of the the project)

Wind turbine

1 + ($82,629.57 /  $-887,600 =  1.09

Biofuel

1 + ( $128,431.68 / $911,100) = 1.14

To find 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 find 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.