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FIN622 - Corporate Finance

PROBLEM:
ABC Company is considering the acquisition of a machine to improve its production. The company has to make a choice between two types of machine A and B. Each machine will have a 4-year life with no salvage value.
Cost of capital of the firm is 14%. Initial investments required to purchase and install the machines A and B, are PKR 28,700 and PKR 27,050 respectively. Machine A will generate an inflow of PKR 10,000 each year while Machine B is expected to generate cash inflows in the following manner.


Year          Cash Inflows (PKR)
1               11,000
2               10,000
3               9,000
4                8,000


Required:


Calculate NPV and IRR for both options. Which machine should be preferred and why?

Note:
For calculating IRR you are required to use “Trial and Error Method” along with “Interpolation Technique/Formula”. In this particular regard, you are advised to consult PPT slideshow “Finding IRR is no more difficult” uploaded in the lesson contents of Lesson # 10.

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Replies to This Discussion

Great Work All

Machine B is preferred:

1. NPV of B= 1105 > NPV of A=437
2. IRR of B= 16.5% > IRR of A=14.74%
3. Initial Investment of B = Rs.27050 < Initial Investment of A= Rs.28700

B ny A ko Bingo kerdia . . am I good?

kya npv ka leya 10% or 20% hi examin kar sakty hy ka hum 12% or 16% b kar sakty hy 


                                                                  

FOR MACHINE (A):

 

 

TIME

CASH FLOW            

DISCOUNT
FACTOR
(10%)

PV OF CASH FLOW AT (10%)

DISCOUNT
FACTOR
(19%)

       
 CASH FLOW (19%)

0

-28,700

1.00

-28,700

1.00

-28,700

01

10,000

.9091

9,091

.8403

8,403

02

10,000

.8264

8,264

.7062

7,062

03

10,000

.7513

7,513

.5934

5,934

04

10,000

.6830

6,830

.4987

4,987

NPV

11,300

 

2,998

 

-2,314

 

IRR = a+ [{A/ (A-B)} * (b-a)] %

IRR = 10 + [{2,998 / (2,998 + 2,314)} * (19-10) %

IRR = 10 + {(2,998 / 5312) * 9} %

IRR = 10 + (0.56 * 9)

                                        IRR = 15 %

IRR of Machine (B):
 

TIME

CASH FLOW            

DISCOUNT
FACTOR
(10%)

PV OF CASH FLOW AT (10%)

DISCOUNT
FACTOR
(19%)

CASH FLOW (19%)

0

-27050

1.00

-27050

1.00

-27050

01

11,000

.9091

10000

.8403

9243.3

02

10,000

.8264

8264

.7062

7062

03

9,000

.7513

6761.7

.5934

5340.6

04

8,000

.6830

5464

.4987

3989.6

NPV

 

 

3439.7

 

-1414.5

 

 

IRR = a+ [{A/ (A-B)} * (b-a)] %

IRR = 10 + [{3439.7 / (3439.7 + 1414.5)} * (19-10) %

IRR = 10 + {(3439.7 / 4854.2) * 9} %

IRR = 10 + (0.70* 9)

IRR = 16.37 %


  NPV prefers “Machine B” to “Machine A

  IRR prefers “Machine A” to “Machine B

Note:
If the IRR of a project is lower then the target return , the project is deemed unfeasible.
AND
  If the IRR of a project is greater then the target return , the project is deemed feasible.

Good Job All (y)

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