Problem # 7 (5 points) show your work. Mesa Steel is evaluating two mutually exc
ID: 2536526 • Letter: P
Question
Problem # 7 (5 points) show your work. Mesa Steel is evaluating two mutually exclusive peojects that will allow the firm to increase its capacity by 25%. The first alternative requires an investment of $2.00 ,000 and is to generate net annual cash flows of $750,000 in esch of the nest 5 years of it of $3,000,000 and is expected to economic life. The second altermative requires an generate net annual cash flows of $700,000 in each of the nesxt 10 years of its economic le. Mesa Steel requires a 15% rate of retum on the projects. Use the approash to determine which project should be adopted?Explanation / Answer
Methods of evaluating and ranking profitability of investment projects
1).Net Present Value (NPV): Net present value is calculated by using an appropriate rate of interest which is the capital cost of a firm. This is the minimum rate of expected return likely to be earned by the firm on investment proposals.Net present value is the difference between total present value of cash outflows and total present value of cash inflows occurring in periods over the entire life of the project.When the net present value is positive, the investment proposal is profitable and worth selecting
2).Internal Rate of Return (IRR). discount rate at which the present value of return minus costs is zero”. In other words, the discount rate which equates the present value of project with zero is called IRR.
Thus, IRR is the discount rate which equates the present value of cash inflows with the present value of cash outflows.
Higher the better for both NPV and IRR
NPV = C x {(1 - (1 + R)-T) / R} ? Initial Investment
where C is the expected cash flow per period, R is the required rate of return, and T is the number of periods over which the project is expected to generate income.
Cash flow from Project 2
It is profitable to invest in project 1 as net present value and IRR both are higher in project 1
Calculate Net present vaue for both projectsRelated Questions
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