Hosier and Wogan (H&W;) is a partnership that owns a small company. It is consid

Question

Hosier and Wogan (H&W;) is a partnership that owns a small company. It is considering two alternative investment opportunities. The first investment opportunity will have a four-year useful life, will cost $9,145.47, and will generate expected cash inflows of $2,700 per year. The second investment is expected to have a useful life of five years, will cost $13,479.56, and will generate expected cash inflows of $3,200 per year. Assume that H&W; has the funds available to accept only one of the opportunities. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Calculate the internal rate of return of each investment opportunity. Internal Rate of Return First investment Second investment b. Based on the internal rates of return, which opportunity should H&W; select? Second investment First investment

Explanation / Answer

1)At IRR ,present value of cash inflow equals initial cost

For calculating IRR ,we will select two discount rate that give present value of cash inflow one above initial investment and below initial investment

First investment :

At 7% ,present value =PVA7%,4*A

= 3.38721*2700

= 9145.47

Since the exact value of present value of cash inflow at 7% equal initial cost of9145.47 ,IRR =7%

for second investment:

Present value at 7%,5 =PVA7%,5*A

    = 4.10020*3200

          = 13120.63

Present value 5% =PVA5%,5*A

     = 4.32948*3200

= 13854.33

IRR =lower discount rate +[(PV at LDR-initial cost)(HDR-LDR)/(PV at LDR-PV at HDR)]

    = 5+[(13854.33-13479.56)(7-5)/(13854.33-13120.63)]

   = 5+ [374.77*2/733.7]

= 5+ 1.02

= 6.02%

b)First investment as it has higher IRR than second investment

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