Weeden Inc. intends to invest in one of two competing types of computer-aided ma

Question

Weeden Inc. intends to invest in one of two competing types of computer-aided manufacturing equipment: CAM X and CAM Y. Both CAM X and CAM Y models have a project life of 10 years. The purchase price of the CAM X model is $2,400,000, and it has a net annual after-tax cash inflow of $600,000. The CAM Y model is more expensive, selling for $2,800,000, but it will produce a net annual after-tax cash inflow of $700,000. The cost of capital for the company is 10%.

Required:

1. Calculate the NPV for each project. Round present value calculations and your final answers to the nearest dollar.

Which model would you recommend?
CAM Y

2. Calculate the IRR for each project.

Which model would you recommend?
both

Explanation / Answer

Req 1: NPV of both the Equipment Equipment- CAM X Initial Investment   $ 2400,000 Annual cash inflows   $ 600,000 Estimated life = 10 years Salvage Value Nil Annuity factor @10% discount rate for 10 years   6.145 Present value of cash inflows ($ 600,000 *6.145) 3,687,000 Less: Present value of investment 2,400,000 Net present value 1,287,000 Equipment- CAM Y Initial Investment   $ 2800,000 Annual cash inflows   $ 700,000 Estimated life = 10 years Salvage Value Nil Annuity factor @10% discount rate for 10 years   6.145 Present value of cash inflows ($ 700,000 *6.145) 4,301,500 Less: Present value of investment 2,800,000 Net present value 1,501,500 CAM Y must be accepted as NPV is higher Req 2. IRR NPV at 20% for both the project Annuity factor @20% discount rate for 10 years   4.192 CAM X Present value of cash inflows ($ 600,000 *4.192) 2,515,200 Less: Present value of investment 2,400,000 Net present value 115,200 CAM Y Present value of cash inflows ($ 700,000 *4.192) 2,934,400 Less: Present value of investment 2,800,000 Net present value 134,400 NPV at 25% for both project Annuity factor @25% discount rate for 10 years   3.57 CAM X Present value of cash inflows ($ 600,000 *3.57) 2,142,000 Less: Present value of investment 2,400,000 Net present value -258,000 CAM Y Present value of cash inflows ($ 700,000 *3.57) 2,499,000 Less: Present value of investment 2,800,000 Net present value -301,000 IRR OF CAM X Lowest rate + NPV at lower rate / difference in NPV at both rates * Difference in rates 20 % +115,200 /( 115200+258000) * 5%    = 21.54% IRR OF CAM X Lowest rate + NPV at lower rate / difference in NPV at both rates * Difference in rates 20 % +134,400 /( 134,400+301,000) * 5%    = 21.54% Both Equipment have same IRR, so each can be accepted

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