Big Steve\'s, makers of swizzle sticks, is considering the purchase of a new pla

Question

Big Steve's, makers of swizzle sticks, is considering the purchase of a new plastic stamping machine. This investment requires an initial outlay of $95,000 and will generate net cash inflows of $21,000 per year for 8 years. What is the project's NPV using a discount rate of 8%? Should the project be accepted? Why or why not? What is the project's NPV using a discount rate of 17%? Should the project be accepted? Why or why not? What is the project's internal rate of return? Should the project be accepted? Why or why not?

Explanation / Answer

Data. Cash Out flow= Co = $ 95,000 Cash Inflow = Ci = $21,000 for 8 years n = 8 A: if i = 8%, NPV = ($21,000 * (1- 1.08^-8)/0.08) - $ 95,000 = $120,679.42 - $ 95,000 = $ 25,679.42 Yes the project should be accepted, as it offers more than the initial cash outflows at the given discount rate. B: Given i = 17% NPV = ($21,000 * (1- 1.17^-8)/0.17) - $ 95,000 = $ 88,350.41 - $ 95,000 = - $ 6,649.59 = - $ 6,650 This project can not be accepted at the given discount rate, because the project provides less cash outflows after discounting than the initial cash outflows. so the company will suffer losses if it goes on with the project. C: IRR = Lower discount rate (LDR) + Difference in discount rates * (|NPV LDR| / ( |NPV LDR| + |NPV HDR|)) IRR = 0.08 + 0.09 *( $ 25,679.42 / ($ 25,679.42 + $ 6,650)) = 0.1515 = 15.15% This is the cut point for decision making. this implies if the discount rate is lower than or equal to the IRR (15.15%), the project will be accepted, however if the discount rate would be higher than the IRR the project will be rejected.

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