Turner Video will invest $76,344 in a project. The firm’s cost of capital is 10
ID: 2715867 • Letter: T
Question
Turner Video will invest $76,344 in a project. The firm’s cost of capital is 10 percent. The investment will provide the following inflows. Use Appendix A for an approximate answer but calculate your final answer using the formula and financial calculator methods. Year Inflow 1 $ 15,000 2 17,000 3 21,000 4 25,000 5 29,000 The internal rate of return is 11 percent.
a. If the reinvestment assumption of the net present value method is used, what will be the total value of the inflows after five years? (Assume the inflows come at the end of each year.) (Do not round intermediate calculations and round your answer to 2 decimal places.)
Total value of inflows $
b. If the reinvestment assumption of the internal rate of return method is used, what will be the total value of the inflows after five years? (Use the given internal rate of return. Do not round intermediate calculations and round your answer to 2 decimal places.)
Total value of inflows $
c. Which investment assumption is better?
Reinvestment assumption of NPV
Reinvestment assumption of IRR
Explanation / Answer
Answer to part a:
Total value of inflows after 5 years if if the reinvestment assumtion of the NPV method is used:
Reinvestment assumption of NPV method is that inflows are reinvested at cost of capital.
Cost of Capital = 10%
Value of inflows after 5 years = FV of cash inflows
= (15000(1+0.1)4)+(17000(1+0.1)3)+(21000(1+0.1)2)+(25000(1+0.1)1)+29000
=(15000*1.4641)+(17000*1.331)+(21000*1.21)+(25000*1.1)+29000
=21961.5 + 22627 + 25410 + 27500 +29000
= $ 126498.50
Total value of inflows after five years if the reinvestment assumption of NPV method is used = $126498.50
Answer to part b:
Total value of inflows after 5 years if if the reinvestment assumtion of the IRR method is used:
Reinvestment assumption of IRR method is that inflows are reinvested at IRR.
IRR = 11%
Value of inflows after 5 years = FV of cash inflows
= (15000(1+0.11)4)+(17000(1+0.11)3)+(21000(1+0.11)2)+(25000(1+0.11)1)+29000
=(15000*1.5181)+(17000*1.3676)+(21000*1.2321)+(25000*1.11)+29000
=22771.50 + 23249.20 + 25874.10 + 27750 +29000
= $ 128644.80
Total value of inflows after five years if the reinvestment assumption of IRR method is used = $128644.80
Answer to Part c:
As the total value of inflows under reinvestment assumption of IRR method are greater when compared to that of the reinvestment assumption of NPV method, Reinvestment assumption of IRR is better.
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