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 $105,000 and will generate net cash inflows of $20,000 per year for 11 years.

a. What is the project's NPV using a discount rate of 9%? Should the project be accepted? Why or why not?

b. What is the project's NPV using a discount rate of 17%? Should the project be accepted? Why or why not?

c. What is this project's internal rate of return? Should the project be accepted? Why or why not?

Explanation / Answer

Part A

NPV = Annual cash flow x PVIFA (n,R) – initial Investment

         = 20,000 x PVIFA (11, 9%) – 105,000

         = 20,000 x 6.805191 -105,000

         = 31,103.82

Since the NPV is positive, this project should be selected.

Part B

NPV = Annual cash flow x PVIFA (n,R) – initial Investment

         = 20,000 x PVIFA (11, 17%) – 105,000

         = 20,000 x 4.83641336 -105,000

         = -8271.73

Since the NPV is negative, this project should not be selected.

Part C

IRR is the discount rate at which NPV is zero.

NPV = Annual cash flow x PVIFA (n,R) – initial Investment

105,000 = 20,000 x PVIFA (11, R)

PVIFA (11, R) =5.25

R= 14.92%

So IRR would be 14.92%.

Since IRR is greater than required return, this project should be selected.

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