The Pan American Bottling Co. is considering the purchase of a new machine that
ID: 2765082 • Letter: T
Question
The Pan American Bottling Co. is considering the purchase of a new machine that would increase the speed of bottling and save money. The net cost of this machine is $45,000. The annual cash flows have the following projections: (15 points)
Year Cash Flow
1 .................... $15,000
2 .................... $20,000
3 .................... $25,000
4 .................... $10,000
5 ....................$ 5,000
a. If the cost of capital is 10 percent, what is the net present value of selecting a new machine?
b. What is the internal rate of return?
c. Should the project be accepted? Why?
Explanation / Answer
Year
Cash Flow
PV @ 10%
PV
0
(45,000)
1.0000
(45,000)
1
15,000
0.9091
13,636
2
20,000
0.8264
16,529
3
25,000
0.7513
18,783
4
10,000
0.6830
6,830
5
5,000
0.6209
3,105
NPV
13,883
NPV=$13,883
Computation of IRR
Let us try with 22%
Year
Cash Flow
PV @ 22%
PV
0
(45,000)
1.0000
(45,000)
1
15,000
0.8197
12,295
2
20,000
0.6719
13,437
3
25,000
0.5507
13,768
4
10,000
0.4514
4,514
5
5,000
0.3700
1,850
NPV1
864
As NPV is positive let us try with 23%
Year
Cash Flow
PV @ 22%
PV
0
(45,000)
1.0000
(45,000)
1
15,000
0.8130
12,195
2
20,000
0.6610
13,220
3
25,000
0.5374
13,435
4
10,000
0.4369
4,369
5
5,000
0.3552
1,776
NPV2
(6)
IRR= R1 +[NPV1 x (R2-R1)]/[NPV1-(-NPV2)]
=22% +[864 x(23%-22%)]/[864-(-6)]
=22 % + 8.64/870
= 22% +0.99
=22.99%
Project can be accepted as NPV is positive and IRR is greater than cost of capital.
Year
Cash Flow
PV @ 10%
PV
0
(45,000)
1.0000
(45,000)
1
15,000
0.9091
13,636
2
20,000
0.8264
16,529
3
25,000
0.7513
18,783
4
10,000
0.6830
6,830
5
5,000
0.6209
3,105
NPV
13,883
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