Elgin Restaurant Supplies is analyzing the purchase of manufacturing equipment t

Question

Elgin Restaurant Supplies is analyzing the purchase of manufacturing equipment that will cost $41,000. The annual cash inflows are as follows Year Cash flow 1 $20,000 2 19,000 3 16,500 a. Determine the IRR using interpolation.. (Round the final answer to 2 decimal places.) Internal rate of return % b. With a cost of capital of 16 percent, should the machine be purchased? Yes No c. With information from part b, compute the profitability index. (Round the final answer to 3 decimal places.) Profitability index =

Explanation / Answer

Computation of IRR :

Fake pay back value = Initial Cash Outlay / Average Cash Inflows = $ 41, 000 / $ 18,500 = 2.21622

The PVA table indicates that the PV Factor closest to 2.21622 is 17 % at 2.2096.

a. IRR = 17% + $ ( 41,276 - 41,000) / ( 41,276 - 40,637) = 17.43 %

b. With a cost of capital of 16% , the machine should be purchased.

c. Profitability Index :'

Profitability Index = Present Value of Cash Inflows / Initial Investment = $ 41,932.33 / $ 41,000 = 1.023

Year Cash Inflows Present Values at 17 % Present Values at 18% 1 $ 20,000 $ 17,094 $ 16,949 2 19,000 13,880 13,646 3 16,500 10,302 10,042 41,276 40,637

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