Question

Edelman Engineering is considering including two pieces of equipment, a truck and an overhead pulley system, in this year’s capital budget. The projects are independent. The cash outlay for the truck is $17,100 and that for the pulley system is $22,430. The firm’s cost of capital is 14%. After-tax cash flows, including depreciation, are as follows:

Year Truck Pulley

1 $5,100 $7,500

2 5,100 7,500

3 5,100 7,500

4 5,100 7,500

5 5,100 7,500

Calculate the IRR, the NPV, and the MIRR for each project, and indicate the correct accept–reject decision for each.

Answer 1

Answer:

For Truck:

* IRR: 14.99%

* NPV: $408.71

* MIRR: 14.54%

=> As NPV is higher than 0, the project is accepted.

For Pulley system:

* IRR: 20.00%

* NPV: $3,318.1

* MIRR: 17.19%

=> As NPV is higher than 0, the project is accepted.

Explanation:

For Truck:

* IRR is the discounted rate that brings NPV of the project to zero. Thus:

-17,100 + (5,100/IRR)/[ 1 - (1+IRR)^-5] = 0 <=> IRR = 14.99%.

* NPV calculation:

-17,100 + (5,100/14%)/[ 1 - (1+14%)^-5] = $408.71

* MIRR calculation:

+ Future value of the cashflow: (5,100/14%) x ( 1.14^5-1) = 33,712

+ MIRR = 5√33,712/17,100 -1 = 14.54%.

* As NPV is higher than 0, the project is accepted.

For Pulley system:

* IRR is the discounted rate that brings NPV of the project to zero. Thus:

-22,430 + (7,500/IRR)/[ 1 - (1+IRR)^-5] = 0 <=> IRR = 20.00%.

* NPV calculation:

-22,430 + (7,500/14%)/[ 1 - (1+14%)^-5] = $3,318.1

* MIRR calculation:

+ Future value of the cashflow: (7,500/14%) x ( 1.14^5-1) = $49,575.8

+ MIRR = 5√49,575.8/22,430 -1 = 17.19%.

* As NPV is higher than 0, the project is accepted.