Question

Performance Needlework needs to purchase a new machine costing $1.25 million. Management is estimating the machine will generate cash inflows of $175,000 the first year and $500,000 for the following three years. If management requires a minimum 10 percent rate of return, should the firm purchase this particular machine based on its IRR? Why or why not?

Answer 1

Answer:

The project should be accepted because its IRR is higher than 10%.

Explanation:

initial outlay = $1,250,000

NCF1 = $175,000

NCF2 = $500,000

NCF3 = $500,000

NCF4 = $500,000

NPV = -$1,250,000 + $175,000/1.1 + $500,000/1.1² + $500,000/1.1³ + $500,000/1.1⁴ = $39,478.18

IRR = 11.28% ≥ 10%, so the project should be accepted

We can tell that the project's IRR will be higher than 10% (discount rate) because its NPV is positive. The IRR is the discount rate at which a project's NOV = 0.