Chapter 16, Problem 19P

Problem 10-19A Using net present value and internal rate of return to evaluate investment opportunities

Dwight Donovan, the president of Donovan Enterprises, is considering two investment opportunities. Because of limited resources, he will be able to invest in only one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of four years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $400,000 and for Project B are $160,000. The annual expected cash inflows are $126,000 for Project A and $52,800 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Donovan Enterprises’ cost of capital is 8 percent.

Required

1. a. Compute the net present value of each project. Which project should be adopted based on the net present value approach? Round your computations to two decimal points.
2. b. Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach? Round your rates to six decimal points.
3. c. Compare the net present value approach with the internal rate of return approach. Which method is better in the given circumstances? Why?