Question

A Machine will cost Tk 100,000 and will provide annual net cash inflow of Tk 30,000 for six years. The cost of capital is 15 per cent. Calculate the Machine’s net present value and internal rate of return. Should the Machine be purchased?

Answer 1

Concept:

Net Present Value is the current value of all future cash flows generated by a project. It is calculated as follows-

NPV = Present value of future cash inflows – Initial cash Outflow

Internal Rate of Return is the rate which makes the NPV of all cash flows equal to zero. It is calculated as follows-

Refer irr image

Given:

Initial outflow= 100000

Cash Inflows = 30000

n=6

cost of capital= 15%

PVIFA(15,6) = 3.7845

PVIFA(20,6) =3.3255

Find:

NPV and IRR

Solution:

1. Using the values given and applying the NPV formula we get,     NPV = (30000 x 3.7845) – 100000                                                   NPV = 13535
2. Using the values given and applying the IRR formula we get,         Let us take two rates that are 15% and 20% and calculate the NPV using the formula                                                                          NPV(15) = 13535

        NPV(20) = (235)

Now using the IRR formula calculate the IRR

  IRR = 15 + [(13535) x (20 – 15)] / [13535 – (235)]

  IRR = 19.92%

Hence we can conclude that,

NPV = 13535     and     IRR = 19.92%

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