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Making Informed Investment Decisions: Net Present Value vs. Internal Rate of Return

 

Scenario: Dwight Donovan, the president of Donovan Enterprises, is considering 2 investment opportunities. Because of limited resources, he will be able to invest in only 1 of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of 4 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 4 years. Donovan Enterprises’ desired rate of return is 8 percent. Your task as Senior Accountant is to use your knowledge of net present value and internal rate of return to identify the preferred method and best investment opportunity for the company and present your results to Dwight Donovan.

Use Excel®—showing all work and formulas—to compute the following:
• Compute the net present value of each project. Round your computations to 2 decimal points.
• Compute the approximate internal rate of return for each project. Round your rates to 6 decimal points

Create an 8- to 12-slide PowerPoint® presentation showing the comparison of the net present value approach with the internal rate of return approach calculated above. Complete the following in your presentation:
• Analyze the results of the net present value calculations and the significance of these results, supported with examples.
• Determine which project should be adopted based on the net present value approach and provide a rationale for your decision.
• Analyze the results of the internal rate of return calculation and the significance of these results, supported with examples.
• Determine which project should be adopted based on the internal rate of return approach and provide a rationale for your decision.
• Determine the preferred method in the given circumstances and provide reasoning and details to support the method selected.
• Synthesize results of analyses and computations to determine the best investment opportunity to recommend to the president of Donovan Enterprises.

 

Sample Answer

 

 

Title: Making Informed Investment Decisions: Net Present Value vs. Internal Rate of Return

Slide 1: Introduction

– Title: Making Informed Investment Decisions
– Subtitle: Net Present Value vs. Internal Rate of Return
– Brief introduction to the topic and its significance

Slide 2: Project A – Machine Purchase

– Initial Cash Expenditure: $400,000
– Annual Cash Inflows: $126,000
– Expected Useful Life: 4 years
– Calculate the Net Present Value (NPV) and Internal Rate of Return (IRR)

Slide 3: Project B – Training Program

– Initial Cash Expenditure: $160,000
– Annual Cash Inflows: $52,800
– Expected Useful Life: 4 years
– Calculate the Net Present Value (NPV) and Internal Rate of Return (IRR)

Slide 4: Net Present Value Approach

– Definition of Net Present Value
– Formula for NPV calculation
– Results of NPV calculations for Project A and Project B

Slide 5: Net Present Value Analysis

– Interpretation of NPV results for Project A and Project B
– Significance of positive and negative NPV values
– Examples to illustrate NPV analysis

Slide 6: Decision Based on Net Present Value

– Recommendation for the project to be adopted based on NPV approach
– Rationale for the decision considering NPV results

Slide 7: Internal Rate of Return Approach

– Definition of Internal Rate of Return
– Formula for IRR calculation
– Results of IRR calculations for Project A and Project B

Slide 8: Internal Rate of Return Analysis

– Interpretation of IRR results for Project A and Project B
– Significance of IRR in evaluating investment opportunities
– Examples to illustrate IRR analysis

Slide 9: Decision Based on Internal Rate of Return

– Recommendation for the project to be adopted based on IRR approach
– Rationale for the decision considering IRR results

Slide 10: Preferred Method Selection

– Comparison between NPV and IRR approaches
– Factors influencing the selection of the preferred method
– Justification for choosing the most appropriate method in the given circumstances

Slide 11: Synthesis of Analyses

– Integration of NPV and IRR results
– Determination of the best investment opportunity
– Final recommendation to President Donovan Enterprises

Slide 12: Conclusion

Summary of key findings and recommendations
– Encouragement to make informed investment decisions using financial analysis tools

References

– Include any sources or references used in the presentation.

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