Olsen Inc.purchased a $600,000 machine to manufacture a specialty tap for electrical equipment.The tap is in high demand and Olsen can sell all that it could manufacture for the next ten years.The government exempts taxes on profits from new investments in order to encourage capital investments.This legislation most likely will remain in effect in the foreseeable future.The equipment is expected to have ten years of useful life with no salvage value.The firm uses straight-line depreciation.The net cash inflow is expected to be $144,000 each year.Olsen uses a discount rate of 10% in evaluating its capital investments.The estimated internal rate of return (IRR)on this proposed investment is:
(Note: the PV annuity factor from Table 2,Appendix C,10%,10 years is 6.145):

Question

Quizplus · Accepted Answer

The annual net cash inflow of $144,000 is a constant annuity for the next ten years. The initial cost of the machine is $600,000 and its salvage value is zero. Therefore, the payback period for this investment is $600,000/$144,000=4.17 years, which is less than the machine's useful life of ten years. We can also calculate the net present value (NPV) of this investment using the formula:

NPV = -Initial Cost + PV of Annuity

NPV = -$600,000 + $144,000 x PV annuity factor (10%, 10 years)
NPV = -$600,000 + $144,000 x 6.145
NPV = $373,080

Since the NPV is positive, this investment will generate a return greater than the required rate of return of 10%. To find the IRR, we can set the NPV to zero and solve for the discount rate that results in a zero NPV:

0 = -$600,000 + $144,000 x PV annuity factor (IRR, 10 years)

Solving for IRR, we get:

IRR = 15.9%

Since the IRR (15.9%) is greater than the required rate of return (10%), the best choice is D: Greater than 12%.

Olsen Incpurchased a $600,000 Machine to Manufacture a Specialty Tap for for Electrical