The following information is available on a new piece of equipment: $\begin{array} { l r }
\text { Cost of the Equipment } & \$ 21,720 \
\text { Annual Cash Inflows } & \$ 5,000 \
\text { Internal Rate of Return } & 16 \% \
\text { Required Rate of Return } & 10 \%
\end{array}$ What is approximately the life of the equipment? (Ignore income taxes in this problem.)

Question

The following information is available on a new piece of equipment: $\begin{array} { l r } 
\text { Cost of the Equipment } & \$ 21,720 \
\text { Annual Cash Inflows } & \$ 5,000 \
\text { Internal Rate of Return } & 16 \% \
\text { Required Rate of Return } & 10 \%
\end{array}$ What is approximately the life of the equipment? (Ignore income taxes in this problem.)

Quizplus · Accepted Answer

To determine the life of the equipment, we need to use the internal rate of return (IRR) and compare it with the required rate of return (RRR). If the IRR is greater than the RRR, then the project is acceptable, and we can calculate the life of the equipment as the number of years it takes for the cash inflow to equal the initial cost of the equipment.

In this case, the IRR is 16%, which is greater than the RRR of 10%. Therefore, the project is acceptable.

To calculate the life of the equipment, we need to use the formula:

$\text{Life of equipment} = \dfrac{\text{Initial Cost}}{\text{Annual Cash Inflows}}$

Plugging in the given values, we get:

$\text{Life of equipment} = \dfrac{\$21,720}{\$5,000}\approx 4.3 \text{ years}$

However, this is only an approximation. To get a more accurate answer, we can use the IRR formula to calculate the cash inflows for each year and add them up until they equal the initial cost of the equipment. This would give us a more precise estimate of the life of the equipment, but it is not necessary for this problem.

The Following Information Is Available on a New Piece of Equipment