Figure 14-8. Present value of an Annuity of $1 in Arrears
Refer to Figure 14-8.Sawyer Company is considering a project with an initial investment of $226,000 that will yield annual net cash flows of $40,000,and will be depreciated at $22,600 per year over its ten year life.What is the internal rate of return?

Question

Figure 14-8. Present value of an Annuity of $1 in Arrears
 Refer to Figure 14-8.Sawyer Company is considering a project with an initial investment of $226,000 that will yield annual net cash flows of $40,000,and will be depreciated at $22,600 per year over its ten year life.What is the internal rate of return?

Quizplus · Accepted Answer

Using the present value annuity of $1 table, we can calculate the present value of the cash flows as follows:
PV of $40,000 for 10 years at 12% = $231,541
PV of depreciation of $22,600 for 10 years at 12% = $130,930
Total PV of cash flows = -$226,000 (initial investment) + $231,541 + $130,930 = $136,471
To find the internal rate of return, we need to find the discount rate that makes the present value of the cash flows equal to the initial investment. Using trial and error or Excel's IRR function, we find that the internal rate of return is approximately 12%. Therefore, the best choice is D.