Olive Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $250,000. The equipment will have an initial cost of $1,300,000 and have an 8-year life. There is no salvage value for the equipment. If the hurdle rate is 10%, what is the internal rate of return? Ignore income taxes.

Question

Quizplus · Accepted Answer

To find the internal rate of return, we need to calculate the present value of all cash inflows and outflows from the equipment, and find the interest rate that makes the net present value equal to zero (since the hurdle rate is 10%). Using a financial calculator or spreadsheet, we find that the internal rate of return is 12.05%, which is greater than the hurdle rate of 10%. Therefore, Olive Corp. should pursue the purchase of the new equipment, as it has a rate of return greater than the cost of capital.