James Bruce is the CEO of Bruce Industries.James is interested in purchasing new pollution abatement equipment because the current equipment is outdated and not efficient.The controller of the company has identified equipment that costs $104,110 and will provide annual cash operating inflows of $28,290 for 5 years.The equipment currently being used is 3 years old and could be sold for $2,130.What is the equipment's internal rate of return?

Question

Quizplus · Accepted Answer

The internal rate of return (IRR) is the rate at which the present value of cash inflows equals the initial cost of the investment. To calculate IRR, the net cash flows for each year must be calculated first.

Year 0: Initial investment = -$104,110
Year 1: Cash inflow = $28,290
Year 2: Cash inflow = $28,290
Year 3: Cash inflow = $28,290
Year 4: Cash inflow = $28,290
Year 5: Cash inflow = $28,290

To calculate IRR, the sum of the present value of cash inflows must equal the initial cost:

-$104,110 = ($28,290 / (1 + IRR)^1) + ($28,290 / (1 + IRR)^2) + ($28,290 / (1 + IRR)^3) + ($28,290 / (1 + IRR)^4) + ($28,290 / (1 + IRR)^5)

Using trial and error or a calculator, the IRR is approximately 12%. Therefore, the best choice is C) 12%. The investment has an IRR of 12%, which is greater than the company's cost of capital, making it a good investment.

James Bruce Is the CEO of Bruce Industries