Question

Phoenix Company can invest in each of three cheese-making projects: C1, C2, and C3. Each project requires an initial investment of \(228,000 and would yield the following annual cash flows.

C1 C2 C3

Year 1 . . . . . . . . . . . . . . . . . . . . . . . . . \) 12,000 \( 96,000 \)180,000

Year 2 . . . . . . . . . . . . . . . . . . . . . . . . . 108,000 96,000 60,000

Year 3 . . . . . . . . . . . . . . . . . . . . . . . . . 168,000 96,000 48,000

Totals . . . . . . . . . . . . . . . . . . . . . . . \(288,000 \)288,000 $288,000

1. Assuming that the company requires a 12% return from its investments, use net present value to determine which projects, if any, should be acquired.

2. Using the answer from part 1, explain whether the internal rate of return is higher or lower than 12% for Project C2.

Short answer

The NPV of projects C2 and C3 is positive and the NPV of project C2 is positive then IRR will be more than 12%.

Step-by-step solution

Step-by-Step SolutionStep 1 :Determining the project

Project C1
Initial Investment = $228,000, Charts values are based on: I = 12%
Year	Cash inflow	X	PV Factor	=	Present Value
1	12,000		0.8929		10,715
2	108,000		0.7972		86,098
3	168,000		0.7118		119,582
					$216,395
Present value of cash inflows					$216,395
Present Value of cash outflows					228,000
Net present value					-$11,605
Should the company acquire this investment?					No

Project C2
Initial Investment = $228,000, Charts values are based on: I = 12%
Year	Cash inflow	X	PV Factor	=	Present Value
1	96,000		0.8929		85,718
2	96,000		0.7972		76,531
3	96,000		0.7118		68,333
					$230,582
Present value of cash inflows					$230,582
Present Value of cash outflows					228,000
Net present value					$2,582
Should the company acquire this investment?					Yes

Project C3
Initial Investment = $228,000, Charts values are based on: I = 12%
Year	Cash inflow	X	PV Factor	=	Present Value
1	180,000		0.8929		160,722
2	60,000		0.7972		47,832
3	48,000		0.7118		34,166
					$242,720
Present value of cash inflows					$242,720
Present Value of cash outflows					228,000
Net present value					$14,720
Should the company acquire this investment?					Yes

Computation IRR of project C2

The net present value is $2,582 at 12%. As it is a positive number, which means that IRR should be greater than the 12% of the project C2.