Chee Company Data On A Proposed I
Chee Company Has Gathered the Following Data On A Proposed Investment
Chee Company has gathered the following data on a proposed investment project: an investment of $240,000 in equipment, annual cash inflows of $50,000, no salvage value, an 8-year investment life, a required rate of return of 10%, and assets will be depreciated using the straight-line depreciation method. The task is to evaluate whether this investment is good using the net present value (NPV) and the internal rate of return (IRR) methods.
Paper For Above instruction
Introduction
Investment appraisal is critical for determining the financial viability of proposed projects within a company. Two of the most widely used methods for evaluating such investments are the Net Present Value (NPV) and the Internal Rate of Return (IRR). These methods help in assessing whether the expected cash inflows from the project will generate adequate returns relative to the initial outlay and the company's required rate of return. This paper analyzes the proposed investment of Chee Company using NPV and IRR methodologies to decide if the project is a worthwhile investment.
Understanding the Investment Parameters
The investment requires an initial outlay of $240,000 for equipment. This capital expenditure is expected to generate annual cash inflows of $50,000 over eight years, with no salvage value at the end of the project. The company's required rate of return, which is also the discount rate for NPV calculations, is 10%. Since assets are depreciated straight-line, the annual depreciation expense is calculated as:
\[
\text{Depreciation} = \frac{\text{Investment Cost}}{\text{Life of the Asset}} = \frac{240,000}{8} = 30,000\text{ dollars}
\]
This depreciation may impact taxable income but does not directly influence cash flows for the NPV and IRR calculations.
Net Present Value (NPV) Calculation
The NPV method involves discounting all future cash inflows to their present value using the company's required rate of return (10%) and subtracting the initial investment. The cash inflows are considered net of depreciation since depreciation is a non-cash expense; hence, cash flow is $50,000 annually. The NPV formula is:
\[
NPV = \sum_{t=1}^{n} \frac{C}{(1 + r)^t} - C_0
\]
Where:
- \(C\) is the annual cash inflow ($50,000),
- \(r\) is the discount rate (10%),
- \(n\) is the number of years (8),
- \(C_0 = 240,000\) is the initial investment.
Using the present value of an annuity of $50,000 for 8 years at 10%:
\[
PV = 50,000 \times \text{PVIF}_{10\%,8}
\]
Referring to standard present value tables, \(\text{PVIF}_{10\%,8} \approx 5.3349\). Therefore:
\[
PV = 50,000 \times 5.3349 = 266,745
\]
\[
NPV = 266,745 - 240,000 = 26,745
\]
Since the NPV is positive, it indicates that the project is expected to generate value exceeding the company's required rate of return.
Internal Rate of Return (IRR) Calculation
IRR is the discount rate at which the project's NPV equals zero. To estimate the IRR, we find the rate \(r\) satisfying:
\[
0 = 50,000 \times \text{PVIF}_{r,8} - 240,000
\]
\[
50,000 \times \text{PVIF}_{r,8} = 240,000
\]
\[
\text{PVIF}_{r,8} = \frac{240,000}{50,000} = 4.8
\]
Using the PVIF tables for different discount rates, we look for the rate that corresponds to a PVIF of approximately 4.8 for 8 years. At 12%, PVIF is about 4.9684, and at 13%, it's about 4.6290. Since 4.8 lies between these values, the IRR is approximately 12.8%. Because the IRR exceeds the company's required rate of 10%, the investment is considered favorable.
Discussion and Conclusion
Both evaluation methods—NPV and IRR—indicate that the proposed project is financially viable. The positive NPV of approximately $26,745 suggests that the project will add value to Chee Company beyond its cost of capital. Similarly, the IRR of roughly 12.8% exceeds the company's threshold of 10%, reinforcing the recommendation to proceed with the investment.
It is also important to note that the analysis assumes stable cash flows and ignores potential risks or variability in cash inflows. Nevertheless, based on quantitative assessment, the investment appears to be a good opportunity for Chee Company.
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