Asked by Amirul Hasan on Jul 11, 2024
Verified
(Ignore income taxes in this problem.) Laws Corporation is considering the purchase of a machine costing $16,000.Estimated cash savings from using the new machine are $4,120 per year.The machine will have no salvage value at the end of its useful life of six years and the required rate of return for Laws Corporation is 12%.The machine's internal rate of return is closest to:
A) 12%
B) 14%
C) 16%
D) 18%
Cash Savings
The amount of money a company or individual keeps on hand that is not invested, spent, or used in paying off debts.
Salvage Value
The estimated value for which an asset can be sold at the end of its useful life, typically used for depreciation calculations.
Internal Rate
Often referred to as the internal rate of return (IRR), it is a financial metric used to estimate the profitability of potential investments.
- Gain an understanding of the Internal Rate of Return (IRR) concept and its computational process, along with its role in the evaluation of investment options.
- Recognize the effects of discount rates on a project's Net Present Value and Internal Rate of Return.
Verified Answer
PF
Patrick FelkinsJul 14, 2024
Final Answer :
B
Explanation :
To calculate the internal rate of return (IRR), we need to find the discount rate at which the present value of cash inflows equals the present value of cash outflows. The cash inflow for each year is $4,120 and the cash outflow is the initial cost of $16,000.
Using a financial calculator, the IRR is calculated to be approximately 14%. Therefore, the best choice is B as it is the closest option.
Using a financial calculator, the IRR is calculated to be approximately 14%. Therefore, the best choice is B as it is the closest option.
Explanation :
Factor of the internal rate of return = Investment required ÷ Annual net cash inflow
= $16,000 ÷ $4,120 = 3.884
This factor is closest to the present value of an annuity for 6 periods at 14% per period.
= $16,000 ÷ $4,120 = 3.884
This factor is closest to the present value of an annuity for 6 periods at 14% per period.
Learning Objectives
- Gain an understanding of the Internal Rate of Return (IRR) concept and its computational process, along with its role in the evaluation of investment options.
- Recognize the effects of discount rates on a project's Net Present Value and Internal Rate of Return.