Using net present value and internal rate of return to evaluate investment opportunities
Veronica Tanner, the president of Tanner Enterprises, is considering two investment opportunities. Because of limited resources, she will be able to invest in only one of them.
Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of four years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment.
Initial cash expenditures for Project A are $ 100,000 and for Project B are $ 40,000. The annual expected cash inflows are $ 31,487 for Project A and $ 13,169 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Tanner Enterprise’s cost of capital is 8 percent.
a. Compute the net present value of each project. Which project should be adopted based on the net present value approach?
b. Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach?
c. Compare the net present value approach with the internal rate of return approach. Which method is better in the given circumstances? Why?