Comparing internal rate of return with unadjusted rate of return Ledlow Corporation faces stiff market competition. Top

Question:

Comparing internal rate of return with unadjusted rate of return Ledlow Corporation faces stiff market competition. Top management is considering the replacement of its current production facility. The board of directors requires all capital investments to meet or exceed a 9 percent rate of return. However, the board has not clearly defined the rate of return. The president and controller are pondering two different rates of return: unadjusted rate of return and internal rate of return. To purchase a new facility with a life expectancy of four years, the company must pay $90,000. The increased net profit per year resulting from improved conditions would be approximately $10,000; the increased cash inflow per year would be approximately $27,500.

Required

a. If it uses the unadjusted rate of return (use average investment) to evaluate this project, should the company invest in the new facility?

b. If it uses the internal rate of return to evaluate this project, should the company invest in the new facility?

c. Which method is better for this capital investment decision?

Internal Rate of Return
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