Based upon net present value, which project has the more favorable profit prospects? Based upon the present value index, which project is ranked higher? Feedback Check My Work project life and required rate of return. Part Six APPLY THE CONCEPTS: Internal rate of return Note: Enter the IRR factor, to 5 decimal places. Project A: The calculated IRR factor is and this value corresponds to which percentage in the present value of ordinary annuity table? % Project B: The calculated IRR factor is and this value corresponds to which percentage in the present value of ordinary annuity table? % APPLY THE CONCEPTS: Net present value and Present value index Calculate the net present value and the present value index for each project using the present value tables provided below. Present Value of $1 (a single sum) at Compound Interest. Present Value of an Annuity of $1 at Compound Interest. Note: - Use a minus sign to indicate a negative NPV. - If an amount is zero, enter " 0 ". - Enter the present value index to 2 decimals. Present Value of an Annuity of $1 at Compound Interest. IRR Factor =$=, rounded to 6 decimals The calculated factor corresponds to which percentage in the present value of ordinary annuity table? % Feedback Check My Work The internal rate of return calculation is a two-step process. First, you must divide the present value of the initial investment by the annual cash flows of the project to arrive at the IRR factor. Next, use the table for the present value of an annuity of $1 at compound interest, looking down the row of the number of years the project will exist. At the column where you hit the value closest to your computed value, you have determined a percentage that is the internal rate of return for the project. Part Five APPLY THE CONCEPTS: Net present value and Present value index The company has a project with a 5-year life, an initial investment of $170,000, and is expected to yield annual cash flows of $56,500. Whathat is the present value index of the project if the required rate of return is set at 8% ? Note: Round total present value of net cash flows and initial investment to nearest dollar. Round present value index to two decimal places. Feedback Check My Work To calculate the total present value of net cash flows, find the correct present value discount factor. Then multiply it by the annual cash flow for the project. Part Four Internal Rate of Return Method The internal rate of return (IRR) method uses present value concepts to compute the rate of return from a capital investment proposal based on its expected net cash flows. This method, sometimes called the time-adjusted rate of return method, starts with the proposal's net cash flows and works backward to estimate the proposal's expected rate of return. Let's look at an example of internal rate of return calculation with even cash flows. A company has a project with a 4-year life, requiring an initial investment of $175,300, and is expected to yield annual cash flows of $56,500. What is the internal rate of return? IRR Factor a= Annual cash Present Value of an Annuity of $1 at Compound Interest. NetPresentValue=($x)$ Note: Round your answer to the nearest whole dollar. What NPV does the previous calculation yield? $ Based on the NPV computed above, what is indicated? 1. The project is 2. , the initial investment will be recovered. 3. , the required rate of return will be recovered. 4. 1 NPV in excess of the initial investment and required rate of return has been achieved. Feedback Check My Work Click on the Present Value of an Annuity of $1 at Compound Interest link and look for the intersection of the number of years row and the required rate of return column. Part Three Present Value Index When funds for capital investments are limited, projects can be ranked using a present value index. A project with a negative net present value will have a present value index below 1.0. Also, it is important to note that a project with the largest net present value may, in fact, return a lower present value per dollar invested. Let's look at an example of how to determine the present value index. The company has a project with a 5-year life, an initial investment of $170,000, and is expected to yield annual cash flows of $56,500. Whathat is the present value Companies use capital investment analysis to evaluate long-term investments. Capital investment evaluation methods that use present values are (1) Net present value method (NPV) and (2) Internal rate of return (IRR) method. Methods That Use Present Values Of the two capital investment evaluation methods, a defining characteristic NPV and IRR is that they the time value of money. This means that money tomorrow is worth money today. And, that cash invested today has the potential to earn income and in value over time. True or False: When making an investment decision between two mutually exclusive projects, the project with the greatest return on investment should be chosen. Feedback Check My Work Review the definition of Methods that use present value by rolling your mouse over the underlined item. Review the definition of Mutually Exclusive Projects by rolling your mouse over the underlined item. Part Two Net Present Value Method Net present value (NPV) is one method that can be used to evaluate the financial viability of potential projects. It determines the present value of all future cash flows associated with potential projects and measures this against the cost of the project. To use net present value, a required rate of return must be defined. The required rate of return is the acceptable rate of return that an investment must yield for it to make sense economically. Managers often choose a required rate of return above their cost of capital to ensure that the inherent uncertainties surrounding future cash flows is addressed. This can be risky, however, as it biases the process toward short-term projects. If the NPV is positive, then the project should be ; if it is negative, then the project should be Let's look at a net present value example using the present value of an ordinary annuity table. The company has a project with a 5 -year life that requires an initial investment of $220,000, and is expected to yield annual cash flows of $62,500. What is the net present value of the project if the required rate of return is set at 10%