P26-38 Using payback, ARR, NPV, and IRR to make capital investment

decisions

This problem continues the Davis Consulting, Inc. situation from Problem P25-34

of Chapter 25. Davis Consulting is considering purchasing two different types of

servers. Server A will generate net cash inflows of $25,000 per year and have a zero

residual value. Server As estimated useful life is three years and it costs $40,000.

Server B will generate net cash inflows of $25,000 in year 1, $11,000 in year 2,

and $4,000 in year 3. Server B has a $4,000 residual value and an estimated life of

three years. Server B also costs $40,000. Daviss required rate of return is 14%.

Requirements

1. Calculate payback, accounting rate of return, net present value, and internal

rate of return for both server investments. Use Microsoft Excel to calculate NPV

and IRR.

2. Assuming capital rationing applies, which server should Davis invest in?