The company has a project with a 5-year life that requires an initial investment of $200,000, and is expected to yield annual cash flows of $61,000. What is the net present value of the project if the required rate of return is set at 12%? Calculation Steps Present Value of an Annuity of $1 at Compound Interest. Net Present Value ( $) x ) - $ Note: Round your answer to the nearest whole dollar. What NPV does the previous calculation yield? $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 $195,000, and is expected to yield annual cash flows of $59,000. Whathat is the present value index of the project if the required rate of return is set at 8%? Total present value of net cash flows Present value index Initial investment Calculation Steps Note: Round total present value of net cash flows and initial investment to nearest dollar. Round present value index to two decimal places. $ 59,000 X Present value index = $ 195,000Internal 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 6-year life, requiring an initial investment of $235,500, and is expected to yield annual cash flows of $52,500. What is the internal rate of return? IRR Investment Factor Annual cash flows BIRR Factor: This is the factor which Investment: This is the present Annual Cash Flows: you'll use on the table for the value of cash outflows associated This is the amount of present value of an annuity of $1 with a project. If all of the cash flows to be dollar in order to find the investment is up front at the received annually as percentage which corresponds to beginning of the project, the present a result of the the internal rate of return. value factor is 1.000. project. Calculation Steps 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? %APPLY THE CONCEPTS: Net present value and Present value index Krause Enterprises is looking to invest in Project A or Project B. The data surrounding each project is provided below. Krause's cost of capital is 11%. Project A Project B This project requires an initial investment of This project requires an initial investment of $165,000. The project will have a life of 6 $130,000. The project will have a life of 4 years. Annual revenues associated with the years. Annual revenues associated with the project will be $130,000 and expenses project will be $111,000 and expenses associated with the project will be $35,000. associated with the project will be $60,000. 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. Project A Project B Total present value of net cash flow $ Amount to be invested Net present value Present value index: Project A Project BAPPLY THE CONCEPTS: Internal rate of return The Krause purchasing department has made revisions to their costs and annual cash flows for Project A and Project B, as outlined below. Project A Project B Project A's revised investment is $208,100. The Project B's revised investment is $161,800. project's life and cash flow have changed to 5 The project's life and cash flow have changed years and $53,500, respectively, while expenses to 6 years and $90,000 while expenses have been eliminated. reduced slightly to $55,000. Compute the internal rate of return factor for Project A and Project B and then identify each project's corresponding percentage from the PV ordinary annuity table. 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? %