Question

(Ignore income taxes in this problem.) Allen Company's required rate of return is 14%. The company is considering the purchase of a new machine that will save $10,000 per year in cash operating costs. The machine will cost $40,000 and will have an 8-year useful life with zero salvage value.

Required:

i） Compute the machine's internal rate of return to the nearest whole percent. Would you recommend purchase of the machine? Explain.

Answer 1

i.). Factor of the internal rate of return = Investment required $\div$ Net annual cash flow

IRR factor = 40,000/10,000 = 4

Searching the 8th-period row in the PV annuity table, the value closest is 4.078 in the 18% column.

Actual IRR = 18.62$\%$

The machine should be purchased.

This is because the actual IRR is more than the required rate of return of 14$\%$.