Watertown Paper Corporation is considering adding another machine for the manufacture of corrugated cardboard. The machine would cost $900,000. It would have an estimated life of 6 years and no salvage value. The company estimates that annual cash inflows would increase by $400,000 and that annual cash outflows would increase by $190,000. Management has a required rate of return of 9%.
(a)Calculate the net present value on this project, and discuss whether it should be accepted.
(b)Calculate the internal rate of return on this project, and discuss whether it should be accepted.
Compute net annual cash flow: Estimated annual cash inflows – Estimated annual cash outflows.
Use the NPV technique to calculate the difference between net cash flows and the initial investment.
Accept the project if the net present value is positive.
Compute the IRR factor: Capital investment ÷ Net annual cash flows.
Look up the factor in the present value of an annuity table to find the internal rate of return.
Accept the project if the internal rate of return is equal to or greater than the required rate of return.
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