a. Compute the net present value, using a rate of return of 12%. Use the present value of an annuity of $1 table in the chapter (Exhibit 2).
b. Based on the analysis prepared in part (a), is the rate of return (1) more than 12%, (2) 12%, or (3) less than 12%? Explain.
c. Determine the internal rate of return by computing a present value factor for an annuity of $1 and using the present value of an annuity of $1 table presented in the text (Exhibit 2).
Answer:
a. Present value of annual net cash flows ($35,000 × 4.968*)…………………… $173,880
Less amount to be invested……………………………………………………… 186,725
Net present value…………………………………………………………………… $ (12,845)
* Present value of an annuity of $1 at 12% for 8 periods from text Exhibit 2.
b. The rate of return is less than 12% because there is a negative net present
value.
c. Present Value Factor
for an Annuity of $1 =
=
Amount to Be Invested
Annual Net Cash Flow
$186,725
$35,000
Internal Rate of Return
= 5.335
= 10% (from text Exhibit 2, 8 periods)
