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Q26E

Expert-verified
Horngren'S Financial And Managerial Accounting
Found in: Page 1470

Short Answer

Using IRR to make capital investment decisions

Refer to the data regarding Hawkins Products in Exercise E26-25. Compute the IRR of each project, and use this information to identify the better investment.

IRR of Project A equals 8.14% and of Project B equals 14.43%. Project B is acceptable because the internal rate of return for this project is higher than the minimum required rate of return.

See the step by step solution

Step by Step Solution

Step 1: Definition of Internal Rate of Return

The metric used in capital budgeting to determine the project’s profitability is the internal rate of return. IRR is calculated using the same formula as used for NPV. Under calculation of IRR net present value is considered as 0.

Step 2: Calculation of IRR of each project and its analysis

Project A:

Project B:

Project A will not be accepted because the internal rate of return is lower than the minimum required rate of return.

Most popular questions for Business-studies Textbooks

Spencer Wilkes is the marketing manager at Darby Company. Last year, Spencer recommended the company approve a capital investment project for the addition of a new product line. Spencer’s recommendation included predicted cash inflows for five years from the sales of the new product line. Darby Company has been selling the new products for almost one year. The company has a policy of conducting annual post audits on capital investments, and Spencer is concerned about the one-year post-audit because sales in the first year have been lower than he estimated. However, sales have been increasing for the last couple of months, and Spencer expects that by the end of the second year, actual sales will exceed his estimates for the first two years combined.

Spencer wants to shift some sales from the second year of the project into the first year. Doing so will make it appear that his cash flow predictions were accurate. With accurate estimates, he will be able to avoid a poor performance evaluation. Spencer has discussed his plan with a couple of key sales representatives, urging them to report sales in the current month that will not be shipped until a later month. Spencer has justified this course of action by explaining that there will be no effect on the annual financial statements because the project year does not coincide with the fiscal year––by the time the accounting year ends, the sales will have actually occurred.

Requirements

1. What is the fundamental ethical issue? Who are the affected parties?

2. If you were a sales representative at Darby Company, how would you respond to Spencer’s request? Why?

3. If you were Spencer’s manager and you discovered his plan, how would you respond?

4. Are there other courses of action Spencer could take?

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