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Expert-verified Found in: Page 1475 ### Horngren'S Financial And Managerial Accounting

Book edition 6th
Author(s) Tracie L. Miller-Nobles, Brenda L. Mattison
Pages 992 pages
ISBN 9780134486833

# Hamilton Company is considering two capital investments. Both investments have an initial cost of $7,000,000 and total net cash inflows of$16,000,000 over 10 years. Hamilton requires a 20% rate of return on this type of investment. Expected net cash inflows are as follows:YearPlan AlphaPlan Beta1$1,600,000$1,600,0002$1,600,0002,200,0003$1,600,0002,800,0004$1,600,0002,200,0005$1,600,0001,600,0006$1,600,0001,500,0007$1,600,0001,300,0008$1,600,0001,100,0009$1,600,000900,00010$1,600,000800,000Total$16,000,000$16,000,000Requirements 1. Use Excel to compute the NPV and IRR of the two plans. Which plan, if any, should the company pursue? 2. Explain the relationship between NPV and IRR. Based on this relationship and the company’s required rate of return, are your answers as expected in Requirement 1? Why or why not? 3. After further negotiating, the company can now invest with an initial cost of$6,500,000. Recalculate the NPV and IRR. Which plan, if any, should the company pursue?

1. The company should pursue plan Beta with a positive NPV.

 Plan Alpha Plan Beta NPV ($292,044.66)$610,050.83 IRR 18.76% 22.89%

2. NPV and IRR have direct relation.

3. When the initial investment declines to $6,500,000, plan beta must be selected because of higher NPV and IRR.  Plan Alpha Plan Beta NPV$207,955.34 $1,110,050.83 IRR 20.94% 25.59% See the step by step solution ### Step by Step Solution ## Step 1: Definition of Internal Rate of Return The internal rate of return is the metric used in capital budgeting to determine the project’s profitability. 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 NPV and IRR using excel  Project Plan Alpha Plan Beta Useful life 10 10 Discount rate 0.2 0.2 Initial investment -7000000 -7000000 1 1600000 1600000 2 1600000 2200000 3 1600000 2800000 4 1600000 2200000 5 1600000 1600000 6 1600000 1500000 7 1600000 1300000 8 1600000 1100000 9 1600000 900000 10 1600000 800000 Total 16,000,000 16000000 Outputs NPV ($292,044.66) $610,050.83 IRR 18.76% 22.89% Excel formula for NPV: =NPV(Discount rate, Cash flow from 1st year to 10th year)+Initial investment Excel formula for IRR: =IRR(All cash flows from year 1st year to 10th year including initial investment) ## Step 3: Relationship between IRR and NPV It can be said that the IRR and NPV have a direct relationship with each other. So, the higher the NPV higher the IRR, and the lower the NPV, the lower the IRR. The results of requirement 1 are not as expected because the net present value of plan A is negative, and its IRR is still higher than plan B. It is so because the negative value of the NPV is higher than the positive value of the NPV. ## Step 4: When the initial investment is$6,500,000

 Project Plan Alpha Plan Beta Useful life 10 10 Discount rate 0.2 0.2 Initial investment -6500000 -6500000 1 1600000 1600000 2 1600000 2200000 3 1600000 2800000 4 1600000 2200000 5 1600000 1600000 6 1600000 1500000 7 1600000 1300000 8 1600000 1100000 9 1600000 900000 10 1600000 800000 Total 16,000,000 16000000 Outputs NPV $207,955.34$1,110,050.83 IRR 20.94% 25.59%

Excel formula for NPV: =NPV(Discount rate, Cash flow from 1st year to 10th year)+Initial investment

Excel formula for IRR: =IRR(All cash flows from year 1st year to 10th year including initial investment) ### Want to see more solutions like these? 