Describe what is meant by the term,internal rate of return

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Reference no: EM1312265

Selection of a machine through IRR.

The following machines are mutually exclusive.You may select only one.

Machine A will cost $150,000, save the company $40,000 per year for 5 years and can be sold for an additional $20,000 at the end of 5 years. At your firm's 10% cost of capital, it has a Net Present Value of $14,050. Its IRR (or ROI) is 13.4%.

Machine B will cost $190,000, save the company $50,000 per year for 5 years, and have a salvage value of $25,000. At your firm's 10% cost of capital, it has a Net Present Value of $15,062. Its IRR (or ROI) is 12.9%.

a. Which one would you choose?

b. Explain what is meant by the term,Internal Rate of Return.

PRESENT VALUE OF A SINGLE PAYMENT
(Payment to be received in the future)
Year	8%	9%	10%	11%	12%	13%	14%	15%
1	0.9259	0.9174	0.9091	0.9009	0.8929	0.8850	0.8772	0.8696
2	0.8573	0.8417	0.8264	0.8116	0.7972	0.7831	0.7695	0.7561
3	0.7938	0.7722	0.7513	0.7312	0.7118	0.6931	0.6750	0.6575
4	0.7350	0.7084	0.6830	0.6587	0.6355	0.6133	0.5921	0.5718
5	0.6806	0.6499	0.6209	0.5935	0.5674	0.5428	0.5194	0.4972
6	0.6302	0.5963	0.5645	0.5346	0.5066	0.4803	0.4556	0.4323
7	0.5835	0.5470	0.5132	0.4817	0.4523	0.4251	0.3996	0.3759
8	0.5403	0.5019	0.4665	0.4339	0.4039	0.3762	0.3506	0.3269
9	0.5002	0.4604	0.4241	0.3909	0.3606	0.3329	0.3075	0.2843
10	0.4632	0.4224	0.3855	0.3522	0.3220	0.2946	0.2697	0.2472
11	0.4289	0.3875	0.3505	0.3173	0.2875	0.2607	0.2366	0.2149
12	0.3971	0.3555	0.3186	0.2858	0.2567	0.2307	0.2076	0.1869
13	0.3677	0.3262	0.2897	0.2575	0.2292	0.2042	0.1821	0.1625
14	0.3405	0.2992	0.2633	0.2320	0.2046	0.1807	0.1597	0.1413
15	0.3152	0.2745	0.2394	0.2090	0.1827	0.1599	0.1401	0.1229
16	0.2919	0.2519	0.2176	0.1883	0.1631	0.1415	0.1229	0.1069
17	0.2703	0.2311	0.1978	0.1696	0.1456	0.1252	0.1078	0.0929
18	0.2502	0.2120	0.1799	0.1528	0.1300	0.1108	0.0946	0.0808
19	0.2317	0.1945	0.1635	0.1377	0.1161	0.0981	0.0829	0.0703
20	0.2145	0.1784	0.1486	0.1240	0.1037	0.0868	0.0728	0.0611
PRESENT VALUE OF AN ORDINARY ANNUITY
(Payments at the end of each year)
Year	8%	9%	10%	11%	12%	13%	14%	15%

1	0.9259	0.9174	0.9091	0.9009	0.8929	0.8850	0.8772	0.8696
2	1.7833	1.7591	1.7355	1.7125	1.6901	1.6681	1.6467	1.6257
3	2.5771	2.5313	2.4869	2.4437	2.4018	2.3612	2.3216	2.2832
4	3.3121	3.2397	3.1699	3.1024	3.0373	2.9745	2.9137	2.8550
5	3.9927	3.8897	3.7908	3.6959	3.6048	3.5172	3.4331	3.3522
6	4.6229	4.4859	4.3553	4.2305	4.1114	3.9975	3.8887	3.7845
7	5.2064	5.0330	4.8684	4.7122	4.5638	4.4226	4.2883	4.1604
8	5.7466	5.5348	5.3349	5.1461	4.9676	4.7988	4.6389	4.4873
9	6.2469	5.9952	5.7590	5.5370	5.3282	5.1317	4.9464	4.7716
10	6.7101	6.4177	6.1446	5.8892	5.6502	5.4262	5.2161	5.0188
11	7.1390	6.8052	6.4951	6.2065	5.9377	5.6869	5.4527	5.2337
12	7.5361	7.1607	6.8137	6.4924	6.1944	5.9176	5.6603	5.4206
13	7.9038	7.4869	7.1034	6.7499	6.4235	6.1218	5.8424	5.5831
14	8.2442	7.7862	7.3667	6.9819	6.6282	6.3025	6.0021	5.7245
15	8.5595	8.0607	7.6061	7.1909	6.8109	6.4624	6.1422	5.8474
16	8.8514	8.3126	7.8237	7.3792	6.9740	6.6039	6.2651	5.9542
17	9.1216	8.5436	8.0216	7.5488	7.1196	6.7291	6.3729	6.0472
18	9.3719	8.7556	8.2014	7.7016	7.2497	6.8399	6.4674	6.1280
19	9.6036	8.9501	8.3649	7.8393	7.3658	6.9380	6.5504	6.1982
20	9.8181	9.1285	8.5136	7.9633	7.4694	7.0248	6.6231	6.2593

Reference no: EM1312265

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