Introduction
Donovan Enterprises needs to select a project
Project A (Purchasing machine for automation):
- Initial Investment: $400,000
- Annual cashflow: $126,000
- Length: 4 years
- No salvage value
Project B (staff training):
- Initial Investment: $160,000
- Annual cashflow: $52,800
- Length: 4 years
Net Present Value
Net present value (NPV) – a financial metric that seeks to capture the total present value of a potential investment opportunity (Fernando, 2021).
Formula: Useful for comparing projects of similar sizes.
Results of NPV Analysis
Project A: NPV = $17,327.98
Project B: NPV = $14,880.30
Recommendation based on NPV: Select Project A
Internal Rate of Return
- Internal rate of return (IRR) is a discount rate that makes NPV of all cash flows equal to zero in a discounted cash flow analysis (Fernando, 2022).
- Helpful for analyzing projects of different caliber.
- Does not provide the dollar value of investment.
Results of IRR Analysis
Project A: IRR = 9.931039%
Project B: IRR = 12.110361%
Both are above the minimal accepted rate of 8%.
Recommendation based on IRR: Select Project B
Preferred Method
The initial investments differ significantly:
- Project A: $400,000
- Project B: $160,000
- IRR method is preferred
- Recommendation: Project B
Synthesis
- Both project are profitable
- Project A provides higher net profit by 16.4%
- Project B provides free cash of $240,000 that can be invested elsewhere
- IRR is of Project B is higher by 2.2%.
Final Recommendation
Invest in Project B
Higher IRR by 2.2%;
$260,000 of free cash
Look for investment opportunities of additional cash.
References
Fernando, J. (2021). Net Present Value (NPV). Investopedia. Web.
Fernando, J. (2022). Internal Rate of Return (IRR).Investopedia. Web.