Amitron Inc. is considering an engineering project that requires an investment of $250,000 and is expected to generate the following stream of payments (income) in the future. Use the TIMEVAL program to determine if the project is a good idea in a present value sense. That is, does the present value of expected cash inflows exceed the value of the investment that has to be made today?
Year Payment
1 .............$63,000
2 ............69,500
3 ..............32, 700
4 ..............79,750
5 ............62,400
6 .............38, 250
a. Answer the question if the relevant interest rate for taking present values is 9%, 10%, 11%, and 12%. In the program, notice that period zero represents a cash flow made at the present time, which isn’t discounted. The program will do the entire calculation for you if you input the initial investment as a negative number in this cell.
b. Use trial and error in the program to find the interest rate (to the nearest hundredth of a percent) at which Amitron would be just indifferent to the project. This problem is a preview of an important method of evaluating projects known as capital budgeting. We’ll study the topic in detail in Chapters 10, 11, and 12. In part a of this problem, we find the net present value (NPV) of the project’s cash flows at various interest rates and reason intuitively that the project is a good idea if that figure is positive. In part b, we find the return inherent in the project itself, which is called the internal rate of return (IRR).