Agriculture Reference
In-Depth Information
of 15 percent is used and the net present value is calculated to be - $1,897.40 (
Table 13.9)
,
which is negative, but closer to 0 than the net present value for 14 percent. Hence, the internal
rate of return is slightly below 15 percent. In fact, the exact IRR for the fertilizer applicator
is calculated using a fi nancial calculator and is determined to be 14.7336 percent.
So, the applicator project is an acceptable project, but to determine if the applicator
project should be selected by management, the IRRs for other projects being considered by
BF&G would need to be calculated and compared to that of the applicator. The project that
satisfi es the required rate of return criterion and has the highest IRR should be selected.
Using a fi nancial calculator, the calculated IRR for the grain storage expansion alterna-
tive is 16.5925 percent. So, the additional grain storage would be selected over the self-
propelled fertilizer applicator investment alternative when the IRR method is used. However,
recall the opposite was the case when the payback and simple rate of return methods were
used to analyze the investment alternatives.
Comparing net present value and internal rate of return
The net present value and internal rate of return methods are closely linked because each
uses the same discounting procedure. However, the net present value method requires a
specifi ed discount rate, while the internal rate of return method solves for the discount rate
that yields a zero net present value.
The IRR method gives the same ranking of investments as the NPV method under most
circumstances. Although both methods account for differences in the time pattern of cash
fl ows, occasional differences in ranking can arise because of different assumptions about
the rate of return on reinvested net cash fl ows. The IRR method implicitly assumes that net
cash infl ows from an investment are reinvested at the same rate as the internal rate of return
of the investment under consideration. The NPV method, on the other hand, assumes
that these funds can be reinvested to earn a rate of return that is the same as the fi rm's
discount rate.
Which reinvestment is more realistic? The NPV rate has the advantage of being consist-
ently applied to all investment proposals. Also, the NPV rate may be more realistic if the
Table 13.9
Net present value for applicator investment with 15 per
cent discount factor
Year
Net Cash Infl ow
(dollars)
15 Percent
Discount Factor
Present Value
(dollars)
1
90,000
0.8696
= 78,264.00
2
88,000
0.7561
= 66,536.80
3
86,000
0.6575
= 56,545.00
4
84,000
0.5718
= 48,031.20
5
98,000
0.4972
= 48,725.60
Total Present Value
298,102.60
Initial Investment in
Applicator
300,000.00
Net Present Value
-1,897.40
