Business & Finance

(Ignore income taxes in this problem.) XYZA Company has an opportunity to invest in a machine that would cost $28,000, and that would produce cost savings of $8,000 each year for the next five years.

If the machine has zero salvage value, then the internal rate of return is closest to:

Honestly, I'm mostly interested in seeing the process as to how to solve this problem. Thanks!

There are a number of ways. Here are two of them:

1. Use the IRR function in Excel. In a column, put negative 28,000 in as the amount for year 0, and 8,000 in for the amounts for years 1 - 5. The formula tells us that the result is .132. Turn that into a percent, and you get 13.2%

2. Use the Present Value tables that are located in your book. If your book doesn't come with them, you can look them up online. You need the table that shows the present value of an annuity. Take the 28,000 cost and divide it by the annual savings of 8,000. The result is 3.5. Now look in the table on the line for 5 years and slide along until you find a multiplier that is closest to 3.5. The table I have shows the closest multiplier is 3.517, which shows up under the 13% column. The number under the 14% column is 3.433. Now you need to interpolate between the two to find the exact number. The difference between 3.517 and 3.433 is 0.084. Then calculate .017 / .084, which equals 0.20. add the 0.20 to the 13.0 and the result is 13.2%