Problem - Using payback, ARR, NPV, and IRR to make capital investment decisions
Davis Consulting is considering purchasing two different types of servers. Server A will generate net cash inflows of $25,000 per year and have a zero residual value. Server A's estimated useful life is three years and it costs $40,000. Server B will generate net cash inflows of $25,000 in year 1, $11,000 in year 2, and $4,000 in year 3. Server B has a $4,000 residual value and an estimated life of three years. Server B also costs $40,000. Davis's required rate of return is 14%.
Requirements
1. Calculate payback, accounting rate of return, net present value, and internal rate of return for both server investments. Use Microsoft Excel to calculate NPV and IRR.
2. Assuming capital rationing applies, which server should Davis invest in?