Dave Hirsh publishes his own manuscripts and is unsure which of two new printers he should purchase. He is a novelist living in Parkman, Illinois. Having slept through most of his Finance 300 course in college, he is unfamiliar with cash flow analysis. He enlists the help of the finance professor at the local university, Dr. Gwen French, to assist him. Together they estimate the following expected initial investment (a negative cash flow) and net positive cash flows for years 1 through 3 for each machine. Dave only needs one printer and estimates it will be worthless after three years of heavy use. Dave’s required rate of return for this project is 8 percent.
Expected Net Cash Flow
Year Printer 1 Printer 2
0 $(2,000) $(2,500)
1 900 1,500
2 1,100 1,300
3 1,300 800
a. Calculate the payback period for each printer.
b. Calculate the net present value for each printer.
c. Calculate the internal rate of return for each printer.
d. Which printer do you think Dr. French will recommend? Why?
e. Suppose Dave’s required rate of return were 16 percent. Does the decision about which printer to purchase change?