The Following Data Have Been Collected by Capital Budgeting Analysts

question 86

Essay

The following data have been collected by capital budgeting analysts at Erica, Inc.concerning a new product line currently under consideration by management:
$\begin{array}{lrr} \text { Investment in machinery and equipment required to produce the product } &\$3,500,000\\ \text { Net increase in working capital associated with the new product. } &\\ \text {Assume that this investment will be recovered at the end of the project } &500,000\\ \text { Net cash inflow from operations for the expected life of the product line for: } &\\ \text { Year 1 } &550,000\\ \text { Yeat 2 } &900,000\\ \text { Year 3 } &1,400,000\\ \text {Year 4 } &1,800,000\\ \text {Salvage value of machinery and equipment at the end of the } &\\ \text {product line's life } &300,000\\ \text { Cost of capital } &10\%\\\end{array}$

(a.)Calculate the net present value of the proposed investment in the new product line.Ignore income taxes, and round all answers to the nearest $1.
(b.)What will the internal rate of return on this investment be relative to the cost of capital? Explain your answer.

---

Definitions:

Ideal Economic Efficiency

A situation in which resources are allocated in a way that maximizes the net benefit to society.

Market Failure

Refers to a situation where the allocation of goods and services by a free market is not efficient, often leading to negative externalities.

Externalities

Indirect effects of production or consumption activities on third parties, which can be either positive or negative and are not reflected in market prices.

Ideal Economic Efficiency

A state where resources are allocated in the most efficient way possible, maximizing total net benefit to society or economy.