Net Present Value and IRR Determination and Conclusion

Under the net present value method, the present value of a project's cash inflows is compared to the present value of the project's cash outflows. The difference between the present values of these cash flows is called "the net present value". This net present value determines whether or not the project is an acceptable investment. According to this analysis, Clark Paints should purchase the new machine. The present value of the cost savings is $58,351, as compared to a present value of only $33,035 for the required investment (cost of the machine). Deducting the present value of the required investment from the present value of the cost savings leaves a net value of $25,316. Whenever the net present value is zero or greater, an investment project is acceptable. Whenever the net present value is negative an investment project is not acceptable. Clark Paints could spend up to $58,351 for the new machine and still obtain the minimum required rate of return.

The net present value of $33,035, therefore, shows the amount of cushion. One way to look at this is that the company could underestimate the cost of the new machine by up to $33,035, or overestimate the net present value of the future cash savings by up to $33,035, and the project would still be financially attractive.

Thus, looking at the data, since the machine has a positive NPV and the IRR is more than the cost of capital, I would recommend the acceptance of the proposal.