Question 4: Calculate the internal rate of return of Option 1 and Option 2.

Given
the results of NPV, IRR and Payback period method of the three options, which one do
you think Peregrine company should choose? Why

Option 1: Purchase the CNC Machine with Cash

Use the IRR formula in excel to calculate it.

Formula=
IRR(B4:G4)
The internal rate of return of Option 1 is 59%.

Option 2: Finance the Purchase of the CNC Machine

Use the IRR formula in excel to calculate it.

Formula= IRR(B11:G11)

The internal rate of return of Option 2 is 127%.

Comparison among the three options:

NPV IRR Payback Period

Option 1 255,537.22 59% 1.58 years
 Option 2 239,291.29 127% 0.79 year
Option 3 270,613.03 none none

Based on the table, Option 3 has the highest NPV among the three alternatives,
while Option 2 has the greatest internal rate of return and the shortest payback period.
Both options seem to be good to Peregrine company but the firm can only choose one
in this case. Therefore, if we only consider the numbers, the company should choose
Option 3 as it will offer the most returns. Besides, no initial investment is required in
Option 3, which will decrease the burden of the firm.

When taking account on the real situation, French, the president of Peregrine
assumed that the third option would be hard to execute. Moreover, there is a greater
possibility for the company’s CNC machine to suffer defect as it need to operate
continuously with the additional night shift. In this case, Option 3 might not be the best
choice.

After excluding Option 3, a comparison would be made between Option 1 and 2.

Option 1 have the higher NPV compared to Option 2. So, the company should choose
Option 1 even though the IRR value of Option 2 is greater. This is because the IRR
method ignore the timing of cash flows. In other words, it does not distinguish when do
the company receive the cash flows. Thus, using NPV method to make a decision would
be a better choice as it will take the timing of cash flows into account.

In conclusion, the company should choose Option 1.