The manager of the Knute division of Montauk, Inc., has been considering an investment in new fixed assets. He expects the investment to yield annual net cash flows of $386,250 for its four-year life. The cost is $1 million. The firm has a minimum required rate of return on investment of 15%. The calculation of the minimum required dollar return is based on net assets (cost less accumulated depreciation) at the beginning of each year. The firm uses straight-line depreciation. Ignore taxes.

REQUIRED:

a. Determine the internal rate of return of the investment.

b. Prepare a schedule showing the residual income (or loss) that the investment would give in each of the four years of its life.

c. Suggest a way to reconcile the conflict.