Question

Basic Concepts

Roberts Company is considering an investment in equipment that is capable of producing more efficiently than the current technology. The outlay required is $2,266,667. The equipment is expected to last five years and will have no salvage value. The expected cash flows associated with the project are as follows:

Year	Cash Revenues	Cash Expenses
1	$2,970,000	$2,290,000
2	2,970,000	2,290,000
3	2,970,000	2,290,000
4	2,970,000	2,290,000
5	2,970,000	2,290,000

The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.

Required:

1. Compute the project’s payback period. If required, round your answer to two decimal places.
years

2. Compute the project’s accounting rate of return. Enter your answer as a whole percentage value (for example, 16% should be entered as "16" in the answer box).
%

3. Compute the project’s net present value, assuming a required rate of return of 10 percent. When required, round your answer to the nearest dollar.
$

4. Compute the project’s internal rate of return. Enter your answers as whole percentage values.

Between  % and  %

Answer 1

Initial Investment = $2,266,667

Annual Cash Flow = Annual Cash Revenues - Annual Cash Expenses
Annual Cash Flow = $2,970,000 - $2,290,000
Annual Cash Flow = $680,000

Life of Project = 5 years

Answer to Requirement 1:

Payback Period = Initial Investment / Annual Cash Flow
Payback Period = $2,266,667 / $680,000
Payback Period = 3.33 years

Answer to Requirement 2:

Annual Depreciation = Initial Investment / Life of Project
Annual Depreciation = $2,266,667 / 5
Annual Depreciation = $453,333.40

Annual Net Income = Annual Cash Revenues - Annual Cash Expenses - Annual Depreciation
Annual Net Income = $2,970,000 - $2,290,000 - $453,333.40
Annual Net Income = $226,666.60

Accounting Rate of Return = Annual Net Income / Initial Investment
Accounting Rate of Return = $226,666.60 / $2,266,667
Accounting Rate of Return = 10%

Answer to Requirement 3:

Net Present Value = -$2,266,667 + $680,000 * PVA of $1 (10%, 5)
Net Present Value = -$2,266,667 + $680,000 * 3.791
Net Present Value = $311,213

Answer to Requirement 4:

IRR Factor = Initial Investment / Annual Net Cash Flow
IRR Factor = $2,266,667 / $680,000
IRR Factor = 3.333

Using financial table, IRR is between 15% and 16%.