Question

Assume ABC Company has chosen to invest in new manufacturing equipment. The initial cost of the equipment is $1,200,000. The equipment has a useful life of 20 years. The company uses straight-line depreciation. Their tax rate is 30%. Their weighted average cost of capital is 10%. The new equipment is expected to increase net cash flows by $500,000 in year 1, $350,000 in years 2 through 4, and $100,000 in years 5 through 10. Using all four investment assessment methods (IRR, ARR, NPV, or payback), perform the calculations for this project. Based on just ONE of your calculations should the project be accepted or rejected? Critique the results of the other three calculations you completed. Do they all support your accept/reject decision? Which assessment method is the best? The yearly cash flow is ATCF

Answer 1

ABC Company
Cost of Equipment	1,200,000
Useful life in years	20
Yearly SL deprciation	60,000
NPV Calculation
Details	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10
Cost of Equipment	(1,200,000)
Increased Cash inflows		500,000	350,000	350,000	350,000	100,000	100,000	100,000	100,000	100,000	100,000
Net Cash flows	(1,200,000)	500,000	350,000	350,000	350,000	100,000	100,000	100,000	100,000	100,000	100,000
PV factor @10%	1	0.909	0.826	0.751	0.683	0.621	0.564	0.513	0.467	0.424	0.386
PV of Net Cash inflows =	(1,200,000)	454,545	289,256	262,960	239,055	62,092	56,447	51,316	46,651	42,410	38,554
NPV =	$ 343,286.71
Payback period is Years =	3 Years
ARR Calculation
Cost of Equipment	1,200,000
Book Value after 10 years	600,000
Average Investment =(120000+600000)/2=	900,000
Total Net Cash flow in 10 years=	2,150,000
Less depreciation for 10 years	600,000
Net Accounting Income for 10 years=	1,550,000
Average Accounting Income per year=	155,000
Accounting rate of return=155000/900000=	17.22%
IRR Calculation
Details	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10
Cost of Equipment	(1,200,000)
Increased Cash inflows		500,000	350,000	350,000	350,000	100,000	100,000	100,000	100,000	100,000	100,000
Net Cash flows	(1,200,000)	500,000	350,000	350,000	350,000	100,000	100,000	100,000	100,000	100,000	100,000
PV factor @19.691%	1	0.835	0.698	0.583	0.487	0.407	0.340	0.284	0.237	0.198	0.166
PV of Net Cash inflows =	(1,200,000)	417,742	244,312	204,119	170,538	40,709	34,012	28,416	23,741	19,836	16,572
NPV =	$             (1.02)
So NPV at required rate 19.691% is 0.
IRR =19.691%
All the 4 paramaters , IRR , NPV, Payback,ARR
indicate that the project can be accpeted.
The NPV is positive, payback period is
very less.
IRR and ARR are both way above the cost
of capital.
We can accept the project on the basis of
NPV alone , but even the other criteria
are also supporting the acceptance of the
project.