Question

Water Planet is considering purchasing a water park in Miami, Florida​, for $ 2,100,000. The new facility will generate annual net cash inflows of $ 535,000 for eight years. Engineers estimate that the facility will remain useful for eight years and have no residual value. The company uses​ straight-line depreciation. Its owners want payback in less than five years and an ARR of 10​% or more. Management uses a 12% hurdle rate on investments of this nature.

.

Requirement 1. Compute the payback​ period, the​ ARR, the​ NPV, and the approximate IRR of this investment.​ (If you use the tables to compute the​ IRR, answer with the closest interest rate shown in the​ tables.) ​(Round the payback period to one decimal​ place.)

The payback period is

years.

​(Round the percentage to the nearest tenth​ percent.)

The ARR (accounting rate of return) is

%.

​(Round your answer to the nearest whole​ dollar.)

Net present value $

The IRR​ (internal rate of​ return) is between

.

Requirement 2. Recommend whether the company should invest in this project.

Answer 1

Solution 1:

Payback period = Initial investment / Annual cash inflows = $2,100,000 / $535,000 = 3.9 years

Annual net income = Annual cash inflows - Depreciation = $535,000 - ($2,100,000 /8 ) = $272,500

Accounting rate of return = Average annual income / Initial investment = $272,500 / $2,100,000 = 12.98%

Computation of NPV - Water Planet
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Initial investment	$2,100,000.00	0	1	$2,100,000
Present Value of Cash Outflows (A)				$2,100,000
Cash Inflows:
Annual cash inflows	$535,000.00	1-8	4.96764	$2,657,687
Present Value of Cash Inflows (B)				$2,657,687
Net Present Value (B-A)				$557,687

Present value factor at IRR = Initial investment / Annual cash inflows = $2,100,000 / $535,000 = 3.92523

This factor falls between interest rate 19% and 20%

Therefore IRR is between 19% and 20%

Solution 2:

As all the conditions are met, company should invest in this project.