Question

Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter, he expects demand to stabilize. The following table presents the expected cash flows:

Year of
Operation	Cash Inflow			Cash Outflow
2019	$	14,000		$	9,800
2020		18,500			11,900
2021		21,500			13,100
2022		21,500			13,100

In addition to these cash flows, Aaron expects to pay $21,300 for the equipment. He also expects to pay $3,200 for a major overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $1,300 salvage value and a four year useful life. Aaron desires to earn a rate of return of 9 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

1. Calculate the net present value of the investment opportunity. (Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal places.)

2. Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and whether it should be accepted.

	a. Net present value b. Will the return be above or below the cost of capital? Should the investment opportunity be accepted?

Answer 1

Answer a

Net present Value = -$ 1277.18

( -1233.40 if three decimals are taken for present Value as table provided are not shown i have taken four decimal of present value factor)

Answer b.

Return from the investment is below the cost of capital i.e. 9% as required by Aaron Heath because NPV is negative @ 9% pv factor

Aaron Heath should not accept the investment opportunity.

Detailed working is as follow

Year	0	2,019	2020	2021	2022
Initial Investment	$       (21,300)
Overhauling cost			$         (3,200)
Salvage Value					$            1,300
Cash Inflows		$           14,000	$         18,500	$         21,500	$         21,500
Cash Outflows		$           (9,800)	$       (11,900)	$       (13,100)	$       (13,100)
Net Cash inflow or Outflow	$       (21,300)	$             4,200	$            3,400	$            8,400	$            9,700

year	Cash Inflow(outflow)	PV factor@ 9%
0	-21300	1	-21300
2019	4200	0.9174	3853.08
2020	3400	0.8417	2861.78
2021	8400	0.7722	6486.48
2022	9700	0.7084	6871.48
			-1227.18

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