Question

In: Accounting

(Ignore income taxes in this problem.) Acme, Inc. is considering a project that would have a...

(Ignore income taxes in this problem.) Acme, Inc. is considering a project that would have a ten-year life and would require a $1,275,000 investment in equipment. At the end of ten years, the project would terminate and the equipment would have no salvage value. The project would provide net operating income each year as follows:

           

Sales..........................................................

$1,750,650

Less variable expenses..............................

900,125

Contribution margin..................................

850,525

Less fixed expenses:

Fixed out-of-pocket cash expenses........

$517,100

Depreciation...........................................

119,200

    636,300

Net operating income................................

$   214,225

            All of the above items, except for depreciation, represent cash flows. The company's required rate of return is 16.5%.

           

            Required: (5 points)

  1. Compute the project's net present value.
  1. Compute the project's internal rate of return.
  1. Compute the project's payback period.
  1. Compute the project's simple rate of return.
  1. Based on your analysis above, should Acme, Inc. purchase this equipment? Why or why not? You must address ALL four capital budgeting methods in this answer.

Solutions

Expert Solution

1 Net Present Value = $     3,06,969
2 IRR = 22.80%
3 Payback period =                  3.82
4 Simple rate of return = 16.80%
5 Yes
1
Year Value Flows Present Factor @ 16.5% Present Value
Initial Cost 0 $ -12,75,000 1 $     -12,75,000
Cash Inflows (2,14,225+1,19,200) 1 - 10 $     3,33,425 4.745 $      15,81,969
Net Present Value $         3,06,969
2 Computation of IRR
Year Value Flows
0 $ -12,75,000
1 $     3,33,425
2 $     3,33,425
3 $     3,33,425
4 $     3,33,425
5 $     3,33,425
6 $     3,33,425
7 $     3,33,425
8 $     3,33,425
9 $     3,33,425
10 $     3,33,425
IRR = 22.80%
Formula =IRR(I15:I20)
3 Payback period = initial investment / Annual net cash flows
= $12,75,000 / $3,33,425
=                  3.82 years
4 Computation of Simple rate of return:
Simple rate of return = Net Profit / Investment
= $2,14,225 / $12,75,000
= 16.80%
5 Yes

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