Question

(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.

2. Compute the project's internal rate of return.

3. Compute the project's payback period.

4. Compute the project's simple rate of return.

5. 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.

Answer 1

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