Question

Ursus, Inc., is considering a project that would have a ten-year life and would require a $4,500,000 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 (Ignore income taxes.):

Sales				$	2,900,000
Variable expenses					1,800,000
Contribution margin					1,100,000
Fixed expenses:
Fixed out-of-pocket cash expenses	$	350,000
Depreciation		450,000			800,000
Net operating income				$	300,000

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using the tables provided.

All of the above items, except for depreciation, represent cash flows. The company's required rate of return is 10%.

Required:

a. Compute the project's net present value. (Round your intermediate calculations and final answer to the nearest whole dollar amount.)

b. Compute the project's internal rate of return. (Round your final answer to the nearest whole percent.)

c. Compute the project's payback period. (Round your answer to 2 decimal place.)

d. Compute the project's simple rate of return. (Round your final answer to the nearest whole percent.)

Answer 1

a) Since depreciation is the only noncash item on the income statement, the net annual cash flow can be computed by adding back depreciation to net operating income.
	Amount ($)
Net operating income	3,00,000
Depreciation	4,50,000
Net annual cash flow	7,50,000

	Year(s)	Amount	10% Factor	Present Value
Initial investment	1	-45,00,000	1	-45,00,000
Net annual cash flows	1-10	7,50,000	6.144567	46,08,425.00
Net present value				1,08,425

b. The formula for computing the factor of the internal rate of return (IRR) is:

Factor of the IRR = Investment required ÷ Net annual cash inflow

= $4,500,000 ÷ $7,50,000 = 6 Factor.

To the nearest whole percent, the internal rate of return is 10.50% (aprox)

c. The formula for the payback period is:

Payback period = Investment required ÷ Net annual cash inflow

= $4,500,000 ÷ $7,50,000 = 6 years

d. The formula for the simple rate of return is:

Simple rate of return = Net operating income ÷ Initial investment

= $3,00,000 ÷ $4,500,000 = 6.67%