Question

In: Accounting

Revenues $300,000 Less operating expenses: Rent $169,000 Insurance 15,000 Depreciation 46,000 Maintenance 20,000 250,000 Net operating...

Revenues

$300,000

Less operating expenses:

Rent

$169,000

Insurance

15,000

Depreciation

46,000

Maintenance

20,000

250,000

Net operating income

$   50,000

1. A company has estimated the annual revenues and expenses for a project it is considering (listed above) that will cost a total of $500,000, have a ten-year useful life, and has a salvage value of $40,000. The company requires a payback period of 5 years or less.

  1. Using the information above, what is the expected annual cash flow for this company? ______________
  2. What is the payback period?    __________________________
    Would the company consider this project?   ______________
  3. What is the internal rate of return to the nearest percent?   _______________
  4. What is the simple rate of return promised by the project? _____________________________
    If the company requires a simple rate of return of at least 10%, will the games be purchased?    __________

Please show work

Solutions

Expert Solution

Solution a): Calculation of Expected Annual Cash flows of the company

Year

Net Operating Income

Depreciation

Expected Annual Cash Flows = Net Operating Income + Depreciation

1

                                  50,000.00

                             46,000.00

                        96,000.00

2

                                  50,000.00

                             46,000.00

                        96,000.00

3

                                  50,000.00

                             46,000.00

                        96,000.00

4

                                  50,000.00

                             46,000.00

                        96,000.00

5

                                  50,000.00

                             46,000.00

                        96,000.00

6

                                  50,000.00

                             46,000.00

                        96,000.00

7

                                  50,000.00

                             46,000.00

                        96,000.00

8

                                  50,000.00

                             46,000.00

                        96,000.00

9

                                  50,000.00

                             46,000.00

                        96,000.00

10

                                  50,000.00

                             46,000.00

                     1,36,000.00

Solution b) Calculation of Payback period:

Year

Net Operating Income

Depreciation

Expected Annual Cash Flows = Net Operating Income + Depreciation

Cumulative Expected Annual Cash Flows

1

                                  50,000.00

                             46,000.00

                        96,000.00

                96,000.00

2

                                  50,000.00

                             46,000.00

                        96,000.00

              1,92,000.00

3

                                  50,000.00

                            46,000.00

                        96,000.00

              2,88,000.00

4

                                  50,000.00

                             46,000.00

                        96,000.00

              3,84,000.00

5

                                  50,000.00

                             46,000.00

                        96,000.00

              4,80,000.00

6

                                  50,000.00

                             46,000.00

                        96,000.00

              5,76,000.00

7

                                  50,000.00

                             46,000.00

                        96,000.00

              6,72,000.00

8

                                  50,000.00

                             46,000.00

                        96,000.00

              7,68,000.00

9

                                  50,000.00

                             46,000.00

                        96,000.00

              8,64,000.00

10

                                  50,000.00

                             46,000.00

                     1,36,000.00

           10,00,000.00

As the Initial Investment is $500,000, the Payback period is between 5th and 6th Year.

PayBack Period                                   

= Completed Number of Years + (Cash Inflows to be recovered / Cash inflows for the next Year)

= 5 + (500,000 – 480,0000 / 96,000)

= 5.21 Years

The Payback period is 5.21 Years

As the company requires Payback period less than 5 years, the company should not consider this project.

Solution c) Calculation of Internal Rate of Return

Year

Cash Flows $

0

                            -5,00,000.00

1

                                  96,000.00

2

                                  96,000.00

3

                                  96,000.00

4

                                  96,000.00

5

                                  96,000.00

6

                                  96,000.00

7

                                  96,000.00

8

                                  96,000.00

9

                                  96,000.00

10

                              1,36,000.00

Following are the steps to be followed on Microsoft Excel to calculate the IRR:

Step 1: Click on "FORMULAS" tab at the top of Microsoft Excel
Step 2: Select the option "Financial"
Step 3: Under "Financial" select the option "IRR"
Step 4: Insert Values: (-500000;96000;96000;96000;96000;96000;96000;96000;96000;96000;136000)

IRR = 14.57%

The Internal Rate of Return is 14.57%


Solution d) Calculation of Simple Rate of Return

Simple Rate of Return = Average Net Income / Investment x 100

                                       = 50,000 / 500,000 x 100

                                       = 10%   


Simple Rate of Return for the Investment is 10%

If the company requires a simple rate of return of at least 10%, will the games be purchased?
Yes. The games should be purchased as the project is earning return of 10%


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