In: Accounting
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.
Please show work
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%