Question

Briar Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $208,000. The equipment will have an initial cost of $1,208,000 and have an 8 year life. The salvage value of the equipment is estimated to be $208,000. The hurdle rate is 6%. Ignore income taxes. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor from the PV tables.)


a. What is the accounting rate of return? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)



b. What is the payback period? (Round your answer to the nearest whole number.)

c. What is the net present value? (Round your answer to nearest dollar amount.)



d. What would the net present value be with a 14% hurdle rate? (Negative value should be indicated by a minus sign. Round your answer to nearest dollar amount.)



e. Based on the NPV calculations, in what range would the equipment’s internal rate of return fall? (Round your answer to 2 decimal places.)

Answer 1

Solution a:

Annual depreciation = (Cost - Salvage value) / Useful life = ($1,208,000 - $208,000) / 8 = $125,000

Annual income = Annual increase in cash inflows - Depreciation = $208,000 - $125,000 = $83,000

Average investment = (Cost + salvage value) / 2 = ($1,208,000 + $208,000)/2 = $708,000

Accounting rate of return = $83,000 / $708,000 = 11.72%

Solution b:

Payback period = Initial investment / Annual cash inflows = $1,208,000 / $208,000 = 6 years

Solution c:

Computation of NPV - Briar Corp.
Particulars	Period	Amount	PV Factor (6%)	Present Value
Cash Outflows:
Cost of Equipment	0	$1,208,000	1	$1,208,000
Present value of cash outflows (A)				$1,208,000
Cash Inflows:
Annual net cash inflows	1-8	$208,000	6.20979	$1,291,636
Salvage value of Equipment	8	$208,000	0.62741	$130,501
Present value of cash Inflows (B)				$1,422,138
NPV (B-A)				$214,138

solution d:

Computation of NPV - Briar Corp.
Particulars	Period	Amount	PV Factor (14%)	Present Value
Cash Outflows:
Cost of Equipment	0	$1,208,000	1	$1,208,000
Present value of cash outflows (A)				$1,208,000
Cash Inflows:
Annual net cash inflows	1-8	$208,000	4.63886	$964,883
Salvage value of Equipment	8	$208,000	0.35056	$72,916
Present value of cash Inflows (B)				$1,037,799
NPV (B-A)				-$170,201

Solution e:

IRR will fall in range of 6% to 14%.