Question

Linda’s Luxury Travel (LLT) is considering the purchase of two Hummer limousines. Various information about the proposed investment follows:   

Initial investment (2 limos)	$	1,260,000
Useful life		10	years
Salvage value	$	130,000
Annual net income generated		114,660
LLT’s cost of capital		14	%

Assume straight line depreciation method is used.     

Required:
Help LLT evaluate this project by calculating each of the following:    

1. Accounting rate of return. (Round your percentage answer to 1 decimal place.)



2. Payback period. (Round your answer to 2 decimal places.)

  

3. Net present value. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Cash Outflows and negative amounts should be indicated by a minus sign. Round your "Present Values" to the nearest whole dollar amount.)

   

	Table or Calculator Function: Cash Outflow (Beginning of the Year) n = i = % Present Value Table or Calculator Function: Cash Inflow (for Next 10 Years) n = i = % Table Factor Present Value Table or Calculator Function: Cash Inflow (for 10th Year) n = i = % Table Factor Present Value Total Net Present Value

4. Without making any calculations, determine whether the IRR is more or less than 14%.

	Less than 14%
	Greater than 14%

Answer 1

1) Accounting rate of return = annual net income/initial investment

accounting rate of return = 114660/1260000= 0.091 = 9.1%

2) payback period = initial investment/annual net cash inflow

net cash inflow = annual net income+depreciation

depreciation = 1260000-130000/10 = 113000

net cash inflow = 114660+113000 = 227660

payback period = 1260000/227660 = 5.53 years

3) calculation of net present value =present value of cash inflow- outflow

cash inflow = 227660*PVIFA(14%,10)+130000*PVIFA(14%,10)

CASH Inflow = 227660*(5.2161)+130000*(0.2697)

cash inflow = 1187497+35061 = 1222558

out flow = 1260000

net present value = 1222558-1260000 = (37442)

calculation of net present value

table or calculator fuction

cash outflow = 1260000

n=0

i=14%

present value =1260000

table or calculator function

cash flow= 114660

add: depreciation =

1260000-130000/10 = 113000

cash inflow = 114660+113000 = 227660

n =10yr

i=14%

pv factor = 5.2161

present value = (227660*5.2161) = 1187475

cash inflow for 10th year = 130000

n= 10

i= 14%

pv factor = 0.2697

present value = 130000*0.2697 = 35061

4) LESS THAN 14%