Question

Amelia Inc. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income of $200,900. The equipment will have an initial cost of $1,200,900 and have an 8 year life. The salvage value of the equipment is estimated to be $200,900. The hurdle rate is 10%. 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.)

What is the accounting rate of return? (Round your answer to 2 decimal places.)



b. What is the payback period? (Round your answer to one decimal place.)



c. What is the net present value? (Do not round intermediate calculations and round your final answer to the nearest dollar amount.)



d. What would the net present value be with a 13% hurdle rate? (Do not round intermediate calculations and round your final answer to the 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:

Accounting rate of return = Average annual income / Average investment

Average investment = (Cost + Salvage value) / 2 = ($1,200,900 + $200,900) / 2 = $700,900

Accounting rate of return = $200,900 / $700,900 = 28.66%

Solution b:

Annual depreciation = (Cost - Salvage value) / Useful life

= ($1,200,900 - $200,900) / 8 = $125,000

Annual cash inflows = Net Income + Depreciation = $200,900 + $125,000 = $325,900

Payback period = Initial investment / Annual cash inflows = $1,200,900 / $325,900 = 3.7 years

Solution c:

Computation of NPV - Amelia Inc.
Particulars	Period	Amount	PV Factor (10%)	Present Value
Cash Outflows:
Cost of Equipment	0	$1,200,900	1	$1,200,900
Present value of cash outflows (A)				$1,200,900
Cash Inflows:
Annual net cash inflows	1-8	$325,900	5.33493	$1,738,654
Salvage value of Equipment	8	$200,900	0.46651	$93,722
Present value of cash Inflows (B)				$1,832,376
NPV (B-A)				$631,476

Solution d:

Computation of NPV - Amelia Inc.
Particulars	Period	Amount	PV Factor (13%)	Present Value
Cash Outflows:
Cost of Equipment	0	$1,200,900	1	$1,200,900
Present value of cash outflows (A)				$1,200,900
Cash Inflows:
Annual net cash inflows	1-8	$325,900	4.79877	$1,563,919
Salvage value of Equipment	8	$200,900	0.37616	$75,571
Present value of cash Inflows (B)				$1,639,490
NPV (B-A)				$438,590

Solution e:

Computation of IRR
Period	Product A
	Cash Flows	IRR
0	-$1,200,900.00	22.54%
1	$325,900.00
2	$325,900.00
3	$325,900.00
4	$325,900.00
5	$325,900.00
6	$325,900.00
7	$325,900.00
8	$526,800.00

Therefore IRR fall in range of 22% to 23%