Question

Tidal WaveTidal Wave

is considering purchasing a water park in

Atlanta comma GeorgiaAtlanta, Georgia​,

for

$ 2 comma 200 comma 000$2,200,000.

The new facility will generate annual net cash inflows of

$ 520 comma 000$520,000

for

tenten

years. Engineers estimate that the facility will remain useful for

tenten

years and have no residual value. The company uses​ straight-line depreciation. Its owners want payback in less than five years and an ARR of

1212​%

or more. Management uses a

1010​%

hurdle rate on investments of this nature.

LOADING...	​(Click the icon to view the present value annuity​ table.)	LOADING...	​(Click the icon to view the present value​ table.)
LOADING...	​(Click the icon to view the future value annuity​ table.)	LOADING...	​(Click the icon to view the future value​ table.)

Read the requirements

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.

Requirement 1. Compute the payback​ period, the​ ARR, the​ NPV, and the approximate IRR of this investment.​ (If you use the tables to compute the​ IRR, answer with the closest interest rate shown in the​ tables.) ​(Round the payback period to one decimal​place.)

The payback period is

years.

​(Round the percentage to the nearest tenth​ percent.)

The ARR (accounting rate of return) is

%.

​(Round your answer to the nearest whole​ dollar.)

Net present value $

The IRR​ (internal rate of​ return) is between

▼

16% and 18%

20% and 22%

22% and 24%

18% and 20%

.

Requirement 2. Recommend whether the company should invest in this project.

​Recommendation:

▼

Do not invest in the new facility.

Invest in the new facility.

Answer 1

Solution:

Part a – Payback Period

Payback Period is the length of time within which initial investment or cost is returned back to the company.

Payback Period
Initial Investment or Cost of Water Park Cash Flow (Initial Cash Outflow) (A)	$2,200,000
Annual Net Cash Inflows (B)	$520,000
Payback Period (A / B)	4.23
	Years

Part b – Accounting Rate of Return (ARR)

Accounting rate of return is the percentage of annual return on initial investment.

This method uses Net Income after depreciation and tax in calculation.

Accounting Rate of Return (ARR) = Net Income after depreciation and taxes / Initial Investment x 100

Accounting Rate of Return (ARR)
Annual Cash Inflow	$520,000
Less: Annual Straight line Depreciation (Refer Note 1)	-$220,000
Net Income after Depreciation (A)	$300,000
Initial Investment (B)	$2,200,000
Accounting Rate of Return (A / B x 100)	13.64%
Note 1 - Annual Depreciation
Cost of Asset	$2,200,000
Less: Salvage Value	$0
Net Depreciable Value of Asset	$2,200,000
Divide by Estimated Useful Life	10 Years
Annual Depreciation ($2,200,000 / 10)	$220,000

Part c – Net present value

Step 2 -	Calculation of Net Present Value
Year		Cash Flow	PV factor @ 10%	Present Value
0	Initial Cash Outflow	($2,200,000)	1.000	($2,200,000)
1	Annual Cash Inflow	$520,000	0.909	$472,727
2	Annual Cash Inflow	$520,000	0.826	$429,752
3	Annual Cash Inflow	$520,000	0.751	$390,684
4	Annual Cash Inflow	$520,000	0.683	$355,167
5	Annual Cash Inflow	$520,000	0.621	$322,879
6	Annual Cash Inflow	$520,000	0.564	$293,526
7	Annual Cash Inflow	$520,000	0.513	$266,842
8	Annual Cash Inflow	$520,000	0.467	$242,584
9	Annual Cash Inflow	$520,000	0.424	$220,531
10	Annual Cash Inflow	$520,000	0.386	$200,483
	Net Present Value			$995,175

Net Present Value of Investment = $995,175

Part d – Internal Rate of Return

IRR is the rate at which all the expected future cash inflows equals to the initial investment.

IRR is the rate at which Present Value of Cash Inflows = Present Value of Cash Outflow

Looking to the Present Value Ordinary Annuity factor table we can get the value for 1 period.

At 18%, the value of future cash inflows

$520,000 x PVIFA (18%, 10) i.e. 4.494 = $2,336,925

At 20%, the present value of future cash inflows

$520,000 x PVIFA (20%, 10) i.e. 4.192 = $$2,180,085

At IRR the present value of future cash flows should be equal or close to initial investment.

Hence, the IRR is between 18% and 20%

The correct option is 18% and 20%

Requirement 2 ---

Net present value is positive of the investment, hence the investment should be accepted.

Invest in the new facility

Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you