Question

Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter, he expects demand to stabilize. The following table presents the expected cash flows:

year of operation	cash inflow	cash outflow
2019	$14400	$9000
2020	19700	11300
2021	21700	13400
2022	21700	13400

In addition to these cash flows, Aaron expects to pay $21,400 for the equipment. He also expects to pay $3,200 for a major overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $1,600 salvage value and a four year useful life. Aaron desires to earn a rate of return of 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

A) Calculate the net present value of the investment opportunity. (Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal places.

B) Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and whether it should be accepted.

a	net present value
b	will the return be above or below the cost of capital?
	Should the investment opportunity be accepted

Answer 1

Facts
Initial outlay	$        21,400
Useful Life	4
Salvage value	$          1,600
Cost of capital	8.00%
Overhaul expenses	$          3,200

WN 1:

Computation of Net cash inflows:
Year of operation	cash inflows	cash outflows	Net cash flows
2019	$     14,400	$       9,000	$    5,400
2020	$     19,700	$     11,300	$    8,400
2021	$     21,700	$     13,400	$    8,300
2022	$     21,700	$     13,400	$    8,300

a)

Net Present Value
Year	Particulars	Amount	PVF @ 8%	NPV
2019-start	Investment	(21,400)	1	(21,400)
2019	Net cash flows	5,400	0.9259	5,000
2020	Net cash flows	8,400	0.8573	7,202
2020	Overhaul	(3,200)	0.8573	(2,743)
2021	Net cash flows	8,300	0.7938	6,589
2022	Net cash flows	8,300	0.7350	6,101
2022	Salvage value	1600	0.7350	1,176
	Net Present value			$ 1,924

b) Return from the investment will be above/more than the cost of capital.  

Therefore, Investment opportunity should be accepted.