Question

Swagelok Enterprises is a manufacturer of miniature fittings and valves. Over a 5-year period, the costs associated with one product line were as follows: first cost of $25,000, and annual costs of $16,000. Annual revenue was $25,000 and the used equipment was salvaged for $4,000. What rate of return did the company make on this product? The rate of return that the company made on the product is

Answer 1

As per the question Swagelok Enterprises is evaluating the cost associated with one product line

Initial cost (I) = $25000

Annual cost = $16000

Annual revenue = $25000

Annual net revenue = Annual revenue - Annual cost = $25000 - $16000 = $9000

Salvage value (S) = $4000

Effective life period (N) = 5 year

The required cash flow is

Years	Cash flow
0	-$25000
1	$9000
2	$9000
3	$9000
4	$9000
5	$5000

The cash flow of year 5 is = Annual net revenue - Salvage value = 9000-4000 = 5000

For calculation of rate of return we have followed trial and error method

Years	Cash flow	PVF@20%	PV of Cashflow	PVF@22%	PV of Cashflow
0	-25000	1	-25000	1	-25000
1	9000	0.8333	7499.7	0.8197	7377.3
2	9000	0.6944	6249.6	0.6719	6047.1
3	9000	0.5787	5208.3	0.5507	4956.3
4	9000	0.4823	4340.7	0.4514	4062.6
5	5000	0.4019	2009.5	0.3700	1850
		NPV at 20%=	307.8	NPV at 22%=	-706.7

Rate of return is the interest at which the NPV=0, to estimate it we have followed trial and error method, first we have taken the PV factor = 20%, where the NPV =$307.8, which is positive and then we have taken the PV factor = 22%, where the NPV = -$706.7, which is negative. So the Rate of return must fall in between 20% to 22%.

Therefore

R1 = 20%              NPV1=$307.8

R2= 22%               NPV2= -$706.7

Using linear interpolation method of estimation of Rate of Return

Rate of Return = R1 + (R2-R1)X[NPV1/(NPV1-NPV2)]

Rate of Return = 20 + (22-20)[(307.8)/ {307.8-(-706.7)}]

Rate of Return = 20 + (2)[(307.8)/(307.8+706.7)]

Rate of Return = 20 + 2(307.8/ 1014.5)

Rate of Return = 20 + 2(0.3034)

Rate of Return = 20 + 6068 = 20.6068

Rate of Return = 20.60%

The rate of return company made on the product is 20.60%