Question

In: Accounting

Carper Company is considering a capital investment of $390,000 in additional productive facilities. The new machinery...

Carper Company is considering a capital investment of $390,000 in additional productive facilities. The new machinery is expected to have useful life of 6 years with no salvage value. Depreciation is by the straight-line method. During the life of the investment, annual net income and net annual cash flows are expected to be $20,000 and $85,000, respectively. Carper has an 8% cost of capital rate, which is the required rate of return on the investment.

Instructions (Round to two decimals.)

  1. Compute (1) the cash payback period and (2) the annual rate of return on the proposed capital expenditure.
  2. Using the discounted cash flow technique, compute the net present value.
  3. Carper was presented with a second capital investment that provided similar production facilities as the first one. This investment cost $400,000, had a useful life of 7 years with a salvage value of $15,000. Depreciation is by the straight-line method. During the life of the investment, annual net income and net annual cash flows are expected to be $25,000 and $80,000 respectively. Carper’s 8% cost of capital is also the required rate of return on the investment.
  1. Compute the cash payback period.
  2. Compute the annual rate of return.
  3. Using the discounted cash flow technique, compute the net present value.
  4. Based on these calculations, which investment do you recommend? Explain why.

Solutions

Expert Solution

1 Calculation of Payback period of Project

Calculation of Payback period of Project
Year Initial investment Cashflows cumilativ Cashflow Balance
0 -390000 0
1 85000 85000 305000
2 85000 170000 220000
3 85000 255000 135000
4 85000 340000 50000
5 85000 425000 Balance 0.59
6 85000 510000
Payback period 4.59 Years

2) annual rate of Return

= 20000/390000 *100 = 5.12%

3) Calculation of NPV Of the Project

year 0 1 2 3 4 5 6
Net Cashflow -390000 85000 85000 85000 85000 85000 85000
Discounting Factor 1 0.92593 0.85734 0.79383 0.73503 0.68058 0.63017
Present Value -390000 78703.704 72873.8 67475.74 62477.54 57849.57 53564.42
NPV 2944.77

PROJECT

1 Projects Payback Period

Calculation of Payback period of Project
Year Initial investment Cashflows cumilativ Cashflow Balance
0 -400000 0
1 80000 80000 320000
2 80000 160000 240000
3 80000 240000 160000
4 80000 320000 80000
5 80000 400000 0
6 80000 480000
7 80000 560000
Payback period 4.00Years

2) ARR of the Project

25000/400000 *100

=6.25%

3) Calculation of NPV of the Project

Calculation of NPV of Machine
year 0 1 2 3 4 5 6 7
Net Cashflow -400000 80000 80000 80000 80000 80000 80000 80000
Discounting Factor 1 0.92593 0.85734 0.79383 0.73503 0.68058 0.63017 0.58349
Present Value -400000 74074.074 68587.11 63506.58 58802.39 54446.66 50413.57 46679.23
NPV 16509.60

Based on the Calculation 2nd Project will give More wealth to shareholders within a short period than 1st project. 2nd project will be more suitable for Carper company. As second projects ARR is bit higher than 1st project it also considered.


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