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 Done
	Cash Inflow			Cash Outflow
2019	$	25,000		$	12,000
2020		29,000			16,000
2021		32,000			18,000
2022		32,000			18,000

In addition to these cash flows, Aaron expects to pay $25,000 for the equipment. He also expects to pay $4,000 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 $4,000 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

1. Calculate the net present value of the investment opportunity. (Round your intermediate calculations and final answer to 2 decimal places.)

2. 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.

Answer 1

a. Net present value (NPV) of the investment opportunity
	A	B	C =(A-B)	D		E =(D*C)
Year of operation	Cash Inflow	Cash Outflow	Net cash flows	PV factor @ 8%		Present value of net cash flows
Initial Cash Outflow	0	25,000	-25,000	1		-25,000.00
2019 (Year 1)	25,000	12,000	13,000	0.9259	1/(1+0.08)^1	12,037.04
2020 (Year 2)	29,000	20,000	9,000	0.8573	1/(1+0.08)^2	7,716.05
2021 (Year 3)	32,000	18,000	14,000	0.7938	1/(1+0.08)^3	11,113.65
2022 (Year 4)	36,000	18,000	18,000	0.7350	1/(1+0.08)^4	13,230.54
Net Present Value of the investment opportunity		19,097.28
Cash Ouflow for Year 2
Cash Ouflow for Year 2 = Cash Outflow + Cverhauling and updating charges
Cash Ouflow for Year 2 = 16,000 + 4,000
Cash Ouflow for Year 2 = 20,000
Cash Inflow for Year 4
Cash Inflow for Year 4 = Cash Inflow + salvage value
Cash Inflow for Year 4 = 32,000 + 4,000
Cash Inflow for Year 4 = 36,000
Note - Since you have not given table I have used calculator to find the factors @ 8%.
(b) The Investment opportunity is expected to earn a return that is above the desired rate of return (8%) as NPV is positive and it should be accepted