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Average Rate of Return, Cash Payback Period, Net Present Value Method for a Service Company Spanish...

Average Rate of Return, Cash Payback Period, Net Present Value Method for a Service Company

Spanish Peaks Railroad Inc. is considering acquiring equipment at a cost of $165,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $33,000. The company's minimum desired rate of return for net present value analysis is 15%.

Present Value of an Annuity of $1 at Compound Interest
Year 6% 10% 12% 15% 20%
1 0.943 0.909 0.893 0.870 0.833
2 1.833 1.736 1.690 1.626 1.528
3 2.673 2.487 2.402 2.283 2.106
4 3.465 3.170 3.037 2.855 2.589
5 4.212 3.791 3.605 3.353 2.991
6 4.917 4.355 4.111 3.785 3.326
7 5.582 4.868 4.564 4.160 3.605
8 6.210 5.335 4.968 4.487 3.837
9 6.802 5.759 5.328 4.772 4.031
10 7.360 6.145 5.650 5.019 4.192

Compute the following:

a. The average rate of return, giving effect to straight-line depreciation on the investment. If required, round your answer to one decimal place.
%

b. The cash payback period.

c. The net present value. Use the above table of the present value of an annuity of $1. Round to the nearest dollar. If required, use a minus sign to indicate negative net present value for current grading purpose.

Present value of annual net cash flows $
Amount to be invested $
Net present value $

Solutions

Expert Solution

Answer-a)- Average rate of return = 10%.

Explanation= Accounting rate of return= (Annual net income/ Initial investment)*100

= ($16500/$165000)*100

= 10%

Where- Net income = Annual cash inflow- Annual depreciation

= $33000 - $16500

= $16500

Explanation- Straight line Method- Annual

Depreciation Expense = Cost of asset- Salvage value of asset/No. of useful life (years)

=($165000 - $0)/10 years

=$165000/10 years

= $16500

2)- Cash payback period = 5 years.

Explanation- Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows generated by the investment. It is one of the simplest investment appraisal techniques.

In case when cash inflow are even, the formula to calculate payback period is:

Cash payback period =Initial investment / Cash Inflow per period

= $165000/$33000

= 5 years

3)- Net present value = $627.

Explanation-Net present value = Present value of cash inflows – Total outflows

= ($33000*5.019) - $165000

= $165627 - $165000

= $627


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