Question

1. Gallatin, Inc., has assembled the estimates shown below relating to a proposed new investment project. The project will last 5 years and requires Gallatin to purchase a machine with a cost of $335,200, a 5-year life and no salvage value.

Annual cash sales	$	350,000
Annual out-of-pocket cash expenses	$	250,000
Annual depreciation on equipment	$	67,040
Initial cost of equipment	$	335,200

           

a. Compute the payback period for the investment

b. Compute the investment's approximate IRR

c. Compute the investment's simple rate of return

2. Gallatin, Inc., has assembled the estimates shown below relating to a proposed new project with a 5-year project life. At the end of the 5 years, the equipment purchased for the project would be sold and working capital would revert to other uses in the company. Gallatin uses a discount rate of 10%. (Ignore income taxes.)

Annual cash sales	$	450,000
Annual out-of-pocket cash expenses	$	340,000
Annual depreciation on new equipment	$	66,000
Initial cost of new equipment	$	380,000
Salvage value of new equipment in 5 years	$	50,000
Working capital requirement	$	40,000

Compute the net present value of the project.

3. Gallatin is using net present value to evaluate two investments, but only has the capital to fund one. The net present values of the investments are similar but the initial investments required are different, as shown below.

                                    Investment 1               Investment 2

            Initial investment                    $125,000                     $80,000

            Net present value                   $ 22,000                     $20,000

Compute the profitability index for each investment.

Answer 1