In: Accounting
(Ignore income taxes in this problem.) Ursus Inc., is considering a project that would have a ten-year life and would require a $1,000,000 investment in equipment. At the end of ten years, the project would terminate and the equipment would have no salvage value. The project would provide net operating income each year as follows:
Sales | $2,000,000 |
Variable Expenses | $1,400,000 |
Contribution Margin | $600,000 |
Fixed Expenses | $400,000 |
Net Operating Income | $200,000 |
All of these items, except for depreciation of $92,500 a
year, represent cash flows. The depreciation is included
in the fixed expenses. The company's required
rate of return is 12%
a. What is the Payback period?_______________
1. should we accept the project based on Payback period? Yes/No _________
2. Why? __________
b. What is the Net Present Value?_____________
1. should we accept the project based on Net Present Value? Yes/No________
2. Why? __________
c. What is the Internal Rate of Return?_________
1. Should we accept the project based on Internal Rate of Return? Yes/No________
2. Why? ___________
d. What is the Simple Rate of Return?_________
1. Should we accept the project based on Simple Rate of Return? Yes/No_________
2. Why? ___________
Answer to Q-A | |||||||
Amt (Rs) | |||||||
Sales | 2000000 | ||||||
Less: Variable Cost | 1400000 | ||||||
Contribution | 600000 | ||||||
Less: Fixed Expense | 400000 | ||||||
Net Operating Income | 200000 | ||||||
Add: Dep | 92500 | ||||||
Cash Inflow | 292500 | ||||||
Payback Period | Initial Outflow | = | 1000000 | ||||
Cash Inflow | 292500 | 3.42 | |||||
So, Payback Period | 3.42 years | ||||||
Yes we should accept the project | |||||||
We should accept the project as our investment will give return in just 3.42 years although the life of equipment is 10years. | |||||||
Answer to Q-B | |||||||
Net Present Value= | Present Value of Inflow- Present Value of Outflow | ||||||
Present Value of Inflow = DF @12, 10 = 5.65 | |||||||
So, 292500 * DF @12, 10 | |||||||
So, 292500 * 5.65 | 1652625 | ||||||
Net Present Value= | Present Value of Inflow- Present Value of Outflow | ||||||
NPV= | 1652625-1000000 | ||||||
NPV= | 652625 | ||||||
Yes the project should be accepted based on NPV | |||||||
The Projected should be accepted as the NPV is positive | |||||||
Answer to Q-C | |||||||
IRR Calculation | |||||||
Discounting Rate | Present Value | ||||||
DF @12, 10 | 12% | 1652625 | (292500*5.65) | ||||
DF @28, 10 | 28% | 956158 | (292500*3.27) | ||||
Using Interpolation | x-12 | = | `1000000-1652625 | ||||
`28-12 | `956158-1652625 | ||||||
x | = | 27% | |||||
Yes | |||||||
On basis of IRR project should be accepted as IRR is greater than Rate of Return | |||||||
Answer to Q-D | |||||||
Simple rate of return is 29.25% | |||||||
Yes | |||||||
so it should be accepted as it is greater than rate of return |