Question

Sally Omar is the manager of the office products division of Cato Enterprises. In this position, her annual bonus is based on an appraisal of return on investment (ROI) measured as Division income ÷ End-of-year division assets (net of accumulated depreciation).

Currently, Sally is considering investing $36,336,000 in modernization of the division plant in Tennessee. She estimates that the project will generate cash savings of $6,180,000 per year for 8 years. The plant improvements will be depreciated over 8 years ($36,336,000 ÷ 8 years = $4,542,000). Thus, the annual effect on income will be $1,638,000 ($6,180,000 - $4,542,000).

a. Using a discount rate of 8 percent, calculate the NPV of the modernization project. (Round present value factor calculations to 4 decimal places, e.g. 1.2151 and final answer to 0 decimal places, e.g. 125. Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

b. Calculate the ROI of the project each year over its 8-year life. (Calculate ROI as effect on income divided by end-of-year book value. Note that the value of ROI is not defined at the end of year 8 when book value is zero.) (Round answers to 2 decimal places, e.g. 15.25%.)

Answer 1

Cash Inflow:-	Year 1	Year2	Year3	Year4	Year5	Year6	Year7	Year 8
Annual Income	6180000	6180000	6180000	6180000	6180000	6180000	6180000	6180000
Less:- Depreciation	4542000	4542000	4542000	4542000	4542000	4542000	4542000	4542000
Net Cash Inflow (a)	1638000	1638000	1638000	1638000	1638000	1638000	1638000	1638000
Discounting (b)	0.9256	0.8573	0.7938	0.735	0.6806	0.6302	0.5835	0.5403
Discounted Cash Inflow (a*b)	1516132.8	1404257.4	1300244	1203930	1114823	1032268	955773	885011.4
Total Discounted Cash Inflow	1516133+1404257+1300244+1203930+1114823+1032268+955773+885011
	9412439.4
NPV	Total Discounted Cash Inflow- Initial Cash outflow
	9412439-36336000
NPV	-26923561
Total Project Cost	36336000
Depreciation every year	4542000
	Year 1	Year2	Year3	Year4	Year5	Year6	Year7	Year 8
Net Income (a)	1638000	1638000	1638000	1638000	1638000	1638000	1638000	1638000
Year End Value of asset (b)	31794000	27252000	22710000	18168000	13626000	9084000	4542000	Nil
ROI (a/b)	0.05	0.06	0.07	0.09	0.12	0.18	0.36