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In: Accounting

Sally Omar is the manager of the office products division of Cato Enterprises. In this position,...

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%.)

Solutions

Expert Solution

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

ekkarill92 answered 1 year ago
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