Question

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 $150,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $30,000. 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.
______ years

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	$

Answer 1

Question 1

Average Rate of Return = Net Cash Flow - Annual Depreciation / Cost of Investment * 100

Net Cash Flow = $ 30,000

Annual Depreciation = $ 15,000

Cost of Investment = $ 150,000

Average Rate of Return = (30,000 - 15,000) / 150,000 * 100

Average Rate of Return = 10%

Annual Depreciation as per Straight Line Method = Cost of Asset - Salvage Value / Useful Life in Years

Annual Depreciation = 150,000 - 0 / 10

Annual Depreciation= 15,000

Question 2

Cash Payback Period = Initial Cost of Investment / Net Annual Cash Flow

Net Annual Cash Flow = $ 30,000

Initial Cost of Investment = $ 150,000

Cash Payback Period = 150,000 / 30,000

Cash Payback Period = 5 Years

Question 3

Calculation of Net Present Value

		A	B	C=A*B
Years	Particulars	Net Cashflow	Discount Factor @ 15%	PV of Cashflow
1-10	Present Value of Cashflows	30,000	5.019	150,570
0	Cost of Investment	150,000	1	(150,000)
	Net Present Value			570