Question

Bi-Coastal Railroad Inc. is considering acquiring equipment at a cost of $340,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $68,000. The company’s minimum desired rate of return for net present value analysis is 10%.

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, assuming the annual earnings are equal to the net cash flows less the annual depreciation expense on the equipment. 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	$
Less amount to be invested	$
Net present value	$

Answer 1

Cost of Equipment = $340,000
Useful Life = 10 years
Annual Net Cash Flow = $68,000

Annual Depreciation = Cost of Equipment / Useful Life
Annual Depreciation = $340,000 / 10
Annual Depreciation = $34,000

Annual Net Income = Annual Net Cash Flow - Annual Depreciation
Annual Net Income = $68,000 - $34,000
Annual Net Income = $34,000

Answer a.

Average Investment = (Cost of Equipment + Residual Value) / 2
Average Investment = ($340,000 + 0) / 2
Average Investment = $170,000

Average Rate of Return = Annual Net Income / Average Investment
Average Rate of Return = $34,000 / $170,000
Average Rate of Return = 20%

Answer b.

Payback Period = Cost of Equipment / Annual Net Cash Flow
Payback Period = $340,000 / $68,000
Payback Period = 5 years

Answer c.

Present Value of Annual Net Cash Flows = Annual Net Cash Flows * PVA of $1 (10%, 10)
Present Value of Annual Net Cash Flows = $68,000 * 6.145
Present Value of Annual Net Cash Flows = $417,860

Net Present Value = Present Value of Annual Net Cash Flows - Amount to be Invested
Net Present Value = $417,860 - $340,000
Net Present Value = $77,860