Question

Equipment Purchasing

The R&R construction company’s purchasing organization with the approval of the CEO is to procure an excavator for their projects rather than outsourcing them. This is a fully loaded CAT 450 loader backhoe, priced at $300,000. The estimated life of this machine is 10 years and during that period the estimated after-tax cash flows (EATCF) are given below. The investments required rate of return is 15%.

Year	0	1	2	3	4	5	6	7	8	9	10
EATCF ($1000)	-$300	$50	$55	$60	$60	$65	$65	$70	$70	$75	$75

Evaluate this investment, in terms of:

a) Average rate of Return

b) Net Present Value

c) Profitability index

Answer 1

a)	Average rate of return	21.50%
Working:
	Average return	=	(50+55+60+60+65+65+70+70+75+75)/10
		=	$               64.50
	Average rate of return	=	Average return	/	Investment
		=	$               64.50	/	$           300.00
		=	21.50%
b)	Net Present Value	$         8,297.36
Working:
Year	Cash Flow	Discount factor	Present Value
a	b	c=1.15^-a	d=b*c
0	$       -3,00,000	1.0000	$ -3,00,000.00
1	$             50,000	0.8696	$       43,478.26
2	$             55,000	0.7561	$       41,587.90
3	$             60,000	0.6575	$       39,450.97
4	$             60,000	0.5718	$       34,305.19
5	$             65,000	0.4972	$       32,316.49
6	$             65,000	0.4323	$       28,101.29
7	$             70,000	0.3759	$       26,315.59
8	$             70,000	0.3269	$       22,883.12
9	$             75,000	0.2843	$       21,319.68
10	$             75,000	0.2472	$       18,538.85
	Net Present Value	$         8,297.36
c)	Profitability Index	1.03
Working:
Year	Cash Flow	Discount factor	Present Value
a	b	c=1.15^-a	d=b*c
1	$             50,000	0.8696	$       43,478.26
2	$             55,000	0.7561	$       41,587.90
3	$             60,000	0.6575	$       39,450.97
4	$             60,000	0.5718	$       34,305.19
5	$             65,000	0.4972	$       32,316.49
6	$             65,000	0.4323	$       28,101.29
7	$             70,000	0.3759	$       26,315.59
8	$             70,000	0.3269	$       22,883.12
9	$             75,000	0.2843	$       21,319.68
10	$             75,000	0.2472	$       18,538.85
	Total		$   3,08,297.36
Profitability Index	=	Present Value of Cash inflow	/	Investment
		=	$   3,08,297.36	/	$ 3,00,000.00
		=	1.03