Question

Ursus, Inc., is considering a project that would have a eleven-year life and would require a $1,848,000 investment in equipment. At the end of eleven years, the project would terminate and the equipment would have no salvage value. The project would provide net operating income each year as follows (Ignore income taxes.):

Sales				$	2,100,000
Variable expenses					1,400,000
Contribution margin					700,000
Fixed expenses:
Fixed out-of-pocket cash expenses	$	370,000
Depreciation		168,000			538,000
Net operating income				$	162,000

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using the tables provided.

All of the above items, except for depreciation, represent cash flows. The company's required rate of return is 9%.

Required:

a. Compute the project's net present value. (Round your intermediate calculations and final answer to the nearest whole dollar amount.)

b. Compute the project's internal rate of return. (Round your final answer to the nearest whole percent.)

c. Compute the project's payback period. (Round your answer to 2 decimal place.)

d. Compute the project's simple rate of return. (Round your final answer to the nearest whole percent.)

Answer 1

Solution : (a.) Computation of Project's net present value

  

Year	Initial cash outflow	Net operating income	Depreciation	Net cash inflow	present value factor (9%)	present value
0	$1,848,000				1	($1,848,000)
1-11		$162,000	$168,000	$330,000	6.805	$2,245,650
	Project's net present value					$397,650

(b.) Computation of Project's internal rate of return

Year	Initial cash outflow	Net cash inflow	present value factor (9%)	present value	present value factor (15%) (Assume)	present value
0	$1,848,000		1	($1,848,000)	1	($1,848,000)
1-11		$330,000	6.805	$2,245,650	5.234	$1,727,220
	Project's net present value			$397,650		($120,780)

Internal rate of return = 9% - (15%-9%) x 397,650 = 9% - 3% = 6%

397,650+120,780

(c.) Computation of project's payback period

payback period = initial investment / cash inflow per year

= $1,848,000/ $330,000

= 5.6 years

(d.) project's simple rate of return

simple rate of return = net operating income/ initial investment x100

= $162,000/ $1,848,000 x 100

= 8.766% = 9%