Question

Curtis industries is considering the purchase of a new machine. It will cost $80,000, last for 8 years, and have a residual value of $10,000. If purchased, the machine is expected to increase cash inflows by $80,000 per 8 years, with $64,000 per year for 8 years in additional cash outlays required to operate the machine. The company uses the straight-line method of depreciation, and desires a 12% minimum rate of return.

The present value factors of $1 due eight years from now:

8%              .540

10%            .467

12%            .404

14%            .351

The present value factors for an annuity of $1 per year due at the end of each of eight years:

8%             5.747

10%            5.335

12%            4.968

14%            4.639

Q#1. Determine the payback period.

Q#2. Determine the internal rate of return of this investment (to the nearest whole percentage)

Q#3. Determine the net present value of this investment at the desired minimum rate of return

Q#4. Determine the accounting rate of return of this investment.

THANK YOU!

Answer 1

1)	Payback period = Initial investment/Annual net cash inflows = 80000/(80000-64000) =	5 Years
2)	IRR is that discount rate for which NPV = 0
	That is
	-80000+16000*PVIFA(irr,8)+10000*PVIF(irr,8) = 0
	The value of irr is to be found out by trial and error, by using different
	discount rates such that NPV is zero.
	Using 12%
	-80000+16000*4.968+10000*0.404 =	3528
	Using 14%
	-80000+16000*4.639+10000*0.351 =	-2266
	IRR lies between 12% and 14%.
	The value of IRR can be found by simple interpolation as below:
	IRR = 10+2*3528/(3528+2266)=	11.22%
3)	NPV = -80000+16000*PVIFA(12,8)+10000*PVIF(12,8) = 0
	-80000+16000*4.968+10000*0.404 =	3528
4)	Accounting rate of return = Annual net income/Initial investment = (16000-70000/8)/80000 =	9.06%
	OR
	Accounting rate of return = Annual net income/Average investment = (16000-70000/8)/((80000+10000)/2)) =	16.11%