Question

ben is considering the purchase of new piece of equipment. the cost savings from the equipment would result in an annual increase in net income of $200000. the equipment will have an initial cost of $1200000 and have an 8 year life. the salvage value of the equipment is estimated to be $200000. the hurdle rate is 10%. what is accounting rate of return? b) what is the payback period? c) what is the net present value? d) what would the net pressent value be with the 15% hurdle rate?

Answer 1

Solution a:

Annual increase in nbet income = $200,000

Cost of equipment = $1,200,000

Salvage value = $200,000

Average investment = (Initial investment + Salvage value) / 2 = ($1,200,000 + $200,000) / 2 = $700,000

Average annual income = $200,000

Accounting rate of return = Average annual income / average investment = $200,000 / $700,000 = 28.57%

Solution b:

Annual depreciation = ($1,200,000 - $200,000) / 8 = $125,000

Annual cash inflows = Net Income + Annual depreciation = $200,000 + $125,000 = $325,000

Payback period = Iniital investment / Annual cash inflows = $1,200,000 / $325,000 = 3.69 years

Solution c:

Computation of NPV
Particulars	Amount	Period	PV Factor (10%)	Present Value
Cash Outflows:
Cost of Investment	$1,200,000.00	0	1	$1,200,000.00
Present Value of Cash Outflows (A)				$1,200,000.00
Cash Inflows:
Annual cash inflows	$325,000.00	1-8	5.334926	$1,733,851.01
Salvage Value	$200,000.00	8	0.466507	$93,301.48
Present Value of Cash Inflows (B)				$1,827,152.49
Net Present Value (B-A)				$627,152.49

Solution d:

Computation of NPV
Particulars	Amount	Period	PV Factor (15%)	Present Value
Cash Outflows:
Cost of Investment	$1,200,000.00	0	1	$1,200,000.00
Present Value of Cash Outflows (A)				$1,200,000.00
Cash Inflows:
Annual cash inflows	$325,000.00	1-8	2.506908	$814,745.23
Salvage Value	$200,000.00	8	0.050894	$10,178.72
Present Value of Cash Inflows (B)				$824,923.96
Net Present Value (B-A)				-$375,076.04