Question

Basic Concepts

Roberts Company is considering an investment in equipment that is capable of producing more efficiently than the current technology. The outlay required is $2,200,000. The equipment is expected to last five years and will have no salvage value. The expected cash flows associated with the project are as follows:

Year	Cash Revenues	Cash Expenses
1	$2,960,000	$2,300,000
2	2,960,000	2,300,000
3	2,960,000	2,300,000
4	2,960,000	2,300,000
5	2,960,000	2,300,000

The present value tables provided in Exhibit 19B.1 and Exhibit 19B.2 must be used to solve the following problems.

Required:

1. Compute the project’s payback period. If required, round your answer to two decimal places.
years

2. Compute the project’s accounting rate of return. Enter your answer as a whole percentage value (for example, 16% should be entered as "16" in the answer box).
%

3. Compute the project’s net present value, assuming a required rate of return of 10 percent. When required, round your answer to the nearest dollar.
$

4. Compute the project’s internal rate of return. Enter your answers as whole percentage values.

Between  % and  %

Answer 1

Solution 1:

Annual cash inflows = Cash revenues - cash expenses = $2,960,000 - $2,300,000 = $660,000

Payback period = Initial investment / annual cash inflows = $2,200,000 / $660,000 = 3.33 years

Solution 2:

Annual operating income = Annual cash inflows - Depreciation = $660,000 - ($2,200,000 / 5) = $220,000

Accounting rate of return = Annual operating income / Initial investment = $220,000 / $2,200,000 = 10%

Solution 3:

Computation of NPV - Roberts Company
Particulars	Period	Amount	PV factor at 10%	Present Value
Cash outflows:
Initial investment	0	$2,200,000.00	1	$2,200,000
Present Value of Cash outflows (A)				$2,200,000
Cash Inflows
Annual cash inflows	1-5	$660,000.00	3.7910	$2,502,060
Present Value of Cash Inflows (B)				$2,502,060
Net Present Value (NPV) (B-A)				$302,060

Solution 4:

Present value factor at IRR = Initial investment / Annual cash inflows = $2,200,000 / $660,000 = 3.333

Refer PV factor table at period 5, this factor falls between 15% and 16%

Hence project IRR lies between 15% and 16%