Question

a taxpaying​ entity, estimates that it can save $23,000 a year in cash operating costs for the next 8 years if it buys a​ special-purpose eye-testing machine at a cost of $ 90000 No terminal disposal value is expected. Seattle Hospital's required rate of return is 12%. Assume all cash flows occur at​ year-end except for initial investment amounts. Seattle Hospital uses​ straight-line depreciation. The income tax rate is 28% for all transactions that affect income taxes.

1.	Calculate the following for the​ special-purpose eye-testing​ machine:
	a.	Net present value
	b.	Payback period
	c.	Internal rate of return
	d.	Accrual accounting rate of return based on net initial investment
	e.	Accrual accounting rate of return based on average investment
2.	How would your computations in requirement 1 be affected if the​ special-purpose machine had a $14,000 terminal disposal value at the end of 8​years? Assume depreciation deductions are based on the $90,000 purchase cost and zero terminal disposal value using the​ straight-line method.

Answer 1

Ans 1
a) NPV
Saving in Cash operating cost	$23,000
Less: depreciation (90000/8)	-11250
Income before taxes	$11,750
Taxes at @28%	$3,290
Net Income	$8,460
Add: Depreciation	11250
Cash flow from operation	$19,710
Net Cash Inflow	$19,710
PVIFA(12%,8)	4.9676
PV of cash inflow	$97,911.40
Less: initial Investment	90000
NPV	$7,911.40
rounded off	$7,911
ans b
Payback Period
90000/19710	4.566	years
	4.57	rounded off
ans c
IRR is where NPV is $0
We assume 14.47% rate
Net Cash Inflow	$19,710
PVIFA(12%,14.47)	4.566
PV of cash inflow	$89,995.86
Less: initial Investment	90000
NPV	($4.14)
rounded off	($4)
IRR=14.47%
ansd
ARR=Net Income/Initail investment	9.40	%
8460/90000*100
ans e
ARR=Net Income/NEt investment	18.80	%
8460/45000*100
ans 2
a) NPV
Saving in Cash operating cost	$23,000
Less: depreciation (90000/8)	-11250
Income before taxes	$11,750
Taxes at @28%	$3,290
Net Income	$8,460
Add: Depreciation	11250
Cash flow from operation	$19,710
Net Cash Inflow	$19,710
PVIFA(12%,8)	4.9676
PV of cash inflow	$97,911
salvage value	$14,000
PVIF(12%,8)	0.4039
PV of salvage value	5654.3
Total PV	$103,566
Less: initial Investment	90000
NPV	$13,565.72
rounded off	$13,566
ans b
Payback Period
90000/19710	4.566	years
	4.57	rounded off
ans c
IRR is where NPV is $0
We assume 14.47% rate
Net Cash Inflow	$19,710
PVIFA(15.56%,8)	4.3492
PV of cash inflow	$85,722.67
salavage value	$14,000.00
PVIF(15.56%,8)	0.3059
PV of salvage value	4282.2
Total PV	$90,005
Less: initial Investment	90000
NPV	$4.82
rounded off	$5
IRR=15.96%
ansd
ARR=Net Income/Initail investment	9.40	%
8460/90000*100
ans e
ARR=Net Income/Average investment	16.27	%
8460/52000*100
Avg investment=(90000+14000)/2	52000