Question

Crazy Eight Kolaches owns a chain of breakfast eateries. The company is considering an investment opportunity costing $8,000,000. The investment would yield annual net cash inflows of $1,500,000 for the next eight years. The estimated residual value of the investment is $800,000. Crazy Eight uses straight-line depreciation and requires a payback period of fewer than seven years and an annual rate of return of 8%.

1. What is the payback of the proposed investment?

5.33 years

8000000/1500000

2. What is the accounting rate of return (ARR) of the proposed investment?

13.64%

3. What is the net present value (NPV) of the proposed investment?

$1,052,500

4. What is the internal rate of return (IRR) of the proposed investment (to the nearest whole percent)?

10%

Answer 1

a)

Payback Period:
Payback period = Initial Investment / Annual Cash Flow
= $8000000 /1500000
= $5.33 years

b)

Accoutning Rate Of Return (ARR):
Annual Depreciaiton =Cost - Salvage Value / Life of Asset
= ( $8000000 -800000 ) /8 years
= $ 900000 per year
Annual Net Income = Annual Cash Flow - Depreciation
= $1500000-900000
= $600000
Average Investment = (Intial Investment + Salvage Value )/2
= ( $8000000 + 800000 ) / 2
= $ 4400000
Accounting Rate Of Return = Net Income / Average Investment
= $600000 /4400000
= $13.64 %

c)

Net Present Value
	Calculation Of NPV
a	Investment	$       8,000,000
b	annual cash inflow	$       1,500,000
c	PV annuity factor for 8 years and 8 %	5.7466
d	PV of Annual Cash Inflow (b*c)	$       8,619,958
e	Salvage Value	800000
f	PV factor of year 8	0.54027
g	PV Of Salvage Value	432215.1076
h	Net Present Value (d+g-a))	$ 1,052,173.52

d) IRR