Question

The FAX of Life Company is considering the purchase of 100 FAX machines which will be leased to a convenience store chain. Individual convenience stores will then charge a small fee for the use of the machine by customers. The FAX machines will cost $70,000 and will be sold at the end of four years for the estimated $16,000 salvage value. The annual cash inflow from leasing the machines is expected to be $20,000. The income tax rate is 25%. The cost of capital is 12%.

Calculate the answer for each of the following capital budgeting methods. 1. Net Present Value 2. Internal Rate of Return 3. Payback Period 4. Accountant's Rate of Return

Answer 1

Depreciation per year = $70000-16000/4 years
	=$13500
Calculation of net income and annual cash flow after tax
	Annual Cash Inflow	$         20,000
	Less: Depreciation	$         13,500
	Income Before tax	$           6,500
	Less Tax @25%	$           1,625
	Net Income	$           4,875
	Add: Depreciation	$         13,500
	Net Cash Flow After Tax	$         18,375
1)	Net Present Value
a	Annual net cash inflow	$         18,375
b	PV Annuity Factor (4 years,12%)	3.0373
c	PV of annual cash flow (a*b)	$   55,811.29
d	Salvage Value	$         16,000
e	PV Factor for 4th year	0.63552
f	PV of Salvage Value (d*e)	$   10,168.29
g	Initial Investment	$         70,000
h	NPV (c+f-g)	$   -4,020.42
2)	Internal Rate Of Return
	Using excel function IRR =9.51%
3)	Payback period
	= initial investment / Annual cash inflow
	=$70000/18375
	=3.81 years
4)	Average Investment = Cost+ salvage Value /2
	=($70000+16000)/2
	=$43000
	Accountant rate of return = Net Income / Average Investment
	=$4875/43000
	11.34%
Let me know the wrong answer if any. I can correct it.