Question

Bi-Coastal Railroad Inc. is considering acquiring equipment at a cost of $384,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $48,000. The company’s minimum desired rate of return for net present value analysis is 10%.
Present Value of an Annuity of $1 at Compound InterestYear6%10%12%15%20%10.9430.9090.8930.8700.83321.8331.7361.6901.6261.52832.6732.4872.4022.2832.10643.4653.1703.0372.8552.58954.2123.7913.6053.3532.99164.9174.3554.1113.7853.32675.5824.8684.5644.1603.60586.2105.3354.9684.4873.83796.8025.7595.3284.7724.031107.3606.1455.6505.0194.192
Compute the following:
a. The average rate of return, assuming the annual earnings are equal to the net cash flows less the annual depreciation expense on the equipment. If required, round your answer to one decimal place.
%
b. The cash payback period.
  years
c. The net present value. Use the above table of the present value of an annuity of $1. Round to the nearest dollar. If required, use a minus sign to indicate negative net present value" for current grading purpose.
Present value of annual net cash flows$Less amount to be invested$Net present value$

Answer 1

A) Average rate of return

Average rate of return is the amount of income which is earned over the life of the investment. It is used to measure the average income as a percent of the average investment of the business, and it is also known as the accounting rate of return.

Average rate of return = Estimated average annual income / Average Investment

= $ 9600 / $ 192000 = 5%

Explanation :

Estimated average annual income = Net Cash flows - Depreciation

= $ 48000 - $ 38400 = $ 9600

Average Investment = $ 384000 / 2 = $ 192000

Depreciation = Cost of Equipment - Residual Value / Useful life of asset

= $ 384000 - $ 0 / 10 = $ 38400

b) Cash back period

Cash back period is the expected time period which is required to recover the cost of investment. It is one of the capital investment method used by the management to evaluate the long term investment of the business.

Cash back Period = Initial Investment / Net annual cash inflow

= $ 384000 / $ 48000

= 8 years

c) Net Present Value

Net Present Value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value , the interest rate is desired by the business based on the net income from the investment , and it is also called the discounted cash flow method.

Net Present Value = Present value of cash inflows - Initial cash outflow of investment

= $ 294960 - $ 384000 = ($ 89040)

Discounted Rate = 10%

Present Value of Annuity ( 10 years , 10%) = 6.14457

Cash inflow = $ 48000

Present value of cash inflow = $ 48000 x 6.145 = $ 294960