Question

Spanish Peaks Railroad Inc. is considering acquiring equipment at a cost of $480,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $60,000. The company's minimum desired rate of return for net present value analysis is 10%.

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	1.833	1.736	1.690	1.626	1.528
3	2.673	2.487	2.402	2.283	2.106
4	3.465	3.170	3.037	2.855	2.589
5	4.212	3.791	3.605	3.353	2.991
6	4.917	4.355	4.111	3.785	3.326
7	5.582	4.868	4.564	4.160	3.605
8	6.210	5.335	4.968	4.487	3.837
9	6.802	5.759	5.328	4.772	4.031
10	7.360	6.145	5.650	5.019	4.192

Compute the following:

a. The average rate of return, giving effect to straight-line depreciation on the investment. 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	$
Amount to be invested	$
Net present value	$

Check My Work

Answer 1

Cost of Equipment = $480,000
Residual Value = $0
Useful Life = 10 years

Annual Depreciation = (Cost of Equipment - Residual Value) / Useful Life
Annual Depreciation = ($480,000 - $0) / 10
Annual Depreciation = $48,000

Annual Net Income = Annual Net Cash Flows - Annual Depreciation
Annual Net Income = $60,000 - $48,000
Annual Net Income = $12,000

Answer a.

Average Investment = (Cost of Equipment + Residual Value) / 2
Average Investment = ($480,000 + $0) / 2
Average Investment = $240,000

Average Rate of Return = Annual Net Income / Average Investment
Average Rate of Return = $12,000 / $240,000
Average Rate of Return = 5.00%

Answer b.

Payback Period = Initial Investment / Annual Net Cash Flows
Payback Period = $480,000 / $60,000
Payback Period = 8.00 years

Answer c.

Present Value of Annual Net Cash Flows = $60,000 * PVA of $1 (10%, 10)
Present Value of Annual Net Cash Flows = $60,000 * 6.145
Present Value of Annual Net Cash Flows = $368,700

Net Present Value = Present Value of Annual Net Cash Flows - Amount to be Invested
Net Present Value = $368,700 - $480,000
Net Present Value = -$111,300