P9-7 Net Present Value, Internal Rate of Return, Payback, Accounting Rate of Ret
ID: 2349983 • Letter: P
Question
P9-7
Net Present Value, Internal Rate of Return, Payback, Accounting Rate of Return, and Taxes [LO 2, 3, 4, 6]
Adrian Sonnetson, the owner of Adrian Motors, is considering the addition of a paint and body shop to his automobile dealership. Construction of a building and the purchase of necessary equipment is estimated to cost $800,000 and both the building and equipment will be depreciated over 10 years using the straight-line method. The building and equipment have zero estimated residual value at the end of 10 years. Sonnetson’s required rate of return for this project is 12 percent. Net income related to each year of the investment is as follows:
Revenue $500,000
Less:
Material cost 70,000
Labor 150,000
Depreciation 80,000
Other 10,000
Income before taxes 190,000
Taxes at 40% 76,000
Net income $114,000
Determine the net present value of the investment in the paint and body shop. (Round the present value factor calculations to 4 decimal places, e.g. 0.2525. Round all other calculations the final answer to 2 decimal places, e.g. 25.21.)
Net present value = $ ___________
Should Sonnetson invest in the paint and body shop?
No or Yes
Calculate the internal rate of return of the investment (approximate). (Round the present value factor calculations to 4 decimal places, e.g. 0.2525. Round your final answer to 0 decimal places, e.g. 10%.)
Internal rate of return = %
Calculate the payback period of the investment. (Round the answer to 1 decimal place, e.g. 25.1.)
Payback period years
Calculate the accounting rate of return. (Round the answer to 0 decimal places, e.g. 10%.)
Accounting rate of return = %
AE10-15
Flexible Budget [LO 2,3]
Expected manufacturing costs for Imperial Data Devices are as follows:
Variable Costs Fixed Costs per Month
Direct material $7.50/unit Supervisory salaries $21,000
Direct labor 4.00/unit Factory depreciation 11,000
Variable overhead 1.90/unit Other factory costs 3,300
Estimate manufacturing costs for production levels of 13,000 units, 16,000 units, and 18,500 units per month.
13,000 units $ __________
16,000 units $ ___________
18,500 units $ ____________
Explanation / Answer
a. The net present value is positive $296,138.80. Thus the company should invest in the paint and body shop.
Add depreciation 80,000
Annual cash flow $194,000
Cash Present Value
$194,000 5.6502 $1,096,138.80
(800,000) 1.0000 (800,000.00)
$ 296,138.80
b. A present value of an annuity factor of 4.1237 implies an IRR of approximately 20 percent.
Initial outlay $800,000
Annuity amount 194,000
Note—the annuity factor for 20% is 4.1925.
c. The payback period is approximately 4.1 years:
Initial outlay $800,000
Annual cash flow 194,000
Cost ÷ annuity = number of years to
recover initial investment 4.1237
d. The accounting rate of return is approximately 29%:
Average income $114,000
Average investment
($800,000 ÷ 2) 400,000
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