Thurman Munster, the owner of Adams Family RVs, is considering the addition of a

Question

Thurman Munster, the owner of Adams Family RVs, is considering the addition of a service center his lot. The building and equipment are estimated to cost $1,100,000 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. Munster’s required rate of return for this project is 12 percent. Net income related to each year of the investment is as follows:

Revenue $450,000
Less:
Material cost $ 60,000
Labor 100,000
Depreciation 110,000
Other 10,000 280,000
Income before taxes 170,000
Taxes at 40% 68,000
Net income $102,000

(a) Determine the net present value of the investment in the service center. Should Munster invest in the service center?
(b) Calculate the internal rate of return of the investment to the nearest ½ percent.
(c) Calculate the payback period of the investment.
(d) Calculate the accounting rate of return.

Explanation / Answer

DCF0 = -1100000/(1+0.12)^0 = -1100000 DCF1 = 102000/(1+0.12)^1 = 91071.43 DCF2 = 102000/(1+0.12)^2 = 81313.78 DCF3 = 102000/(1+0.12)^3 = 72601.59 DCF4 = 102000/(1+0.12)^4 = 64822.84 DCF5 = 102000/(1+0.12)^5 = 57877.54 DCF6 = 102000/(1+0.12)^6 = 51676.37 DCF7 = 102000/(1+0.12)^7 = 46139.62 DCF8 = 102000/(1+0.12)^8 = 41196.09 DCF9 = 102000/(1+0.12)^9 = 36782.22 DCF10 = 102000/(1+0.12)^10 = 32841.27 NPV = -523677.25 Using IRR Calculation tool at http://thinkanddone.com/finance/online-i… IRR = -1.35% f(x) = -1100000(1+i)^0 +102000(1+i)^-1 +102000(1+i)^-2 +102000(1+i)^-3 +102000(1+i)^-4 +102000(1+i)^-5 +102000(1+i)^-6 +102000(1+i)^-7 +102000(1+i)^-8 +102000(1+i)^-9 +102000(1+i)^-10 f'(x) = -102000(1+i)^-2 -204000(1+i)^-3 -306000(1+i)^-4 -408000(1+i)^-5 -510000(1+i)^-6 -612000(1+i)^-7 -714000(1+i)^-8 -816000(1+i)^-9 -918000(1+i)^-10 -1020000(1+i)^-11 x0 = 0.1 f(x0) = -473254.1552 f'(x0) = -2692420.6731 x1 = 0.1 - -473254.1552/-2692420.6731 = -0.0757727386158 Error Bound = -0.0757727386158 - 0.1 = 0.175773 > 0.000001 x1 = -0.0757727386158 f(x1) = 513922.1247 f'(x1) = -10727816.1489 x2 = -0.0757727386158 - 513922.1247/-10727816.1489 = -0.0278671707393 Error Bound = -0.0278671707393 - -0.0757727386158 = 0.047906 > 0.000001 x2 = -0.0278671707393 f(x2) = 95471.8589 f'(x2) = -7049928.8782 x3 = -0.0278671707393 - 95471.8589/-7049928.8782 = -0.0143249264813 Error Bound = -0.0143249264813 - -0.0278671707393 = 0.013542 > 0.000001 x3 = -0.0143249264813 f(x3) = 5190.9012 f'(x3) = -6300312.0919 x4 = -0.0143249264813 - 5190.9012/-6300312.0919 = -0.0135010147313 Error Bound = -0.0135010147313 - -0.0143249264813 = 0.000824 > 0.000001 x4 = -0.0135010147313 f(x4) = 17.494 f'(x4) = -6257904.1977 x5 = -0.0135010147313 - 17.494/-6257904.1977 = -0.0134982192189 Error Bound = -0.0134982192189 - -0.0135010147313 = 3.0E-6 > 0.000001 x5 = -0.0134982192189 f(x5) = 0.0002 f'(x5) = -6257760.8996 x6 = -0.0134982192189 - 0.0002/-6257760.8996 = -0.0134982191869 Error Bound = -0.0134982191869 - -0.0134982192189 = 0 < 0.000001 IRR = x6 = -0.0134982191869 or -1.35% Using Payback period Calculation tool at http://thinkanddone.com/finance/online-p… N###Net Cash Flows###Cumulative Cash Flows 0###-1100000## -1100000 1###102000## -998000 2###102000## -896000 3###102000## -794000 4###102000## -692000 5###102000## -590000 6###102000## -488000 7###102000## -386000 8###102000## -284000 9###102000## -182000 10###102000## -80000 No payback period exist.

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