Golden Flights, Inc., is considering buying some specializedmachinery that would

Question

Golden Flights, Inc., is considering buying some specializedmachinery that would enable the company to obtain a six-yeargovernment contract for the design and engineering of a futuristicplane. The machinery costs $975,000 and must be destroyed forsecurity reasons at the end of the six-year contract period. Theestimated annual operating results of the project are asfollows:

Revenue from sales under thecontract…………………………

$975,000

Expenses other thandepreciation………………………………

$560,000

Depreciation (straight-linebasis)………………………………

162,500

(722,500)

Increase in net income from governmentcontract…………………………………………………………

$252,500

All revenue from the contract and all expenses (exceptdepreciation) will be received or paid in cash in the same periodas recognized for accounting purposes. You are to compute thefollowing three factors for this project:

(a) Payback period: __________ years

(b) Return on average investment: __________%

(c) Net present value of the investment in this machinery,discounted at an annual rate of 12% (an annuity table shows thatthe present value of $1 received annually for six years discountedat 12% is 4.111): $__________

Revenue from sales under thecontract…………………………

$975,000

Expenses other thandepreciation………………………………

$560,000

Depreciation (straight-linebasis)………………………………

162,500

(722,500)

Increase in net income from governmentcontract…………………………………………………………

$252,500

Explanation / Answer

1. Net Cash Flow = Revenue - Expenses = 975000-560000 =415,000. As Dep is a Non-cash exp, it is written-back. So Payback period = Investment/annual Net Cash flow =975000/415000 = 975000/415000 = 2.3494 years 2. Compound return = (capital / return) ^ (1 / n) - 1 where n= number of years. So Rate of Return = (975000/415000)^(1/6) - 1 = 15.3% 3. NPV = NPV(12%, -975000,415000,..........,415000) =$652,887.54

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