Adrian Sonnetson, the owner of Adrian Motors, is considering the addition of a p

Question

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 $803,000, 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:

1.Determine the net present value of the investment in the paint and body shop.

2.Calculate the payback period of the investment

3.Calculate the accounting rate of return

Revenue $647,000 Less:     Material cost 69,100     Labor 152,000     Depreciation 80,300     Other 11,000 Income before taxes 334,600 Taxes at 40% 133,840 Net income $200,760

Explanation / Answer

Payback Period = Cash Outflows/ Annual Cash Inflows

= 803000/(200760+80300) i.e 2.85 years

Particulars Year PVF @ 12% Cash Flow Present Value Installed Cost 0 1 803000 803000 PV of cash outflws 803000 Annual Income 1 to 10 5.6502 200760     11,34,334 Depreciation 1 to 10 5.6502 80300       4,53,711 Present Value of cash Inflows     15,88,045 Net Present Value       7,85,045

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