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ID: 2468591 • Letter: L
Question
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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 $646,000 Less: Material cost 68,700 Labor 149,000 Depreciation 80,000 Other 10,000 Income before taxes 338,300 Taxes at 40% 135,320 Net income $202,980
Explanation / Answer
Net income $202,980
Add depreciation $80,000
Annual cash flow $282,980
Cash Present Value
Flow Factor @ 12% Total
$282,980 5.6502 $1,598,893.60
(800,000) 1.0000 (800,000.00)
$798,893.60
b.
Year
Cashflow
0
(800,000)
1
282,980
2
282,980
3
282,980
4
282,980
5
282,980
6
282,980
7
282,980
8
282,980
9
282,980
10
282,980
IRR
33.39%
c.The payback period is approximately 4.1 years:
Initial outlay $800,000
Annual cash flow $282,980
Cost ÷ annuity = number of years to
recover initial investment 2.83 years
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d. The accounting rate of return is approximately 29%:
Average income $202,980
Average investment ($800,000 ÷ 2) $400,000
Average income ÷ average investment
=accounting rate of return 50.75%
Year
Cashflow
0
(800,000)
1
282,980
2
282,980
3
282,980
4
282,980
5
282,980
6
282,980
7
282,980
8
282,980
9
282,980
10
282,980
IRR
33.39%
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