Payback, Accounting Rate of Return, Net Present Value, Internal Rate of Return F

Question

Payback, Accounting Rate of Return, Net Present Value, Internal Rate of Return

Follow the format shown in Exhibit 14B-1 and Exhibit 14B-2 as you complete the requirements below.

Booth Company wants to buy a numerically controlled (NC) machine to be used in producing specially machined parts for manufacturers of tractors. The outlay required is $960,000. The NC equipment will last 5 years with no expected salvage value. The expected after-tax cash flows associated with the project follow:

Required:

1. Compute the payback period for the NC equipment. Round your answer to two decimal places.
______ years

2. Compute the NC equipment's ARR. Round the percentage to one decimal place.
______%

3. Compute the investment's NPV, assuming a required rate of return of 10%. Round present value calculations and your final answer to the nearest dollar.
______$

4. Compute the investment's IRR.

_______

Year Cash Revenues Cash Expenses 1 $1,275,000 $900,000 2   1,275,000   900,000 3   1,275,000   900,000 4   1,275,000   900,000 5   1,275,000   900,000

Explanation / Answer

Net cash flow = cash revenues - cash expenses.

= 1275000 - 900000 = $375,000 per year.

1. Payback is the length of time that is required to recover the initial outlay. The initial outlay here is $960,000

payback = initial outlay/net cash inflow each year

= 960,000/375,000 = 2.56 years

2. Accounting rate of return = profit/book value of the investment

Cost of the equipment = 960,000 and time period = 5 years. Depreciation (assuming a straight line method) = cost/life in years = 960,000/5 = 192,000

Book value = opening value - depreciation. book value at the end of year 1 = 960,000 - 192,000 = 7,68,000. book value at the end of year 2 = 768000-1920000 = 576,000

Each year's profit = 375,000.

Thus ARR = [1/5*(375,000*5)]/[1/5*(768000+576000+384000+192000+0)]

= 375,000/384,000 = 97.7%

3. NPV = sum of all present values (pv). PV = amount of cash flow/(1+rate)^n, where n is the year in which the cash flow happens.

Thus NPV = $461,545

4. IRR is the rate which will make the NPV as nil.

It has to be calculated using trial and error approach.

Thus 1+IRR = 1.2744336

or IRR = 0.274436 or 27.4436%

Year Net cash flow Book value 1 375000 768000 2 375000 576000 3 375000 384000 4 375000 192000 5 375000 0

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