World Domination Enterprises is considering the purchase of equipment with a cos

Question

World Domination Enterprises is considering the purchase of equipment with a cost of $800,000, a salvage value

of $100,000, and an estimated useful life of 5 years. World Domination depreciates all equipment using the

straight-line method. Additionally, it expects to be subject to a tax rate of 25% in all 5 years.

World Domination projects the following gross cash flows directly resulting from equipment operations:

Year 1 $ 260,000

Year 2 370,000

Year 3 310,000

Year 4 270,000

Year 5 190,000

World Domination uses a time value of money rate of 9% for decision-making purposes.

A) Calculate the payback period of the investment in the equipment.

B) Calculate the net present value of the investment in the equipment.

C) Calculate the profitability index of the investment in the equipment.

Explanation / Answer

Year Profit before tax Tax @ 25% Profit after tax PVIF @9% PV Cumulative PV 1                  2,60,000           65,000       1,95,000 0.917431193        1,78,899              1,78,899 2                  3,70,000           92,500       2,77,500 0.841679993        2,33,566              4,12,465 3                  3,10,000           77,500       2,32,500 0.77218348        1,79,533              5,91,998 4                  2,70,000           67,500       2,02,500 0.708425211        1,43,456              7,35,454 5                  1,90,000           47,500       1,42,500 0.649931386            92,615              8,28,069                14,00,000       3,50,000     10,50,000        8,28,069 Payback period = 4+(800000-735454/92615) = 4.7 years NPV = /828,069 - 800,000 = 28,069 Profitability index = Present value of future cash flows / Initial investment PI = 828,069 / 800,000 = 1.04

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