Ursus, Inc. is considering a project that would have a ten-year life and would r

Question

Ursus, Inc. is considering a project that would have a ten-year life and would require a $2,000,000 investment in equipment. At the end of ten years, the project would terminate and the equipment would have no salvage value. The project would provide net income each year as follows:

Sales

$2,000,000

Less: Variable Expenses

$1,400,000

Contribution Margin

$   600,000

Less: Fixed Expenses

$   400,000

Net Income

$   200,000

All of the above items, except for depreciation of $200,000 a year, represent cash flows. The depreciation is included in the fixed expenses. The company's required rate of return is 12%. (Ignore income taxes in this problem.

Required:

a) What is the project's net present value?

b) What is the project's internal rate of return?

c) What is the project's payback period

d) What is the project's simple rate of return?

Sales

$2,000,000

Less: Variable Expenses

$1,400,000

Contribution Margin

$   600,000

Less: Fixed Expenses

$   400,000

Net Income

$   200,000

Explanation / Answer

Investment = 20,00,000

Annual cash Flows = $ 400000 (200000+200000)

Period = 10 years

Required rate of return = 12%

a) Net Present Value = $400000*5.651 - 2000000

= $ 260400

c) Payback Period = 2000000/ 400000 = 5 years

d) Simple rate of return = 200000/2000000

= 10%

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