LR Investment Corporation is considering investing in one of the following four
ID: 2482366 • Letter: L
Question
LR Investment Corporation is considering investing in one of the following four investment opportunities proposed in the table below.
Data
Alt. A
Alt. B
Alt. C
Alt. D
Initial cost, $
400,000
100,000
500,000
200,000
Annual costs, $
900
12,000
23,000
9,000
Annual benefits, $
101,800
39,700
148,200
55,200
Life, years
5
5
5
5
A-Use incremental Rate of Return Analysis to determine the most economical alternative assuming a minimum attractive rate of return of 6%.
B-Develop the depreciation schedule for the best alternative using the MARCS method.
Data
Alt. A
Alt. B
Alt. C
Alt. D
Initial cost, $
400,000
100,000
500,000
200,000
Annual costs, $
900
12,000
23,000
9,000
Annual benefits, $
101,800
39,700
148,200
55,200
Life, years
5
5
5
5
Explanation / Answer
Data Alt. A $ Alt. B $ Incremental NCF ($) Initial cost, $ -4,00,000 -1,00,000 -3,00,000 Annual costs, $ (for 5 years) -4,500 -60,000 55,500 Annual benefits, $ (for 5 years) 5,09,000 1,98,500 3,10,500 Increamental Rate of Return = ( 310,500+55,500-300,000) / 300,000 = 0.22 or 22% Data Alt. A $ Alt. C Incremental NCF ($) Initial cost, $ -4,00,000 -5,00,000 -1,00,000 Annual costs, $ (for 5 years) -4,500 -1,15,000 -1,10,500 Annual benefits, $ (for 5 years) 5,09,000 7,41,000 2,32,000 Increamental Rate of Return = ( 232,000-110,500-100,000) / 100,000 = 0.215 or 21.5% Data Alt. A $ Alt. D Incremental NCF ($) Initial cost, $ -4,00,000 -2,00,000 -2,00,000 Annual costs, $ (for 5 years) -4,500 -45,000 -40,500 Annual benefits, $ (for 5 years) 5,09,000 2,76,000 2,33,000 Increamental Rate of Return = ( 233,000-40,500-200,000) /200,000 = 0.0375 or 3.75% A $ B $ C $ D $ Total Cash inflow 1,00,900 27,700 1,25,200 46,200 Initial cost 5,04,500 1,38,500 6,26,000 2,31,000 Profitability index 1.26 1.39 1.25 1.16 Alternative A is preferable because it has more profitability index compared to others (ie 1.39) Depreciation under MACRS for Alt. B Year Depreciation $ Calculation Using Formula Year 1 40,000 $100,000 × 1/5 × 200% Year 2 24,000 ($100,000-$40,000) × 1/5 × 200% Year 3 24,000 Note A Year 4 6,000 Year 5 6,000 Note A: MACRS declining balance changes to straight-line method when that method provides an equal or greater deduction. Deduction under 200% declining balance MACRS for year 3 would be $14,40 ($100,000 - $40,000 - $24,000) × 1/5 × 200%. This is lower than depreciation under straight line method over the remaining recovery period which comes out to be $ ($100,000 - $40,000 - $24,000) × 1/1.5).
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