Smile photo, inc., is a nationally franchise company with over 50 outlets locate
ID: 2483216 • Letter: S
Question
Smile photo, inc., is a nationally franchise company with over 50 outlets located in the southern states. part of the franchise agreement promises a centralized photo developing process with overnight delivery to the outlets. Because of the tremendous increase in demand for its photo processing, Emma Dubarry, the corporation's president, is considering the purchase of a new, deluxe photo processing machine by the end of this month. Dubarry wants you to formulate a memo showing your evaluation of this purchase. Your memo will be presented at the board of directors' meeting next week. According to your research, the new machine will cost $320,000. It will function for an estimated five years and should have a $32,000 residual value. All capital investments are expected to produce a 20 percent minimum rate of return, and the investment should be recovered in three years or less. All fixed assets are depreciated using the straight-line method. The forecasted increases in operating results for the new machine are as follows: CASH FLOW ESTIMATES Year Cash Inflows Cash Outflows 1 $310,000 $210,000 2 $325,000 $220,000 3 $340,000 $230,000 4 $300,000 $210,000 5 $260,000 $180,000 1. In preparating for writing your memo, answer the following questions: a. What kinds of information do you need to prepare this memo? b. Why is the information relevant? c. Where would you find the information? d. When would you want to obtain the information? 2. Analyze the purchase of the machine and d
decide if the company should purchase it. Use (a) the net present value method, (b) the accounting rate-of-return method, and (c) the payback period method. 3. What is the profitability index of the project? 4. What is the IRR of the project?
Explanation / Answer
(1) Net Present Value
Year
Net Cash Inflows ($)
Discount Factor @ 20%
Present Value
1
310000
0.8333
258323
2
325000
0.6944
225680
3
340000
0.5787
196758
4
300000
0.4823
144690
5
260000
0.4019
104494
Total
929945
Present Value of net cash inflows = $929945
Add : Residual Value = $32000 * 0.4091 =$13091
Less : Initial Investment = $320000
NPV = $623036
(2) Accounting Rate of Return for the investment
Average Income
Year
Net Income ($)
1
310000
2
325000
3
340000
4
300000
5
260000
Total
1535000
Average Income = $1535000 / 5
=$307000
Initial Investment = $320000
Annual Rate of Return = (Average Income / Average Investment) * 100
=($307000 / $320000) * 100
= 95.94 %
Year
Cash Inflow ($)
Cumulative Cash Inflow ($)
1
310000
310000
2
325000
635000
3
340000
975000
4
300000
1275000
5
260000
1535000
Pay Back Period = 1 Year + ($320000 - $310000) * 12
$310000
= 1 Year + $10000 * 12
$310000
= 1 Year + 0.38
= 1 Year
Year
Net Cash Outflow ($)
Discount Factor @ 20%
Present Value ($)
1
210000
0.8333
174930
2
220000
0.6944
152768
3
230000
0.5787
133101
4
210000
0.4823
101283
5
180000
0.4019
72342
Total
634424
Present Value of Cash Outflow = $634424
Profitability Index = P.V. Of inflow / P.V. Of outflow
=$641945 / $634424
= 1.01
Year
Net Cash Inflows ($)
Discount Factor @ 10%
Present Value
1
310000
0.909
281790
2
325000
0.826
268450
3
340000
0.751
255340
4
300000
0.683
204900
5
260000
0.621
141460
Total
1151940
Present Value of net cash inflows = $1151940
Add : Residual Value = $32000 * 0.621
=$19872
Less : Initial Investment = $320000
NPV @10% = $851812
NPV @20% = $623036 (as above calculation)
IRR = 10 % + NPV @ 10% * Difference Rate
Total diff
= 10% + $851812 * 10%
$228776
= 10% + 3.72 %
= 10.37 %
Year
Net Cash Inflows ($)
Discount Factor @ 20%
Present Value
1
310000
0.8333
258323
2
325000
0.6944
225680
3
340000
0.5787
196758
4
300000
0.4823
144690
5
260000
0.4019
104494
Total
929945
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