Tranter, Inc., is considering a project that would have a five-year life and wou

Question

Tranter, Inc., is considering a project that would have a five-year life and would require a $1,650,000 investment in equipment. At the end of five years, the project would terminate and the equipment would have no salvage value. The project would provide net operating income each year as follows: (Ignore income taxes.)

All of the above items, except for depreciation, represent cash flows. The company's required rate of return is 14%.

Compute the project's net present value. (Negative amount should be indicated by a minus sign. Round discount factor(s) to 3 decimal places, intermediate and final answers to the nearest dollar amount. Omit the "$" sign in your response.)

Compute the project's internal rate of return to the nearest whole percent. (Round discount factor(s) to 3 decimal places and final answer to the nearest whole percent. Omit the "%" sign in your response.)

  Sales $ 2,600,000   Variable expenses 1,650,000   Contribution margin 950,000   Fixed expenses:   Fixed out-of-pocket cash expenses $ 400,000   Depreciation 280,000 680,000   Net operating income $ 270,000

Explanation / Answer

Annual Cash Flow = 270000 + 280000 = 550000

Time = 5 years

Project NPV = Present Value of cash inflow - 1650000

Present Value of cash Inflow = 550000 * PVIFA( 5 yr,14%) = 550000 * 3.4331= 1888150

NPV = 1888150 - 1650000 = 238150

For computing IRR, present value of cash inflows must equal 1650000

So, 550000 * PVIFA( 5 yr, X%) = 1650000

Or PVIFA( 5 yr,X%) = 3

Looking at the PVIFA table, we will see that in fifth year , PVIFA of 3 is close to 20%

So IRR = 20%

Total investment recovered till 3 years = 550000 * 3 = 1650000

Total investment cost = 1650000

Payback period = 1650000 / 550000 = 3 years

Simple Interest Rate = 550000 / 1650000 = 33.33

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