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 $750,000 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.)

Tranter, Inc., is considering a project that would have a five-year life and would require a $750,000 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.)

Explanation / Answer

a. Cash flows per year = Net Income + Depreciation = 110000 + 140000 = $250000

NPV = Present Value of Cash inflows - Initial investment

= 250000 x 4.100 - 750000

= $275000

b. NPV @ 15% = 250000 x 3.352 - 750000 = $88000

NPV @ 20% = 250000 x 2.991 - 750000 = -$2250

IRR = Lower rate + [Lower rate NPV / (Lower rate NPV - Higher rate NPV)]

= 15 + [88000 / (88000 + 2250)]

= 15 + 0.98

= 16%

c. Payback period = 750000/ 250000 = 3 years

d. Investment = 750000

Per year = 750000/5 = $150000

Simple rate of return = Net income / Investment

= 110000 / 150000 x 100

= 73

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