Wallowa Company is considering a long-term investment project called ZIP. ZIP wi
ID: 2491413 • Letter: W
Question
Wallowa Company is considering a long-term investment project called ZIP. ZIP will require an investment of $119,480. It will have a useful life of 4 years and no salvage value. Annual revenues would increase by $79,440, and annual expenses (excluding depreciation) would increase by $39,160. Wallowa uses the straight-line method to compute depreciation expense. The company’s required rate of return is 14%. Compute the annual rate of return. (Round answer to 0 decimal places, e.g. 15%.) Annual rate of return % Determine whether the project is acceptable?
Explanation / Answer
Given invesment made =$119,480.---------(A)
Useful life of the project =4 years.
Salvage value=0.
Increase in revenue =$79,440
Increase in annual expenses =$39,160.
Depreciation expense is as follow:
Formula for straight line depreciation = (cost - salvage value)/life of the asset
=($119480 - 0)/4
=$29,870 is the annual depreciation.
Incremental return = Increment revenue - Incremental costs- Depreciation.
=$79,440 -$39,160-$29,870
=$10,410.-------------(B)
Annual return on investment = Annual return/Investment *100
=$10,140/$119,480*100
=8.713%.
Annual rate of return from the project is less than the required rate of return of the company which is 14%. Hence, the project is not acceptable.
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