Lamar Company is considering a project that would have an eight-year life and re

Question

Lamar Company is considering a project that would have an eight-year life and require a $2,700,000 investment in equipment. At the end of 7 years, the project would terminate and the equipment would have no salvage value. The project would provide net operating income each year as follows: The company’s discount rate is 11%. Sales…………………………………………………………………………………………………… $3,000,000 Variable expenses……………………………………………………………………………… 1,800,000 Contribution margin………………………………………………………………………….. 1,200,000 Fixed expenses Adverting, salaries, and other fixed out-of-pocket costs…… $600,000 Depreciation…………………………………………………………………….. 355,000 Total fixed expenses………………………………………………………………………. 955,000 Net Operating Income……………………………………………………………………. $245,000 A. Compute the net annual cash inflow from the project. B. Compute the project’s net present value. Is the project acceptable? C. Find the project’s internal rate of return to the nearest whole percent. D. Compute the project’s payback period. E. Compute the project’s simple rate of return.

Explanation / Answer

Annual Cashflows Sales 30000000 Variable cost -1800000 Contribution 1200000 Fixed costs -600000 Annual Cashflows 600000 Year Particulars Cashflow Disc factor @11% Discounted Cashflow 0 investment -2700000 1 -2700000 1 Annual Cashflows 600000 0.900900901 540540.5405 2 Annual Cashflows 600000 0.811622433 486973.4599 3 Annual Cashflows 600000 0.731191381 438714.8288 4 Annual Cashflows 600000 0.658730974 395238.5845 5 Annual Cashflows 600000 0.593451328 356070.7968 6 Annual Cashflows 600000 0.534640836 320784.5017 7 Annual Cashflows 600000 0.481658411 288995.0465 NPV 127317.7588 Since NPV is positive and hence the project is viable Year Particulars Cashflow Disc factor @12.5% Discounted Cashflow 0 investment -2700000 1 -2700000 1 Annual Cashflows 600000 0.888888889 533333.3333 2 Annual Cashflows 600000 0.790123457 474074.0741 3 Annual Cashflows 600000 0.702331962 421399.177 4 Annual Cashflows 600000 0.624295077 374577.0462 5 Annual Cashflows 600000 0.554928957 332957.3744 6 Annual Cashflows 600000 0.493270184 295962.1106 7 Annual Cashflows 600000 0.438462386 263077.4316 -4619.452896 For increase of 1.5% , NPV changes by 127318+4619 = 131937 for change of 4619 , NPV should be = 12.5%-(4619*1.5%/131937)= 12.45% So IRR = 12.45% Projects simple rate of return = ((600000*7)-2700000)/2700000*100 /7= 7.93%

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