34. Determining net present value Callaghan Company is considering investing in
ID: 2497293 • Letter: 3
Question
34. Determining net present value
Callaghan Company is considering investing in two new vans that are expected to generate combined cash inflows of $28,500 per year. The vans’ combined purchase price is $95,500. The expected life and salvage value of each are five years and $21,900, respectively. Callaghan has an average cost of capital of 14 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)
Calculate the net present value of the investment opportunity. (Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal places.)
Net present value ( )
Indicate whether the investment opportunity is expected to earn a return that is above or below the cost of capital.
Based on your answer in Requirement b-1, should the investment opportunity be accepted.
( ) Accepted of ( ) Rejected
Callaghan Company is considering investing in two new vans that are expected to generate combined cash inflows of $28,500 per year. The vans’ combined purchase price is $95,500. The expected life and salvage value of each are five years and $21,900, respectively. Callaghan has an average cost of capital of 14 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)
Explanation / Answer
Cash Inflow from Two vans = $28500, Purchase price = 95500, Expected life =5 years
Salvage = 21900 * 2 = 43800, Cost of capital 14%
Note Salvage value of one Van is 21900
Answer (a)
Present value annuity factor (14%,5 years) = 3.43308
Present value factor (14%,5%) =0.51936
Present value of cash inflows = 28500 * 3.43308 + 43800 * 0.51936 = 120590.75
Less Purchase Price = 95500
Net Present value = 120590.75 – 95500 = 25090.75
Net Present value 25090.75.
Answer (b)
whether the investment opportunity is expected to earn a return that is above or below the cost of capital is determined by IRR.
Calculating IRR
We know that at 14% we will have NPV of 25090.75. So we need to increase the rate such that it produces Zero NPV.
From Present value table we can derive that discounting cash flows at 22.98% we get a NPV of zero.
Where PVAF = 2.80466 and Present value factor = 0.3555
Present value of cash inflows = 28500 * 2.80466 + 43800 * 0.3555 = 95500(approx)
So IRR is 22.98% and required rate of return is 14% which means project is expected to provide a return which is above its cost of capital.
Answer B-1 : (ABOVE)
Answer B-2 : (ACCEPTED)
Since IRR is expected to produce a return more than its cost of capital so the project is viable option and should be expected.
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