Harrison Corporation is studying a project that would have an eight-year life an
ID: 2499233 • Letter: H
Question
Harrison Corporation is studying a project that would have an eight-year life and would require a $600,000 investment in equipment which has no salvage value. The project would provide net operating income each year as follows for the life of the project:
Sales: $500,000
Less cash var. expenses: (200,000)
Contribution Margin: 300,000
Less Fixed Expenses:
Fixed Cash Expense:(150,000)
Depreciation Expense:(37,500)
Net Operating Income: 112,500
The company's required rate of return is 10%.
1. Compute the project's net present value. Should management ACCEPT or REJECT the project?
2. Compute the project's internal rate of return to the nearest whole percent.
3. If Harrison Company’s minimum acceptable payback period is 3 years, should management ACCEPT or REJECT the project?
4. Compute the project's simple rate of return.
Explanation / Answer
SOLUTION :
1. NPV
net operting income
112500
add : depreciation
37500
cash operating income
150000
discount factor
5.334926198
Present value of cash inflow
800238.9297
Present value of cash outflow
600000
NPV
200238.9297
Yes the company should accept the project as it has positive NPV
2. IRR
Year
cash flow
Discount factor at18%
PV
Discount factor at 19%
PV
0
-600000
1
-600000
1
-600000
1
150000
0.847457627
127118.6441
0.840336134
126050.4202
2
150000
0.71818443
107727.6645
0.706164819
105924.7228
3
150000
0.608630873
91294.6309
0.593415814
89012.37213
4
150000
0.515788875
77368.33127
0.498668751
74800.31271
5
150000
0.437109216
65566.38243
0.419049371
62857.40564
6
150000
0.370431539
55564.73088
0.352142329
52821.34928
7
150000
0.313925033
47088.75498
0.295917923
44387.68847
8
150000
0.266038164
39905.72456
0.248670524
37300.57854
11634.86356
-6845.150235
IRR
19%
as NPV at 19% is close to zero hence IRR = 19%
3.PBP
Year
cash flow
cumulative
0
-600000
-600000
1
150000
-450000
2
150000
-300000
3
150000
-150000
4
150000
0
5
150000
150000
6
150000
300000
7
150000
450000
8
150000
600000
PBP
4 YEARS
If Harrison Company’s minimum acceptable payback period is 3 years, management should Reject as project has 4 year PBP Period
4.simple rate of return
18.75%
net operating income / intial investment
112500/600000
1. NPV
net operting income
112500
add : depreciation
37500
cash operating income
150000
discount factor
5.334926198
Present value of cash inflow
800238.9297
Present value of cash outflow
600000
NPV
200238.9297
Yes the company should accept the project as it has positive NPV
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