Aaron Heath is seeking pa enable him to start a small training services he expec

Question

Aaron Heath is seeking pa enable him to start a small training services he expects demand to stabilize. The following table presents the expected cash flows: rt-time employment while he attends school. He is considering purchasing technical equipment that wl company that will offer tutorial services over the Internet. Aaron expects demand for the ars of operation as customers learn about the availability of the Internet assistance Thereat Year of Operation Cash Inflow Cash Outflow $25,000 29,000 32,000 32,000 2019 2020 2021 2022 $12,000 16.000 18,000 18,000 In addition to these cash flows, Aaron expects to pay $25,000 for the equipment He also expects to pay $4,000 for a major overhau and updating of the equipment at the end of the second year of operation The equipment is expected to have a $4,000 salvage valu and a four year useful life. Aaron desires to earn a rate of return of 8 percent. (PV of $1 and PVA of $) (Use appropriate factoris) from the tables provided.) Required a. Calculate the net present value of the investment opportunity (Round your intermediate caiculations and final answer to 2 decimal places.) b. Indicate whether the investment opportunity is expected to earn a retun that is above or below the desired rate of return and whether it should be accepted search

Explanation / Answer

Part A

Net Present Value = 19351.30

Details:

For Present Value factor = 1/(1+0.08)n where n = year

Net Inflow/(outflow) = (Inflow-Outflow)*PV factor

In 2018 PV will be 1 as its the year of investment. PV of $1 today will be $ 1 only.

It is assumed that investment is made in the beginning of 2018 and is solved accordingly.

Therefore, expense of $ 4000 will be added to the outflow of year 2021.

Part B

Cost of capital refers to the opportunity cost of making a specific investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk. Therefore we have discounted the cashflows 8% as it is our desired rate of return.

In the above case, NPV is +ve which indicates that the rate of return is higher than the desired rate of return.

Therefore we should accept the investment opportunity.

Year Cash inflow Cash Outflow PV @ 8% Net Inflow/(Outflow) 2018 NIL 25000 1.00 (25000) 2019 25000 12000 0.93 12037.04 2020 29000 16000 0.86 11145.40 2021 32000 22000 0.79 7938.32 2022 36000 18000 0.74 13230.54

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