BAM Co. is evaluating a project requiring a capital expenditure of $806,250. The

ID: 2535122 • Letter: B

Question

BAM Co. is evaluating a project requiring a capital expenditure of $806,250. The project has an estimated life of 4 years and no salvage value. The estimated net income and net cash flow from the project are as follows:

The company's minimum desired rate of return is 12%. The present value of $1 at compound interest of 12% for 1, 2, 3, and 4 years is 0.893, 0.797, 0.712, and 0.636, respectively.

Determine the following:

Year Net Income Net Cash Flow 1 $75,000 $285,000 2 102,000 290,000 3 109,500 190,000 4 36,000 125,000 $322,500 $890,000

Explanation / Answer

a. The average rate of return on investment, including the effect of depreciation on the investment

Average rate of return on investment

= [Average Net Income / Average Investments] x 100

Average Net Income = $322500 / 4 = $ 80625

Average Investments = ( $806250 + 0 ) / 2 = $ 403125

Average rate of return on investment = [ $80625 / $ 403125 ] x 100 = 20%

Average rate of return on investment = 20%

(b) The net present value = (105,835.00) (Negative)

Year

Net Cash Flow

Present Value Factor

Present Value

285,000.00

0.893

254,505.00

290,000.00

0.797

231,130.00

190,000.00

0.712

135,280.00

125,000.00

0.636

79,500.00

Total

700,415.00

Initial Investment

806,250.00

Net present value

(105,835.00)