Aaron Heath is seeking part-time employment while he attends school. He is consi

Question

Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter he expects demand to stabilize. The following table presents the expected cash flows Year of Operation Cash Inflow Cash Outflow 2019 2020 2021 2022 $13,800 19,900 22,300 22,300 $ 8,400 11,200 13,500 13,500 In addition to these cash flows, Aaron expects to pay $21,500 for the equipment. He also expects to pay $2,700 for a major overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $1,500 salvage value and a four year useful life. Aaron desires to earn a rate of return of 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. 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.) b. Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and whether it should be accepted a. Net present value b. Will the return be above or below the cost of capital? Should the investment opportunity be accept ed?

Explanation / Answer

Statement showing Cash flows Particulars Time PVf 8% Amount PV Cash Outflows = purchase                                 -                               1.00                (21,500.00)                (21,500.00) Cash Outflows = Major Overhaul                    2,020.00                        0.8573                  (2,700.00)                  (2,314.81) PV of Cash outflows = PVCO                (23,814.81) Cash inflows                    2,019.00                        0.9259                    5,400.00                    5,000.00 Cash inflows                    2,020.00                        0.8573                    8,700.00                    7,458.85 Cash inflows                    2,021.00                        0.7938                    8,800.00                    6,985.72 Cash inflows                    2,022.00                        0.7350                    8,800.00                    6,468.26 Cash inflows = Salvage Value                    2,022.00                        0.7350                    1,500.00                    1,102.54 PV of Cash Inflows =PVCI                  27,015.38 NPV= PVCI - PVCO                    3,200.56 a) net Present Value                    3,200.56 b) return will be above cost of capital Yes Investment oppurtunity should be accepted

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