Grove Corp. is considering the purchase of a new piece of equipment. The cost sa

Question

Grove Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income of $202,000. The equipment will have an initial cost of $1,202,000 and have an 8 year life. The salvage value of the equipment is estimated to be $202,000. The hurdle rate is 11% Ignore incom taxes. (Future Value of $1. Present Value of $1. Future Val lue Annuity of $1. Present Value Annuity of $1) (Use appropriate factor from the PV tables.) a. What is the accounting rate of return? (Round your answer to 2 decimal places.) Rate of Return b. What is the payback period? (Round your answer to one decimal place.) Payback Period Years esent value? (Do not round intermediate calculations and round your final answer to the nearest dollar amount.) Net Present Value

Explanation / Answer

a. Accounting rate of return

= Average Accounting profit / Aveage Initial investment

Depreciation = $1202000 - $202000 / 8 years

= $125000

Aveage accounting profit = $202000 - $125000

= $77000

Accounting rate of return = $77000 / $1202000

= 6.41%

b. Payback period:

Year Cash inflows Cummulative cash flows

1 $327000 $327000

2 $327000 $654000

3 $327000 $981000

4 $327000 $1308000

5 $327000 $1635000

6 $327000 $1962000

7 $327000 $2289000

8 $327000 $2616000

Payback period = 3 + $221000 / $327000

= 3.68 years.

Net pesent value:

Cash inflows $327000

Discount rate 11%

Net present value = PV of cash inflows - PV of cash outflows

= $327000 *5.14612 - $1202000

= $480781.24.

at discount rate 15%

Net present value = $327000* 4.48732 - $1202000

= 265353.64.

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