4. Briar Corp. is considering the purchase of a new piece of equipment. The cost

Question

4. Briar Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in cash flow of $200,000. The equipment will have an initial cost of $1,200,000 and have an 8-year life. The salvage value of the equipment is estimated to be $200,000. The hurdle rate is 8%. Ignore income taxes. Answer the following: a. What is the accounting rate of return? b. What is the payback period? c. What is the net present value? d. What would the net present value be with a 12% hurdle rate? e. Based on the NPV calculations, in what range would the equipment's internal rate of return fall?

Explanation / Answer

a)Depreciation : [cost-salvage]/useful life

               = [1,200,000-200,000]/8

                = 125,000

Annual Income =cash flow -depreciation

        = 200,000-125,000

          = 75,000

Accounting rate of return =Annual net income /investment

           = 75000/1,200,000

            = .0625 or 6.25%

b)Paybackk period =Initial cost/cash flow

                 = 1,200,000/200,000

                  = 6 years

c)Present value of cash flow =[PVA8%,8*Cash flow]+[PVF8%,8*Salvage]

        = [5.74664*200000]+ [.54027*200000]

          = 1149328+ 108054

           = 1,257,382

NPV =Present value -Initial cost

   = 1,257,382- 12,000,000

      = 57,382

d)Present value =[PVA12%,8*Cash flow]+[PVF12%,8*Salvage]

            =[4.96764*200000]+ [ .40388*200000]

         = 993528+ 80776

           = $ 1074304

NPV = 1074304-1200000 =$ - 125696

E)Range of Internal rate if return will be between 8% -12 % since one discount rate gives present value above initial investment and one below initial investment.

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