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:

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 overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $4,000 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

Calculate the net present value of the investment opportunity. (Round your intermediate calculations and final answer to 2 decimal places.)

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.

Year of Operation Cash Inflow Cash Outflow 2019 $ 25,000 $ 12,000 2020 29,000 16,000 2021 32,000 18,000 2022 32,000 18,000

Explanation / Answer

Calculation of net present value of the investment opportunity Year 0 1 2 3 4 NPV Equipment cost -$25,000 Major Overhaul to Equipment -$4,000 Salvage value of equipment $4,000 Cash Inflows $25,000 $29,000 $32,000 $32,000 Cash outflows -$12,000 -$16,000 -$18,000 -$18,000 Net Cash flows -$25,000 $13,000 $9,000 $14,000 $18,000 Discount factor @ 8% 1 0.92592593 0.85733882 0.79383224 0.73502985 Present Values -$25,000.00 $12,037.04 $7,716.05 $11,113.65 $13,230.54 $19,097.28 Positive NPV means investment opprtunity is earning a return above the desired rate of return. The Investment opprtunity should be accepted.

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