Ursus, Inc., is considering a project that would have a nine-year life and would

Question

Ursus, Inc., is considering a project that would have a nine-year life and would require a $3,300,000 investment in equipment. At the end of nine years, the project would terminate and the equipment would have no salvage value. The project would provide net operating income each year as follows (Ignore income taxes.):

340,000

All of the above items, except for depreciation, represent cash flows. The company's required rate of return is 10%.

Required:

a. Compute the project's net present value. (Round your intermediate calculations and final answer to the nearest whole dollar amount.)

b. Compute the project's internal rate of return. (Round your final answer to the nearest whole percent.)

c. compute payback period in years

d. compute simple rate of return

Sales $ 2,700,000 Variable expenses 1,700,000 Contribution margin 1,000,000 Fixed expenses: Fixed out-of-pocket cash expenses $ 400,000 Depreciation 260,000 660,000 Net operating income $

340,000

Explanation / Answer

Answer a Computation of project's net present value Net Present Value = Present value of operating cash flows of the project discounted at 10% - Initial Investment in project. Present value of operating cash flows of the project discounted at 10% = Operating cash inflow per year * Present value annuity factor @ 10% for 9 years Operating cash inflow per year = Net Operating Income + Depreciation = $340000 + $260000 = $600000 Present value annuity factor @ 10% for 9 years = [1-(1+r)^-n] / r where n = no.of years and r = rate of interest per year Present value annuity factor @ 10% for 9 years = [1-(1+0.10)^-9] / 0.10 = 5.759024 Present value of operating cash flows of the project discounted at 10% = $600000 * 5.759024 = $34,55,414 Net Present Value = $34,55,414 - $33,00,000 = $1,55,414 Answer b Project IRR i.e.Internal rate of return Year Cash flow 0 -$3,300,000 1 $600,000 2 $600,000 3 $600,000 4 $600,000 5 $600,000 6 $600,000 7 $600,000 8 $600,000 9 $600,000 IRR = 11% At IRR ,project NPV is equal to zero. Answer c Computation of Payback period Year Cash flow Cumulative Cash flow 0 -$3,300,000 -$3,300,000 1 $600,000 -$2,700,000 2 $600,000 -$2,100,000 3 $600,000 -$1,500,000 4 $600,000 -$900,000 5 $600,000 -$300,000 6 $600,000 $300,000 7 $600,000 $900,000 8 $600,000 $1,500,000 9 $600,000 $2,100,000 Payback period = 5 years + ($300000/$600000) = 5.5 years Answer d Simple rate of return = Net Operating Income / Initial Investment = $340000 / $3300000 = 10.30%

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