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 $ 13,900 $ 8,200 2020 19,400 12,000 2021 21,300 13,500 2022 21,300 13,500 In addition to these cash flows, Aaron expects to pay $20,900 for the equipment. He also expects to pay $3,500 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 $1,700 salvage value and a four year useful life. Aaron desires to earn a rate of return of 10 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. (Negative amount should be indicated by a minus sign. Round 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.

Explanation / Answer

Calculation of net present value of the investment opportunity Year 2018 2019 2020 2021 2022 NPV Purchase of equipment -$20,900 Cash Inflow $13,900 $19,400 $21,300 $21,300 Cash Outflow -$8,200 -$12,000 -$13,500 -$13,500 Major overhaul & updating of equipment -$3,500 Salvage Value $1,700 Net Cash flow -$20,900 $5,700 $3,900 $7,800 $9,500 Discount factor @ 10% 1 0.909090909 0.82644628 0.7513148 0.68301346 Present Values -$20,900.00 $5,181.82 $3,223.14 $5,860.26 $6,488.63 -$146.16 Net present value of the investment opportunity -$146.16 The negative NPV indicates that the investment opportunity is expected to earn a return that is below the desired rate of return. The investment should not be accepted.

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