Linda’s Luxury Travel (LLT) is considering the purchase of two Hummer limousines

Question

Linda’s Luxury Travel (LLT) is considering the purchase of two Hummer limousines. Various information about the proposed investment follows:   

Assume straight line depreciation method is used.     

Required:
Help LLT evaluate this project by calculating each of the following:    

1. Accounting rate of return. (Round your percentage answer to 1 decimal place.)



2. Payback period. (Round your answer to 2 decimal places.)

  

3. Net present value. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Cash Outflows and negative amounts should be indicated by a minus sign. Round your "Present Values" to the nearest whole dollar amount.)

   

4. Without making any calculations, determine whether the IRR is more or less than 13%.

Initial investment (2 limos) $ 660,000 Useful life 10 years Salvage value $ 200,000 Annual net income generated 53,460 LLT’s cost of capital 13 %

Explanation / Answer

1) Calculation of Accouting rate of return :

Accounting rate of return = Net income / Investment

= $53,460 / $660,000

= 8.1%

2) Calculation of Payback period :

Annual depreciation = ($660,000 - $200,000) / 10years

= $46,000

Annual Net cash flow = $53,460 + $46,000

= $99,460

Payback period = $660,000 / $99,460

= 6.64 years

3) Calculation of Net present value :

NPV = - $660,000 + ($99,460*PVAF@13%,10years) + ($200,000*PVF@13%,10th year)

= - $660,000 + ($99,460 * 5.4262) + ($200,000 * 0.2946)

= - $61,388

4) Less than 13%,Since at the risk rate of 13% NPV was showing a negative value.So that the risk rate should be reduced in order to get an indifference NPV which is 0 at the IRR.

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