Exercise 168 (Part Level Submission) (a) (b) Exercise 168 (Part Level Submission

Question

Exercise 168 (Part Level Submission)

(a)

(b)

Exercise 168 (Part Level Submission)

Gantner Company is considering a capital investment of $300,000 in additional productive facilities. The new machinery is expected to have a useful life of 5 years with no salvage value. Depreciation is computed by the straight-line method. During the life of the investment, annual net income and cash inflows are expected to be $27,000 and $87,000, respectively. Gantner has a 12% cost of capital rate, which is the minimum acceptable rate of return on the investment.

Explanation / Answer

(a)

Part 1 - Annual Rate of Return

Annual Return = Net income/Average Investment * 100

Annual Return = $27000/$150000 * 100 = 18%

[Average Investment = [$300000 + $0]/2 = $150000]

Part 2 - Pay Back period

Pay Back period = Investment/Annual Cash Inflow

Investment = $300000

Annual Cash inflow = $87000

Payback Period = $300000/$87000 = 3.45 Years

Part (b) - Calculation of NPV

Present Value of cash Inflow @ 12% for 5 years

Present Value annuity = [1/1+r]n

Here 'r' = 12% or 0.12, n = 5 years

Present value annuity = [1/1.12]5 = 3.60478

Present value of cash inflow - (3.60478 * $87000)

$13616

Annual Return = Net income/Average Investment * 100

Annual Return = $27000/$150000 * 100 = 18%

[Average Investment = [$300000 + $0]/2 = $150000]

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