River Wild is considering purchasing a water park in Atlanta, Georgia, for $2,05
ID: 2655875 • Letter: R
Question
River Wild is considering purchasing a water park in Atlanta, Georgia, for $2,050,000. The new facility will generate annual net cash inflows of $515,000 for eight years. Engineers estimate that the facility will remain useful for eight years and have no residual value. The company uses straight-line depreciation. Its owners want payback in less than five years and an ARR of 10% or more. Management uses a 12% hurdle rate on investments of this nature. (Click the icon to view the present value annuity table.) (Click the icon to view the present value table) (Click the icon to view the future value annuity table) (Click the icon to view the future value table) Read the requirements Requirement 1. Compute the payback period, the ARR, the NPV, and the approximate IRR of this investment. (If you use the tables to compute the IRR, answer with the closest interest rate shown in the tables.) (Round the payback period to one decimal place.) The payback period is years Round the percentage to the nearest t The ARR (accounting rate of return) is Round your answer to the nearest whole dollar.) Net present value S The IRR (internal rate of return) is between Requirement 2. Recommend whether the company should invest in this project. Recommendation enth percent.)Explanation / Answer
Payback Period:
Year
Cash Flow
‘Cum Cash Flow
0
$ (2,050,000)
$ (2,050,000)
1
$ 515,000
$ (1,535,000)
2
$ 515,000
$ (1,020,000)
3
$ 515,000
$ (505,000)
4
$ 515,000
$ 10,000
5
$ 515,000
$ 525,000
6
$ 515,000
$ 1,040,000
7
$ 515,000
$ 1,555,000
8
$ 515,000
$ 2,070,000
Payback Period = A +B/C
Where,
A = Last period with a negative cumulative cash flow = 3
B = Absolute value of a cumulative cash flow at the end of the period A = $ 505,000
C = Total cash flow during the period after A = $ 515,000
Discounted Payback Period = 3 +?$ (505,000) ?/$ 515,000
= 3 + $ 505,000/$ 515,000
= 3 + 0.980582524
= 3.980582524 or 4.0 years
Accounting Rate of Return:
Accounting rate of return = Average annual profit/Initial investment
Average annual profit = Annual cash inflow – Depreciation
= $ 515,000 – ($ 2,050,000/8)
= $ 515,000 – $ 256,250 = $ 258,750
Accounting rate of return = $ 258,750/$ 2,050,000
= 0.126219512 or 12.62 % or 10 %
Net present value:
NPV = C x PVIFA (i, n) – Investment
C = Annual cash flow = $ 515,000
i = Rate of interest = 12 %
n = No. of periods = 8 years
NPV = $ 515,000 x PVIFA (12%, 8) - $ 2,050,000
= ($ 515,000 x 4.968) - $ 2,050,000
= $ 2,558,520 - $ 2,050,000
= $ 508,520
Internal Rate of Return:
A
B
1
Year
Cash Flow
2
0
$ (2,050,000)
3
1
$ 515,000
4
2
$ 515,000
5
3
$ 515,000
6
4
$ 515,000
7
5
$ 515,000
8
6
$ 515,000
9
7
$ 515,000
10
8
$ 515,000
IRR
18.78%
Excel formula for IRR is: “=IRR(B2:B10)”
IRR is between 18 % and 19 %
Recommendation:
Accept the project.
Year
Cash Flow
‘Cum Cash Flow
0
$ (2,050,000)
$ (2,050,000)
1
$ 515,000
$ (1,535,000)
2
$ 515,000
$ (1,020,000)
3
$ 515,000
$ (505,000)
4
$ 515,000
$ 10,000
5
$ 515,000
$ 525,000
6
$ 515,000
$ 1,040,000
7
$ 515,000
$ 1,555,000
8
$ 515,000
$ 2,070,000
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