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	$	13,000		$	9,500
2020		19,100			11,300
2021		21,700			13,300
2022		21,700			13,300

In addition to these cash flows, Aaron expects to pay $20,200 for the equipment. He also expects to pay $3,600 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 $1,800 salvage value and a four year useful life. Aaron desires to earn a rate of return of 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required

1. 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.)

2. 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.

a. Net present value = ?

b. Will the return be above or below the cost of capital?

c. Should the investment opportunity be accepted?

Answer 1

	Equipment	Major	Annual	Annual	Salvage	Net cash	PVF	Present value
Year	Purchase	Overhaul	Inflows	Outflows		flows	at 8%	of CF
0	-20200					-20,200	1	-20200
1			13000	9500		22,500	0.925926	20833.33
2		-3600	19100	11300		26,800	0.857339	22976.68
3			21700	13,300		35,000	0.793832	27784.13
4			21700	13300	1800	36,800	0.73503	27049.1
					Net present value		78443
Net present value of project: $ 78443
Yes, return are above cost of capital
Yes, Project shall be accepted