Question

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

Initial investment(2 limos) $1,620,000

Useful life 10 years

Salvage value $140,000

Annual net income generated 157,140

LLTs cost of capital 15%

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 to one decimal place)

2. Payback period.(round to two decimal places)

3. Net present value

Answer 1

1. Accounting rate of return = 18.8%

Accounting Rate of return = (Cash Flow / Initial Investments) * 100

Depreciation = ($16,20,000 - $1,40,000) / 10 Years = $1,48,000

Cash Flow = Net Income + Depreciation

                   = $1,57,140 + $1,48,000

                   = $3,05,140

Accounting Rate of return       = (Operating Income / Initial Investments) * 100

                                                = ($305140 / $1620000) * 100

                                                = 18.8 %

2. Payback period = 5.31 Years

= Initial Investment / cash flow

= $16,20,000 / $3,05,140

= 5.31 Years

3. Net present value (NPV) = - $53,967 (Negative)

= [ $3,05,140 x (PVAF 15%,10 Years) + $140000 x (PVF 15%,10Years) ] - $16,20,000

= [ ($3,05,140x5.018768626) + ($140000 x 0.247184706) ] - $16,20,000

=$15,31,427 + $34,606 - $16,20,000

= - $53,967 (Negative)