Question

uestion 1: Evaluating investment projects

You are planning to invest $100,000 in new equipment. This investment will generate net cash flows of $60,000 a year for the next 2 years. The salvage value after 2 years is zero. The cost of capital is 25% a year.

a) Compute the net present value
NPV = $  
Enter negative numbers with a minus sign, i.e., -100 not ($100) or (100).

c) Compute the accounting rate of return (ARR).
To compute ARR, first compute:
   annual depreciation=$  
   annual income=$  
   average investment=$  
ARR =  %   
If your answer is 10%, enter 10 without the percent sign.

Answer 1

(a)-Net Present Value (NPV)

Net Present Value (NPV) = Net Present Value (NPV) = Present Value of annual cash inflows - Present Value of outflows

= [{$60,000/(1.25)¹} + {$60,000/(1.25)²}] - $100,000

= [{$60,000/1.25} + {$60,000/1.5625}] - $100,000

= [$48,000 + 38,400] - $100,000

= -$13,600 (Negative NPV)

(b)- Accounting Rate of Return (ARR)

Accounting Rate of Return (ARR) = [Annual Average Income / Average Investment] x 100

Average Net Income = Annual Cash Inflow – Depreciation Expenses

= $60,000 – [$100,000 / 5 Years]

= $60,000 – 50,000

= $10,000

Average investment = [Cost of the Equipment + Salvage Value] / 2

= [$100,000 + $0] / 2

= $100,000

Accounting Rate of Return (ARR) = [Annual Average Income / Average Investment] x 100

= [$10,000 / 100,000] x 100

= 10%

“Accounting Rate of Return (ARR) = 10%”