Average Rate of Return, Cash Payback Period, Net Present Value Method for a Service Company
Spanish Peaks Railroad Inc. is considering acquiring equipment at a cost of $144,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $72,000. The company's minimum desired rate of return for net present value analysis is 12%.
Present Value of an Annuity of $1 at Compound Interest | |||||
Year | 6% | 10% | 12% | 15% | 20% |
1 | 0.943 | 0.909 | 0.893 | 0.870 | 0.833 |
2 | 1.833 | 1.736 | 1.690 | 1.626 | 1.528 |
3 | 2.673 | 2.487 | 2.402 | 2.283 | 2.106 |
4 | 3.465 | 3.170 | 3.037 | 2.855 | 2.589 |
5 | 4.212 | 3.791 | 3.605 | 3.353 | 2.991 |
6 | 4.917 | 4.355 | 4.111 | 3.785 | 3.326 |
7 | 5.582 | 4.868 | 4.564 | 4.160 | 3.605 |
8 | 6.210 | 5.335 | 4.968 | 4.487 | 3.837 |
9 | 6.802 | 5.759 | 5.328 | 4.772 | 4.031 |
10 | 7.360 | 6.145 | 5.650 | 5.019 | 4.192 |
Compute the following:
a. The average rate of return, giving effect to
straight-line depreciation on the investment. If required, round
your answer to one decimal place.
%
b. The cash payback period.
c. The net present value. Use the above table of the present value of an annuity of $1. Round to the nearest dollar. If required, use a minus sign to indicate negative net present value for current grading purpose.
Present value of annual net cash flows | $ |
Amount to be invested | $ |
Net present value | $ |
A |
Annual net cash flows |
$72,000 |
B |
Cost of equipment |
$144,000 |
C |
Resdiual value |
$0 |
D |
Life [years] |
10 |
E = (B-C)/D |
Annual Depreciation |
$14,400 |
F = A - E |
Annual net income |
$57,600 |
G = (B+C)/2 |
Average investment |
$72,000 |
H = (F/G) x 100 |
Average rate of return |
80.0% |
A |
Cost of equipment |
$144,000 |
B |
Annual net cash flows |
$72,000 |
C = A/B |
Cash Payback period |
2 |
A |
Annual net cash flows |
$72,000 |
B |
PVA $1 at 12% for 10th period |
5.65 |
C = A x B |
Present value of annual net cash flows |
$406,800 |
D |
Amount to be invested |
$144,000 |
E = C - D |
Net Present value |
$262,800 |
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