Question

Ursus, Inc., is considering a project that would have a five-year life and would require a $1,650,000 investment in equipment. At the end of five years, the project would terminate and the equipment would have no salvage value. The project would provide net operating income each year as follows (Ignore income taxes.):

Sales				$	2,600,000
Variable expenses					1,650,000
Contribution margin					950,000
Fixed expenses:
Fixed out-of-pocket cash expenses	$	400,000
Depreciation		330,000			730,000
Net operating income				$	220,000

All of the above items, except for depreciation, represent cash flows. The company's required rate of return is 14%.

Required:

a. Compute the project's net present value. (Round your intermediate calculations and final answer to the nearest whole dollar amount.)

b. Compute the project's internal rate of return. (Round your final answer to the nearest whole percent.)

c. Compute the project's payback period. (Round your answer to 2 decimal places.)

d. Compute the project's simple rate of return. (Round your final answer to the nearest whole percent.)

Answer 1

Initial Investment = $340,000
Useful Life = 5 years

Annual Net Cash flows = Annual Net Operating Income + Annual Depreciation
Annual Net Cash flows = $220,000 + $330,000
Annual Net Cash flows = $550,000

Answer a.

Net Present Value = -$1,650,000 + $550,000 * PVA of $1 (14%, 5)
Net Present Value = -$1,650,000 + $550,000 * 3.433
Net Present Value = $238,150

Answer b.

Let IRR be i%

$1,650,000 = $550,000 * PVA of $1 (i%, 5)
PVA of $1 (i%, 5) = 3.000
Using table values, i = 20%

Internal Rate of Return = 20%

Answer c.

Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $1,650,000 / $550,000
Payback Period = 3.00 years

Answer d.

Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $220,000 / $1,650,000
Simple Rate of Return = 13%