Question

ben is considering the purchase of new piece of equipment. the cost savings from the equipment would result in an annual increase in net income of $200000. the equipment will have an initial cost of $1200000 and have an 8 year life. the salvage value of the equipment is estimated to be $200000. the hurdle rate is 10%. what is accounting rate of return? b) what is the payback period? c) what is the net present value? d) what would the net pressent value be with the 15% hurdle rate? E) BASED ON THE NPV IN WHAT RANGE WOULD THE EQUIPMENT INTERNAL RATE OF RETURN FALL?

Answer 1

a) Accounting Rate of return = Average Net Income / Average Investment = 200,000 / 1,200,000/8 = 133.33%

b) Depreciation = Investment / Life = 1,200,000 / 8 = 150,000

Annual Cash Flow = Net Income + Depreciation = 200,000 + 150,000 = 350,000

Payback Period = Investment / Cash Flow = 1,200,000 / 350,000 = 3.43 years

c) NPV = - Investment + PV of annual cash flow + salvage

Present Value can be calculated using PV function

N = 8, PMT = 350,000, FV = 200,000, I/Y = 10% => Compute PV = $1,960,525.65

NPV = 1,960,525.65 - 1,200,000 = $760,525.65

d) If I/Y = 15% => PV = $1,635,942.88

=> NPV = $435,942.88

e) As NPV > 0 at 15%, it means IRR would be greater than 15%.