Question

Jordan and Taylor want to purchase a new 60 quart floor mixer for $12,000. This machine would have a 5 year life with a salvage value of $2,000. The new machine would decrease operating costs by $1,000 each year of its economic life. The straight-line depreciation method would be used for the new machine. The cost of capital is 6%.

Before they spend the money, you calculate the following capital investment figures for them.

1. What is the payback period? (Round to two decimal places and make sure your answer is in the correct format.)

2. What is the annual rate of return? (Round to two decimal places and make sure your answer is in the correct format.)

3. What is the internal rate of return? (Round to nearest whole percent and make sure your answer is in the correct format.)

4. What is the net present value? (Round to whole dollars and make sure your answer is in the correct format.)

5. What is the profitability index? (Round to two decimal places.)

Answer 1

1. Total saving = decrease in operating costs + depreciation costs = 1000 + (12000-2000)/5 = $3000

So, the payback period = $12000 / 3000 = 4 years

2. Annual rate of return = $3000 / $12000 = 25%

3. IRR : at 6%, the PV = $3000 * PVIFA(6%,5) = 3000 * 4.212 = 12636

at 7%, the PV = $3000 * PVIFA(7%,5) = 3000 * 4.100 = 12300

IRR = 6% + (12636 - 12000)/(12636 - 12300) (7%-6%) = 6% + 1.89% = 7.89%

4. NPV : = [$3000 * PVIFA(6%,5)] - $12000 = (3000 * 4.212) - 12000 = 12636 - 12000 = $636

5. Profitability index = pv of cash inflow / intial investment = 12636 / 12000 = 1.053