Question

(Set the entire problem up in an Excel spreadsheet and answer the questions clearly marked in your spreadsheet.)

            You are considering purchasing a machine (use your imagination) that will initially cost $205,000.00. The machine is expected to last 7 years, and you project that you can sell the worn out machine at the end of 7 years for $55,000.00

Annual operating cash inflows and outflows are projected as follows, and are assumed to occur at the end of each year:   Both of years 1 and 2, cash inflow $66,000.00, cash outflow expenses $24,000.00; both of years 3 and 4, cash inflow $72,000.00, cash outflow expenses $27,000.00. In year 5 you have to shut down and rebuild the machine so cash inflows are only $35,000.00 and cash outflows are $44,000.00. In year 6 cash inflow is $65,000.00, and cash outflow expenses are $39,000.00. Finally, in year 7 cash operating inflow is $66,000.00 and cash operating expenses are $34,000.00.

2. What is the calculated simple rate of return for this proposed investment?

2.b. If the required simple rate of return for your firm is 6%, would you purchase this machine?

Answer 1

a.  the calculated simple rate of return for this proposed investment is 4.45%.

b. If the required simple rate of return for your firm is 6%, you would not purchase this machine because simple rate of return of 4.45% is lower than required simple rate of return for your firm of 6%.

	Cash inflow	Cash outflow	Net cash flow
Cost of machine	$0	$205,000	-$205,000
Year 1	$66,000	$24,000	$42,000
Year 2	$66,000	$24,000	$42,000
Year 3	$72,000	$27,000	$45,000
Year 4	$72,000	$27,000	$45,000
Year 5	$35,000	$44,000	-$9,000
Year 6	$65,000	$39,000	$26,000
Year 7	$121,000	$34,000	$87,000
Simple rate of return			4.45%

Calculations