Question

The Jameson Corporation is evaluating a new feature ride for its amusement park at a cost 250,000 and will operate for 10 years. The Company expects annual cash flows from operating this new ride to be $35,000 and a cost of capital of 6%.

a. Should the Jameson Corporation proceed with the purchases? What is the NPV and the IRR?

b. How far off could the Jameson Corporation's cost of capital estimate be before the purchase decision changes?

Answer 1

NPV = Present value of cash inflows – present value of cash outflows

= 35,000*PVAF(6%, 10 years) -250,000

= 35,000*7.360 – 250,000

= $7,600

IRR is the rate at which NPV is zero

Let it be x%

0 = 35,000*PVAF(x%, 10 years) – 250,000

PVAF(x%, 10 years) = 250,000/35,000

= 7.1428

From present value annuity factor table,

PVAF(6%, 10 years) = 7.3601

PVAF(7%, 10 years) = 7.0236

Using interpolation, IRR i.e. x =6%+ (7.1428-7.0236)/(7.3601-7.0236)

= 6.35%

Yes, Jameson Corporation should proceed with the purchases

(since NPV is positive)

b.Cost of capital can go up to IRR i.e. 6.35%