Kansas Corporation is reviewing an investment proposal that has
an initial cost of $78,000. An estimate of the investment's
end-of-year book value, the yearly after-tax net cash inflows, and
the yearly net income are presented in the schedule below. Yearly
after-tax net cash inflows include savings from the depreciation
tax shield. The investment's salvage value at the end of each year
is equal to book value, and there will be no salvage value at the
end of the investment's life.
| Year | Initial Cost and Book Value |
Yearly After-Tax Net cash Inflows |
Yearly Net Income |
||||||||||
| 1 | $ | 43,500 | $ | 28,500 | $ | 11,000 | |||||||
| 2 | 29,500 | 26,000 | 12,000 | ||||||||||
| 3 | 19,000 | 23,500 | 13,000 | ||||||||||
| 4 | 12,000 | 21,000 | 14,000 | ||||||||||
| 5 | 0 | 18,500 | 15,000 | ||||||||||
| $ | 117,500 | $ | 65,000 | ||||||||||
Kansas uses a 12% after-tax target rate of return for new
investment proposals.
| Year | FV of $1 at 12% |
FV of an ordinary annuity at 12% | PV of $1 at 12% |
PV of an ordinary annuity at 12% | |||||||||||
| 1 | 1.120 | 1.000 | 0.893 | 0.893 | |||||||||||
| 2 | 1.254 | 2.120 | 0.797 | 1.690 | |||||||||||
| 3 | 1.405 | 3.374 | 0.712 | 2.402 | |||||||||||
| 4 | 1.574 | 4.779 | 0.636 | 3.037 | |||||||||||
| 5 | 1.762 | 6.353 | 0.567 | 3.605 | |||||||||||
| 6 | 1.974 | 8.115 | 0.507 | 4.111 | |||||||||||
Required:
A. Calculate the project's payback period.
(Do not round intermediate calculations.)
B. Calculate the accounting rate of return on the
initial investment. (Do not round intermediate
calculations. Round your answer to 1 decimal place.)
C. Calculate the proposal's net present value.
(Do not round intermediate calculations. Round your final
answer to nearest dollar amount.)
| Payback period is the time period in which the initial investment is recovered | ||
| Year | Cash flows | Cumulative Cash flows |
| 0 | -78000 | -78000 |
| 1 | 28500 | -49500 |
| 2 | 26000 | -23500 |
| 3 | 23500 | 0 |
| 4 | 21000 | 21000 |
| 5 | 18500 | 39500 |
| Hence, payback period = 3 years | ||
| B.Accounting rate of return = Average Net Income/Initial Investment | ||
| =13000/78000 = 16.7% | ||
| C.NPV = Present value of cash inflows - Present value of cash outflows | ||
| =28500*0.893 + 26000*0.797 + 23500*0.712 + 21000*0.636 + 18500*0.567 - 78000 | ||
| = $8,750.00 |
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