Question

Average Rate of Return, Cash Payback Period, Net Present Value Method

Bi-Coastal Railroad Inc. is considering acquiring equipment at a cost of $128,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $64,000. The company’s minimum desired rate of return for net present value analysis is 15%.

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	1.833	1.736	1.690	1.626	1.528
3	2.673	2.487	2.402	2.283	2.106
4	3.465	3.170	3.037	2.855	2.589
5	4.212	3.791	3.605	3.353	2.991
6	4.917	4.355	4.111	3.785	3.326
7	5.582	4.868	4.564	4.160	3.605
8	6.210	5.335	4.968	4.487	3.837
9	6.802	5.759	5.328	4.772	4.031
10	7.360	6.145	5.650	5.019	4.192

Compute the following:

a. The average rate of return, assuming the annual earnings are equal to the net cash flows less the annual depreciation expense on the equipment. If required, round your answer to one decimal place.
%

b. The cash payback period.
years

c. The net present value. Use the above table of the present value of an annuity of $1. Round to the nearest dollar. If required, use a minus sign to indicate negative net present value" for current grading purpose.

Present value of annual net cash flows	$
Less amount to be invested	$
Net present value	$

Answer 1

Annual Depreciation = (128000 – 0)/10 = $12,800

Average Rate of Return = Average Profit / Initial Investment

Average Profit = Net Annual Cash Flow – Annual Depreciation (Since, project has even cash flows)

Average Profit = $64,000 - $12,800 = $51,200

Average Rate of Return = 51200/128000 = 0.40 or 40%

Cash Payback Period = Initial Investment/Net Annual Cash Flows = 128000/64000 = 2 years

Cash Payback Period = 2 years

Present Value of annual net cash flows = Annual Cash Flow * (P/A, 15%, 10)

(P/A, 15%, 10) = 5.019

Present Value of annual net cash flows	$321,216.00
Less Amount to be invested	$128,000.00
Net Present Value	$193,216.00