A company is considering the introduction of a new product line that is believed
ID: 1123799 • Letter: A
Question
A company is considering the introduction of a new product line that is believed to be marketable for the next 10 years. An initial investment of $215,000 will be required with an estimated salvage value of $40,000 at the end of 10 years. It is estimated that the gross receipts will be about $73,000 a year; disbursements including extra income taxes will be about $26,000 a year. What is the prospective rate of return on this proposal? If the company’s i* is 15% after income taxes, should this project be undertaken?
Explanation / Answer
Annual Net cash flow = Receipt - Disbursement = $(73,000 - 26,000) = $47,000
In year 10, Net cash flow ($) = 47,000 + 40,000 (Salvage value) = 87,000
Rate of return (ROR) is computed using Excel IRR function, as follows.
Since Expected ROR > i*, project should be undertaken.
Year Net Cash Flow ($) 0 -2,15,000 1 47,000 2 47,000 3 47,000 4 47,000 5 47,000 6 47,000 7 47,000 8 47,000 9 47,000 10 87,000 ROR = 18.48%Related Questions
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