Quik Cleaners has been considering the purchase of an industrial dry-cleaning ma
ID: 2381625 • Letter: Q
Question
Quik Cleaners has been considering the purchase of an industrial dry-cleaning machine. Use the following information to help Quik Cleaners make its decision.
Purchase Price $ 90,000 Salvage value $6,000
Useful Life 6 years Rate of Return on Investment 8%
Annual Net Income $5,500 Depreciation Method: Straight-line
a. What is the Net Present Value for the dry-cleaning machine's capital budget project?
b. What is the Internal Rate of Return as a % for the dry-cleaning machine project?
c. What is the Cash Payback in years for the dry-cleaning machine's capital budget project?
d. What is the Accrual Accounting Rate of Return as a % for the dry-cleaning machine?
e. What is your overall suggestion to Quik Cleaners based on purchasing the dry-cleaning machine?
Explanation / Answer
Depreciation = (90,000-6,000)/6 = 14,000
a. Annual cashflow = net income + depreciation = 5,500+14,000 = 19,500
NPV = -90,000 + 19,500/1.08^1 + 19,500/1.08^2 + 19,500/1.08^3 + 19,500/1.08^4 + 19,500/1.08^5 + 19,500/1.08^6 + 6,000/1.08^6 = $ 3,927.17
b. Let IRR be r.
So NPV = 0 = -90,000 + 19,500/(1+r)^1 + 19,500/(1+r)^2 + 19,500/(1+r)^3 + 19,500/(1+r)^4 + 19,500/(1+r)^5 + 19,500/(1+r)^6 + 6,000/(1+r)^6
Solving for r, we get r=IRR = 9.38%
c. Cumulative cashflows for first 4 years = 19500*4 = 78,000
So cash payback period = 4+(90,000-78,000)/19,500 = 4.615 years
d. Average investment = (investment cost+salvage value)/2= (90,000+6,000)/2 = 48,000
Accrual accounting rate of return = net income/average investment = 5,500/48,000 = 11.46%
e. Suggestion to Quik Cleaners would be to purchase the machine as the NPV is greater than zero, and the IRR is also greater than the firm's cost of capital.
Hope this helped ! Let me know in case of any queries.
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