7. Harry Company is evaluating a project requiring a capital expenditure of $720

Question

7. Harry Company is evaluating a project requiring a capital expenditure of $720,000. The project has an estimated life of 8 years and no salvage value. The estimated net income and net cash flow from the project are as follows: Year 2 4 Net Income $36,000 36,000 36,000 36,000 36,000 36,000 36,000 36,000 $126,000 126,000 126,000 126,000 126,000 126,000 126,000 126,000 7 The company's minimum desired rate of return is 12%. Required: a. Calculate average (accounting) rate of return b. Calculate payback period. c. Calculate net present value.

Explanation / Answer

a) average rate of return = net income / capital expenditure x 100

= ( 36,000 x 8 ) / 720,000 x 100 = 40%

b) Pay back period = initital capital expenditure / net casf flow per year

= 720,000 / 126,000 = 5.71 years

i.e 5 years and 8.5 months ( 0.71 x 12 months)

c) Net present value

Net cash flow per year = 126,000

Present value annuity @ 12% = 4.97

Present value of cash flow = 126,000 x 4.97 = 626,220

Net present value = 626,220 - 720,000 = (93,780)

therefore the net present value of the project is negative

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