Obj. 3 Keystone Healthcare Corp. is proposing to spend $260,820 on an eight-year
ID: 2409635 • Letter: O
Question
Obj. 3 Keystone Healthcare Corp. is proposing to spend $260,820 on an eight-year project that has estimated net cash flows of $42,000 for each of the eight years. a. Compute the net present value, using a rate of return of 10%. Use the present value of an annuity of $1 table in the chapter (Exhibit 5) Answer b. Based on the analysis prepared in part (a), is the rate of return (1) more than 10%, (2) 10%, or (3) less than 10%? Explain. c. Determine the internal rate of return by computing a present value factor for an annuity of $I and using the present value of an annuity of $1I table presented in the text (Exhibit 5).Explanation / Answer
a. Here initial investment = 260,820. This will be a cash outflow. This is followed by an annuity of $42,000 in which no. of years = 8 and rate = 10%.
Thus net present value = -260820+(presnet value of annuity of $1 for 8 years and 10%*42,000)
From exhibit 5 presnet value of annuity of $1 for 8 years and 10% = 5.335.
Thus net present value = -260820 + (5.335*42,000)
= - $36,750 (negative $36,750)
b. At 10% the NPV is a negative number. Rate of return is that rate which makes the NPV as nil. So the rate will have to be lower than 10% so that the discounting level is lower and NPV is increased from the present negative number to nil.
Hence rate of return is less than 10%.
c. Let the rate of return be "x"%. As NPV has to be nil, -260820+(presnet value of annuity of $1 for 8 years and x%*42,000) = 0
or (presnet value of annuity of $1 for 8 years and x%*42,000) = 260,820
or present value of annuityof $ 1 for 8 years and x% = 260,820/42,000
or present value of annuityof $ 1 for 8 years and x% = 6.210
From the table we can see that the figure of 6.210 corresponds to 6%.
Hence the internal rate of retutn = 6%
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.