River Wild is considering purchasing a water park in Oakland, California, for $2

Question

River Wild is considering purchasing a water park in Oakland, California, for $2,000,000. The new facility will generate annual net cash inflows of $510,000 for nine years. Engineers estimate that the facility will remain useful for nine years and have no residual value. The company uses straight-line depreciation. Its owners want payback in less than five years and an ARR of 12% or more. The management uses a 10% hurdle rate on investments of this nature.

Based on your reading, complete the given tasks:

o Compute the payback period, the ARR, the NPV, and the approximate IRR of this investment.

o Recommend whether the company should invest in this projec

Explanation / Answer

Payback period = Initial Investment/Annual net Cash inflow

Payback period = 2000000/510000

Payback period = 3.92 Years

ARR = Average Net Income/Average Investment

Average Net Income = Annual net Cash Flow - Annual Depreciation

Average Net Income = 510000- 2000000/9

Average Net Income = 287,777.78

Average Investment = (2000000+0)/2 = 1000000

ARR = 287777.78/1000000

ARR = 28.78%

NPV = -Initial Investment + Annual Cash Inflow *(1-(1+r)^-n)/r

NPV = -2000000 + 510000*(1-(1+10%)^-9)/10%

NPV = 937,102.15

IRR = rate(nper,pmt,pv,fv)

IRR = rate(9,510000,-2000000,0)

IRR = 20.87%

Decision : The Company should invest in this project as it NPV is positive,payback period is lower than the required Payaback period, ARR is greater than the minimum ARR, IRR is greater than cost of capital

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