Consider the following investment opportunity. Initial cost: $850,000 Annual rev

Question

Consider the following investment opportunity. Initial cost: $850,000 Annual revenues: $500,000 Annual operating costs, exclusive of depreciation: $200,000 Expected life: 20 years Salvage value after taxes: $40,000 Annual depreciation for tax purposes: $25,000 Tax rate: 34% Assume the annual figures are unchanged for the expected life of the investment. 1. What is the rate of return on this investment? 2. Assuming the investor wants to earn at least 12 percent, is this investment an attractive one?

Explanation / Answer

Solution-

NPV = -$850,000+$206,500(PVAFr%20 years) +$40,000 (PVFr%20 years) = 0

Now we use Trial and error method with 20%

So,

NPV = -$850,000+$206,500(4.870) +$40,000 (.026) = +$156,695

So, IRR = 24.1%

NPV is positive so the opportunity of the investment is attractive.

Revenue $500,000 Less- Cost $200,000 Less- Depreciation $25,000 Profit Before Tax $275,000 Less- Tax (34%) $93,500 Profit After Tax $181,500 Add- Depreciation $25,000 After tax cash flow $206,500

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.