Question 1 (evaluating investment projects) Generic Motors Corporation is planni

Question

Question 1 (evaluating investment projects)

Generic Motors Corporation is planning to invest $175,000 in year zero (today) in new equipment. This investment is expected to generate net cash flows of $70,000 a year for the next 4 years (years 1-4). The salvage value after 4 years is zero. The discount rate (cost of capital) is 20% a year.

Required:

a) What is the net present value (NPV) of this project? NPV = $

b) What is the payback period for this project? payback period =

c) What is the modified payback period for this project? (between 1 and 2 years) (between 2 and 3 years) (between 3 and 4 years)

d) What is the accounting rate of return (ARR) for this project? To compute ARR, first compute:

annual depreciation=$

annual income=$

average investment=$

ARR = %

Explanation / Answer

A./

NPV = ($175000) + $70000 * PVIFA 20%,4PERIODS

= ($175000) + $70000 * 2.5887

= ($175000) + $181209

= $6209

B./

PAYBACK PERIOD

= LAST YEAR WITH NEGATIVE CASH FLOW + (CUMULATIVE CASH FLOW OF THAT YEAR / CASH FLOW OF NEXT YEAR)

= 2 + ($35000 / $70000)

= 2 + 0.5

= 2.5 YEARS

C./

MODIFIED PAYBACK PERIOD

=LAST YEAR WITH NEGATIVE CASH FLOW + (COST - CUMULATIVE CASH FLOW OF THAT YEAR) / CASH FLOW OF NEXT YEAR

= 2 + ($175000 - $35000) / $70000

= 2 + 2

= 4YEARS

D./

ANNUAL DEPERICATION = ($175000 / 4)

= $43750

ANNUAL INCOME = $70000 - $43750

= $26250

AVERAGE INVESTMENT = $175000

ARR = $26250 / $175000

= 15%

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