Adrian Sonnetson, the owner of Adrian Motors, is considering the addition of a p
ID: 2468473 • Letter: A
Question
Adrian Sonnetson, the owner of Adrian Motors, is considering the addition of a paint and body shop to his automobile dealership.Construction of a building and the purchase of necessary equipment is estimated to cost $796,000, and both the building and equipment will be depreciated over 10 years using the straight-line method. The building and equipment have zero estimated residual value at the end of 10 years.Sonnetson’s required rate of return for this project is 12 percent. Net income related to each year of the investment is as follows:
1. Determine the net present value of the investment in the paint and body shop?
2. Should Sonnetson invest in the paint and body shop?
3. Calculate the internal rate of return of the investment (approximate)?
4. Calculate the payback period of the investment?
5. Calculate the accounting rate of return?
Revenue $651,000 Less: Material cost 71,700 Labor 149,000 Depreciation 79,600 Other 10,000 Income before taxes 340,700 Taxes at 40% 136,280 Net income $204,420Explanation / Answer
Net income
204,420
Add: Depreciation
79,600
Annual cash flow
284,020
Cash flow
PV factor
total
-796,000
1.000
-796,000
284,020
5.6502
1,604,769.80
808,769.80
b) Yes
c)IRR
Initial outlay $796,000
Annual annuity 284,020
PV of annuity factor = cost / annuity amount
= 796,000 / 284,020
= 2.80261
IRR = 32.93%
c) Pay back period = 2.80
d) Account rate of return
Average income / Average investment
204,420 / 398,000
= 51.36%
Net income
204,420
Add: Depreciation
79,600
Annual cash flow
284,020
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