Adrian Sonnetson, the owner of Adrian Motors, is considering the addition of a p

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 $804,000, 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:
Revenue $647,000 Less:     Material cost 69,000     Labor 151,000     Depreciation 80,400     Other 11,000 Income before taxes 335,600 Taxes at 40% 134,240 Net income $201,360

Explanation / Answer

Calculation of NPV:

Net cash inflow per year = Net income + depreciation = $201360 + $80400 = $281760

NPV

= $ 281760 x PVIFA (12%, 10) - $804000

= $281760 x 6.195 - $804000 = $941503

Calculation of Payback Period:

Payback period = initial investment / cash inflow per year = $804000 / $281760 = 2.9 years

Calculation of Accounting rate of return

Accounting Rate of return

= Average accounting profit / average investment

= $201360 / ($804000 + 0)/2 = 50%

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