1) World Domination Enterprises is considering the purchase of equipment with a
ID: 2471260 • Letter: 1
Question
1) World Domination Enterprises is considering the purchase of equipment with a cost of $800,000, a salvage value
of $100,000, and an estimated useful life of 5 years. World Domination depreciates all equipment using the
straight-line method. Additionally, it expects to be subject to a tax rate of 25% in all 5 years.
World Domination projects the following gross cash flows directly resulting from equipment operations:
Year 1 $ 260,000
Year 2 $ 370,000
Year 3 $ 310,000
Year 4 $ 270,000
Year 5 $ 190,000
World Domination uses a time value of money rate of 9% for decision-making purposes.
A) Calculate the payback period of the investment in the equipment.
B) Calculate the net present value of the investment in the equipment.
C) Calculate the profitability index of the investment in the equipment.
Explanation / Answer
Solution:
A) Calculation of Payback Period of the investment in the equipment
Year
Gross Cash Flow
Cumulative Gross Cash Flow
1
$260,000
$260,000
2
$370,000
$630,000
3
$310,000
$940,000
4
$270,000
$1,210,000
5
$190,000
$1,400,000
Initial Investment = $800,000
From the cumulative Cash flow it is clear that the payback period is between 2 and 3 year.
Payback Period = 2 Years + ($800,000 - $630,000) / $310,000 = 2 Years + 0.548 Years = 2.548 Years
B) Calculation the net present value of the investment in the equipment.
Calculation of Present Value of Cash Flow
Year
Gross Cash Flow
PV factor @ 9%
Present Value of Cash Flow
1
$260,000
0.917
$238,532
2
$370,000
0.842
$311,422
3
$310,000
0.772
$239,377
4
$270,000
0.708
$191,275
5
$190,000
0.650
$123,487
5
$100,000
0.650
$64,993
Present Value of Cash Flow
$1,169,085
Present Value of Cash Outflow = Cost of Equipment = $800,000
Net Present Value = Present Value of Cash Flow - Present Value of Cash Outflow = $1,169,085 - $800,000 = $369,085
C) Calculation of profitability index
Profitability Index = Present Value of Cash Flow / Present Value of Cash Outflow = $1,169,085 / $800,000 = 1.4614
Year
Gross Cash Flow
Cumulative Gross Cash Flow
1
$260,000
$260,000
2
$370,000
$630,000
3
$310,000
$940,000
4
$270,000
$1,210,000
5
$190,000
$1,400,000
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