NVP and AARR, goal-congruence issues. Eric Ishton, a manager of the Plate Divsio
ID: 2485449 • Letter: N
Question
NVP and AARR, goal-congruence issues. Eric Ishton, a manager of the Plate Divsion for the Stone Ware Manufacturing company, has the opportunity to expand the division by investing in additional machinery costing $430,000. He would depreciate the equipment using the straight-line method and expects it to have no residual value. It has a useful life of 8 years. The firm mandates a required after-tax rate of return of 12% on investments. Eric estimates annual net cash inflows for this investment of $110,000 before taxes and an investment in working capital of $7,500. The tax rate is 30%.
1. Calculate the net present value of this investment.
2. Calculate the actual accounting rate of return based on net initial investment for this project.
3. Should Eric accept the project? Will Eric accept the project if his bonus depends on acheiving an accrual accounting rate of return of 12%? How can this conflict be resolved?
Explanation / Answer
1. Net present value :
Years Cash flow PVAF(12%,8years) PVF(12 %,8year) Present value
0 -430000 1 430000
0 -7500 1 7500
1-8 77000 4.968 382536
8 7500 0.404 3030
Net present Value = present value of cash inflow - present value of cash outflow
= (382536 + 3030) -(430000 + 7500)
= 385566 - 437500
= -$51934
Note:- Net annual cash inflow = $110000 (1 - tax)
= $110000 (1 - 0.30)
= $77000
We assume that investment in working capital will be released after useful life of machinery.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.