Callaghan Company is considering investing in two new vans that are expected to

Question

Callaghan Company is considering investing in two new vans that are expected to generate combined cash inflows of $31,000 per year. The vans’ combined purchase price is $100,000. The expected life and salvage value of each are seven years and $20,200, respectively. Callaghan has an average cost of capital of 14 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Required a. Calculate the net present value of the investment opportunity. (Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal places.)

b-1. Indicate whether the investment opportunity is expected to earn a return that is above or below the cost of capital. Above Below

b-2. Based on your answer in Requirement b-1, should the investment opportunity be accepted. Rejected Accepted

Explanation / Answer

a. The net present value of the investment opportunity is $ 49,088.

b.Since the net present value is positive at the company's required rate of return, i.e 14%, this investment opportunity is expected to earn a return above the company's cost of capital, and hence expected to add to shareholder value. The internal rate of return is also well above the firm's cost of capital.

c. The investment opportunity should be accepted

PVA of 1 at 14% 7 years is 4.288

PV of 1 at 14% at the 7th year is 0.400

Present value of cash inflows is (31,000 x 4.288) + (40,400 x 0.400) = $ 149,088

Present value of cash outflows is $ 100,000

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