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 $28,000 per year. The vans' combined purchase price is $91,000. The expected life and salvage value of each are four years and $21,000, respectively. Callaghan has an average cost of capital of 7 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required Calculate the net present value of the investment opportunity. (Round intermediate calculations and round your final answer to 2 decimal places.) a. Net present value 35,883.40 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

Explanation / Answer

a.

Cash flows each year = 28,000

Expected life = 4 years

Salvage value = 21,000

Cost of capital = 7%

Initial investment = 91,000

PVAF of 7% for 4 years = 3.387

PVAF of 7% in year 4 = 0.763

Present value of cash inflows = (28,000*3.387) + (21,000*0.763) + (21,000*0.763)

= 94,836 + 16,023 + 16,023

= 126,882

Net present value = Present value of cash inflows - Present value of cash outflows

= 125,882 - 91,000

= 35,882

b-1

Net present value becomes Zero at the Internal rate of return of the investment opportunity. For Net present value to be Zero, the cost of capital to be more than 7%. So the investment opportunity is expected to earn greater than 7%.

Above

b-2

The investment opportunity has to be accepted as it provides rate of return greater than 7%.

Accepted

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