3) Ursus, Inc., is considering a project that would have a ten-year life and wou

Question

3) Ursus, Inc., is considering a project that would have a ten-year life and would require a $1,000,000 investment in equipment. At the end of ten years, the project would terminate and the equipment would have no salvage value. The project would provide net operating income each year as follows (Ignore income taxes. S 2,000,000 1,400,000 600,000 Sales Variable expenses Contribution margin Fixed expenses: Fixed out-of-pocket cash expenses Depreciation Net operating income s 300,000 100,000 400,000 S 200,000 All of the above items, except for depreciation, represent cash flows. The company's required rate of 12% See separate Exhibit 13B-1 and Exhibit 13 provided B-2, to determine the appropriate discount factor(s) using the tables Required: a. Compute the project's net present value. b. Compute the project's intemal rate of return to the nearest whole percent c. Compute the project's payback period. d. Compute the project's simple rate of return.

Explanation / Answer

a) Annual Cash Inflows = Net Operating Income+Depreciation

= $200,000+$100,000 = $300,000

Present Value of Annual Cash Inflows = Annual Cash Inflows*PVAF(12%, 10 yrs)

= $300,000*5.65022 = $1,695,066

Net Present Value = PV of Cash Inflows - Initial Investment

= $1,695,066 - $1,000,000 = $695,066

b) The internal rate of return (IRR) is the rate at which present value of cash inflows is equal to present value of cash outflows (i.e. the rate at which NPV is zero). (Suppose i = IRR)

Initial Investment = Annual Cash Inlflows*PVAF(i%, n yrs)

$1,000,000 = $300,000*PVAF(i%, 10 yrs)

PVAF(i%, 10 yrs) = $1,000,000/$300,000 = 3.3333

The rate for the value of 3.3333 in the present value annuity table for 10 years is 27% (approx).

Therefore, IRR is 27%.

c) Project Payback period = Initial Investment/Annual Cash Inflows

= $1,000,000/$300,000 = 3.33 yrs

d) Project's simple rate of return = Annual Net Operating Income/Initial Investment

= $200,000/$1,000,000 = 20%

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