Curtis industries is considering the purchase of a new machine. It will cost $80

Question

Curtis industries is considering the purchase of a new machine. It will cost $80,000, last for 8 years, and have a residual value of $10,000. If purchased, the machine is expected to increase cash inflows by $80,000 per 8 years, with $64,000 per year for 8 years in additional cash outlays required to operate the machine. The company uses the straight-line method of depreciation, and desires a 12% minimum rate of return.

The present value factors of $1 due eight years from now:

8%              .540

10%            .467

12%            .404

14%            .351

The present value factors for an annuity of $1 per year due at the end of each of eight years:

8%             5.747

10%            5.335

12%            4.968

14%            4.639

Q#1. Determine the payback period.

Q#2. Determine the internal rate of return of this investment (to the nearest whole percentage)

Q#3. Determine the net present value of this investment at the desired minimum rate of return

Q#4. Determine the accounting rate of return of this investment.

THANK YOU!

Explanation / Answer

1) Payback period = Initial investment/Annual net cash inflows = 80000/(80000-64000) = 5 Years 2) IRR is that discount rate for which NPV = 0 That is -80000+16000*PVIFA(irr,8)+10000*PVIF(irr,8) = 0 The value of irr is to be found out by trial and error, by using different discount rates such that NPV is zero. Using 12% -80000+16000*4.968+10000*0.404 = 3528 Using 14% -80000+16000*4.639+10000*0.351 = -2266 IRR lies between 12% and 14%. The value of IRR can be found by simple interpolation as below: IRR = 10+2*3528/(3528+2266)= 11.22% 3) NPV = -80000+16000*PVIFA(12,8)+10000*PVIF(12,8) = 0 -80000+16000*4.968+10000*0.404 = 3528 4) Accounting rate of return = Annual net income/Initial investment = (16000-70000/8)/80000 = 9.06% OR Accounting rate of return = Annual net income/Average investment = (16000-70000/8)/((80000+10000)/2)) = 16.11%

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