Exercise 26-10 Vilas Company is considering a capital investment of $190,400 in
ID: 2557950 • Letter: E
Question
Exercise 26-10 Vilas Company is considering a capital investment of $190,400 in additional productive facilities. The new machinery is expected to have a useful life of 5 years with no salvage value. Depreciation is by the straight-line method. During the life of the investment, annual net income and net annual cash flows are expected to be $12,800 and $49,500, respectively. Vilas has a 12% cost of capital rate, which is the required rate of return on the investment. Click here to view PV table, Compute the cash payback period. (Round answer to 2 decimal places, e.g. 10.50.) Cash payback period Compute the annual rate of return on the proposed capital expenditure. (Round answer to 2 decimal places, e.g. 10.50.) Annual rate of return years Using the discounted cash flow technique, compute the net present value. (If the net present value is negative, use either a negative sign preceding the number e.g.-45 or parentheses e.g. (45). Round answer for present value to o decimal places, e.g. 125. For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Net present valueExplanation / Answer
1. Payback period is - the period in which we get back the amount investment in any project. e.g. if a company invested $100,000 in a project and there will be a cash inflow of 20,000 per year for 8 years, the payback period will be 100,000/20,000 = 5 years i.e. it is getting back it's investment of 100,00 within 5 years.
The formula for payback period is = Initial investment/annual cash inflow
= 190,400/49,500 = 3.85 years approx.
2. Annual rate of return = Annual income / Average investment
= 12,800/190,400x100 = 6.72%
3. Net Present value = NPV is difference of Net present value of cash inflows and net present value of cash outflows.
a. Present value of cash outflow = Initial investment has been made today which means that the present value of the investment will be the same i.e. 190,400.
b. Present value of cash inflows = it is the today's value of all the future cash inflows. It is calculated multiplying future cash inflows with PV factors. As the cash inflows are same we can simply sum the PV of 5 years and multiply with annual cash inflow.
Sum of present value of 1 of next 5 years @12% = 3.6048
Annual cash inflow = 49,500
PV of cash inflows today = 49,500x3.6048 = $178,436
NPV = PV of cash inflow - PV of cash outflows
= 178436-190400 = (11,964)
As the NPV is negative, the project should not be accepted.
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