Cheyenne, Inc. is considering the following capital budgeting project for a new

Question

Cheyenne, Inc. is considering the following capital budgeting project for a new machine. CHEYENNE, INC. CAPITAL BUDGETING INFORMATION FOR NEW MACHINE Cost of machine Estimated useful life Estimated salvage value Estimated annual net cash inflow from machine Minimum desired rate of return Depreciation method 250,000 7 years 65,000 12.00% Straight line REQUIRED: Compute the following for this capital budgeting project. Round percentage answers to four decimal places, dollar amounts to the nearest whole dollar, and all other amounts to two decimal places. ) Cash payback period. (2) Net present value. (3) Accounting rate of return (4) Internal rate of return

Explanation / Answer

Estimated annual net cash inflows = 65,000

Cash outflows(initial investment) = 250,000

Estimated useful life = 7 years

Estimated salvage value = 0

Method of depreciation = Straight line

Minimum desired rate of return = 12%

1. Cash payback period = Total initial investment / Estimated annual net cash inflows

= 250,000 / 65,000 = 3.85 years

2. Discount factor of 12% for 7 years = 4.56

Present value of cash inflows = 65,000 * 4.56 = 296,400

Present value of cash outflows = 250,000

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

= 296,400 - 250,000 = 46,400

3. Depreciation under Straight line method = (cost - estimated salvage value) / estimated useful life

= (250,000 - 0) / 7 = 35,714

Accounting income = Cash inflows - Depreciation = 65,000 - 35,714 = 29,286

Accounting Rate of Return = Accounting Income / Investment

= 29,286 / 250,000 = 11.7144%

4. Internal rate of return is where Net present value = 0

Discount factor of 17% for 7 years = 3.92

Present value of cash inflows = 65,000 * 3.92 = 254,800

Present value of cash outflows = 250,000

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

= 254,800 - 250,000 = 4,800

Discount factor of 18% for 7 years = 3.81

Present value of cash inflows = 65,000 * 3.81 = 247,650

Present value of cash outflows = 250,000

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

= 247,650 - 250,000 = (2,350)

Net present value at 17% = 4,800

Net present value at 18% = (2,350)

Internal Rate of Return = L1 + [NPV(L1) / NPV(L1) - NPV(L2)] * (L1-L2)

= 17 + 4800 / (4,800+2,350) * (18-17)

= 17.6713%.

  

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