13. Average Rate of Return, Cash Payback Period, Net Present Value Method for a
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Question
13.
Average Rate of Return, Cash Payback Period, Net Present Value Method for a Service Company
Spanish Peaks Railroad Inc. is considering acquiring equipment at a cost of $1,250,000. The equipment has an estimated life of eight years and no residual value. It is expected to provide yearly net cash flows of $312,500. The company’s minimum desired rate of return for net present value analysis is 12%.
Compute the following:
a. The average rate of return, giving effect to straight-line depreciation on the investment. If required, round your answer to one decimal place.
%
b. The cash payback period.
c. The net present value. Use the above table of the present value of an annuity of $1. Round to the nearest dollar.
Present Value of an Annuity of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 1.833 1.736 1.690 1.626 1.528 3 2.673 2.487 2.402 2.283 2.106 4 3.465 3.170 3.037 2.855 2.589 5 4.212 3.791 3.605 3.353 2.991 6 4.917 4.355 4.111 3.785 3.326 7 5.582 4.868 4.564 4.160 3.605 8 6.210 5.335 4.968 4.487 3.837 9 6.802 5.759 5.328 4.772 4.031 10 7.360 6.145 5.650 5.019 4.192Explanation / Answer
a. Average Rate of Return = Annual Net Income / Average Investment = $ 156,250 / $ ( 1,250,000 x 1/2) = 25 %
Annual depreciation = $ 1,250,000 / 8 = $ 156,250
Annual net income = $ 312,500 - $ 156,250 = $ 156,250
b. Cash Payback Period = Initial Investment / Annual Cash Inflows = $ 1,250,000 / $ 312,500 = 4 years.
c.
Present value of annual net cash flows ( 312,500 x 4.968) $ 1,552,500 Amount to be invested $ 1,250,000 Net Present Value $ 302,500Related Questions
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