Callaghan Company is considering investing in two new vans that are expected to
ID: 2585672 • Letter: C
Question
Callaghan Company is considering investing in two new vans that are expected to generate combined cash inflows of $33,000 per year. The vans' combined purchase price is $99,000. The expected life and salvage value of each are seven years and $20,000, respectively. Callaghan has an average cost of capital of 12 percent. (PV of S1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Calculate the net present value of the investment opportunity. (Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal places.) et present b-1. Indicate whether the investment opportunity is expected to earn a return that is above or below the cost of capital. Above Below b2. Based on your answer in Requirement b-1, should the investment opportunity be accepted Accepted RejectedExplanation / Answer
a.
Net present value (NPV) is the difference of present value (PV) of cash flows (CF) and initial purchase price.
There are 2 purchases; therefore, there would be a multiplication of 2.
Salvage value of each van is multiplied by 2 to get the total.
NPV = PV of CF – Initial purchase price
= [(33,000 / (1 + 0.12) ^1) + (33,000 / (1 + 0.12) ^2) + (33,000 / (1 + 0.12) ^3) + (33,000 / (1 + 0.12) ^4) + (33,000 / (1 + 0.12) ^5) + (33,000 / (1 + 0.12) ^6) + (33,000 / (1 + 0.12) ^7) + (2 × 20,000 / (1 + 0.12) ^7)] – ($99,000 × 2)
= (29,464.29 + 26,307.39 + 23,488.74 + 20,972.09 + 18,725.08 + 16,718.82 + 14,927.52 + 18,093.96) – 198,000
= 168,697.89 – 198,000
= - 29,302.11 (Answer)
b-1.
The return is below the cost.
It happens because the NPV is negative (as calculated above).
b-2.
It should be rejected.
This is because of getting lower return. The internal rate of return must be above the hurdle rate for the acceptance of project; which is not happening here.
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