Linda’s Luxury Travel (LLT) is considering the purchase of two Hummer limousines

Question

Linda’s Luxury Travel (LLT) is considering the purchase of two Hummer limousines. Various information about the proposed investment follows:   

Assume straight line depreciation method is used.     

Required:
Help LLT evaluate this project by calculating each of the following:    

1. Accounting rate of return. (Round your percentage answer to 1 decimal place.)



2. Payback period. (Round your answer to 2 decimal places.)

  

3. Net present value. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Cash Outflows and negative amounts should be indicated by a minus sign. Round your "Present Values" to the nearest whole dollar amount.)

   

4. Without making any calculations, determine whether the IRR is more or less than 14%.

Initial investment (2 limos) $ 720,000 Useful life 10 years Salvage value $ 100,000 Annual net income generated 59,040 LLT’s cost of capital 14 %

Explanation / Answer

Initial Investment = $720,000 , Useful life = 10 years , Salvage Value = $100,000

Annual Net Income generated = $59,040 , Cost of capital = 14%

Depreciation = 720,000 - 100,000 / 10 = $62,000

Annual Cashflows = $59,040 + $62,000 = $121,040

1. ARR = (Annual Net Income / Average Investment) * 100 = (59,040 / 720,000) * 100 = 8.2%

2. Payback Period = Initial Investment / Annual Cashflows = 720,000 / 121,040 = 5.94 years.  

3. PV of cash flows = 121,040 * PVAF(14% for 10 years) = 121,040 * 5.2161 = $631,356.74

Less: PV of cash outflow = $720,000

NPV = (88,643.26)

4. If IRR = Discount rate, then NPV = 0

If IRR < Discount Rate, Then NPV is negative

If IRR > Discount Rate, Then NPV is positive

Here NPV is negative, so IRR is less than discount rate i.e.14%

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