Fanning Company is considering investing in two new vans that are expected to ge
ID: 340679 • Letter: F
Question
Fanning Company is considering investing in two new vans that are expected to generate combined cash inflows of $32,000 per year. The vans’ combined purchase price is $99,500. The expected life and salvage value of each are seven years and $20,800, respectively. Fanning has an average cost of capital of 12 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required Calculate the net present value of the investment opportunity. (Negative amount should be indicated by a minus sign. Round your intermediate calculations and final answer to 2 decimal places.) Indicate whether the investment opportunity is expected to earn a return that is above or below the cost of capital and whether it should be accepted.
a. Net present value b. Will the return be above or below the cost of capital? Should the investment opportunity be accepted?Explanation / Answer
Answer a.
Cost of Vans = $99,500
Annual Cash Inflows = $32,000
Salvage Value = $20,800
Cost of Capital = 12%
Life of Vans = 7 years
Net Present Value = -$99,500 + $32,000 * PVA of $1 (12%, 7) + $20,800 * PV of $1 (12%, 7)
Net Present Value = -$99,500 + $32,000 * 4.5638 + $20,800 * 0.4523
Net Present Value = $55,949.44
Answer b.
Let return on investment be i%
Net Present Value = -$99,500 + $32,000 * PVA of $1 (i%, 7) + $20,800 * PV of $1 (i%, 7)
0 = -$99,500 + $32,000 * PVA of $1 (i%, 7) + $20,800 * PV of $1 (i%, 7)
Using financial calculator:
N = 7
PV = -99500
PMT = 32000
FV = 20800
I/Y = 27.27%
Return on Investment is 27.27% which is higher than the cost of capital.
So, investment opportunity should be accepted.
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