Question

Ursus, Inc., is considering a project that would have a five-year life and would require a $2,400,000 investment in equipment. At the end of five years, the project would terminate and the equipment would have no salvage value. The project would provide net operating income each year as follows (Ignore income taxes.):

Sales $ 3,500,000
Variable expenses 2,100,000
Contribution margin 1,400,000
Fixed expenses:
Fixed out-of-pocket cash expenses $ 600,000
Depreciation 480,000 1,080,000
Net operating income $ 320,000
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using the tables provided.

All of the above items, except for depreciation, represent cash flows. The company's required rate of return is 14%.

Required:

a. Compute the project's net present value. (Round your intermediate calculations and final answer to the nearest whole dollar amount.)

b. Compute the project's internal rate of return. (Round your final answer to the nearest whole percent.)

c. Compute the project's payback period. (Round your answer to 2 decimal place.)

d. Compute the project's simple rate of return. (Round your final answer to the nearest whole percent.)

Answer 1

Answer:

Part 1. NPV $346,465

Part 2. IRR is 19.8%

Part 3. 3 Years

Part 4. 13.33%

Explanation:

Part 1.

Year  Cash Flow   DF at 14%  Discounted Cash flow  

 0         -2,400,000    1.00               -2,400,000  

 1             800,000    0.8772                   701,754  

 2            800,000    0.7695           615,574  

 3            800,000    0.6750          539,977  

 4            800,000    0.5921                  473,664  

 5            800,000    0.5194                   415,495

               NPV                                 $346,465

   

Part 2.

Year   Cash Flow   DF at 14%  Disc.Cash flow   DF at 20%   Disc. Cash flow

 0     -2,400,000  1.0000     -2,400,000          1.0000          -2400,000

 1      800,000  0.8772        701,754             0.8333            666,667

 2      800,000  0.7695        615,574          0.6944          555,556

 3      800,000  0.6750        539,977          0.5787          462,963

 4      800,000  0.5921        473,664          0.4823          385,802

 5      800,000  0.5194       415,495         0.4019             321,502

                             NPV              $346,465                                    -$7510

IRR can be calculated by using the following formula:

IRR = R at lower %age  + (R at Higher %age - R at Lower %age) * NPV at lower Percentage / (NPV at Higher %age - NPV at Lower %age)

Now by putting values, we have:

IRR = 14%   +  (20% - 14%)  *  346,465 / (346,465 +  7510)

IRR = 14%   +  5.8%  = 19.8%

Part 3.

Now by putting values, we have:

Payback Period = Initial Investment / Cash flow Per Period

Payback Period = $2,400,000 / $800,000  =  3 Years

Part 4.

As we know that:

Simple Rate Of Return = Net operating income ÷ Initial investment

Now by putting values, we have:

Simple Rate Of Return = $320,000 / $2,400,000 = 13.33%