Question

BAM Co. is evaluating a project requiring a capital expenditure of $806,250. The project has an estimated life of four years and no salvage value. The estimated net income and net cash flow from the project are as follows: Year Net Income Net Cash Flow 1 $75,000 $285,000 2 102,000 290,000 3 109,500 190,000 4 36,000 125,000 $322,500 $890,000 The company's minimum desired rate of return is 12%. The present value of $1 at compound interest of 12% for Years 1 through 4 is 0.893, 0.797, 0.712, and 0.636, respectively. Determine the following: a. The average rate of return on investment, including the effect of depreciation on the investment. % b. The net present value. Enter negative values as negative numbers.

Answer 1

Answer:

20% and - $105,835

Explanation:

The computations are shown below:

a. Accounting rate of return:

= Average net income ÷ average investment

where,  

Average net income is $322,500 ÷ 4 years = $80,625

And, the average investment would be

= (Initial investment + salvage value) ÷ 2

= ($806,250 + $0) ÷ 2

= $806,250 ÷ 2

= $403,125

Now put these values to the above formula  

So, the rate would equal to

= $80,625 ÷ $403,125

= 20%

b. Net Present value:

= Present value of all yearly cash inflows after applying discount factor - initial investment

The discount factor should be computed by

= 1 ÷ (1 + rate) ^ years

where,  

rate is 12%  

Year = 0,1,2,3,4 and so on

Discount Factor:

For Year 1 = 1 ÷ 1.12^1 = 0.893

For Year 2 = 1 ÷ 1.12^2 = 0.797

For Year 3 = 1 ÷ 1.12^3 = 0.712

For Year 4 = 1 ÷ 1.12^4 = 0.636

So, the calculation of a Present value of all yearly cash inflows are shown below

= Year 1 cash inflow × Present Factor of Year 1 + Year 2 cash inflow × Present Factor of Year 2 + Year 3 cash inflow × Present Factor of Year 3 + Year 4 cash inflow × Present Factor of Year 4

= $285,000 × 0.893 + $290,000 × 0.797+ $190,000 × 0.712 + $125,000 × 0.636

= $254,505 + $231,130 + $135,280 + $79,500

= $700,415

So, the Net present value equals to

= $700,415 - $806,250

= - $105,835