Question

Alto Clinic plans to purchase a new centrifuge machine for its Massachusetts facility. The machine costs $174,000 and is expected to have a useful life of 9 years, with a terminal disposal value of $20,500. Savings in cash operating costs are expected to be $35,000 per year. However, additional working capital is needed to keep the machine running efficiently. The working capital must continually be replaced, so an investment of $14,000 needs to be maintained at all times, but this investment is fully recoverable (will be "cashed in") at the end of the useful life. Alto Clinic's required rate of return is 10%. Ignore income taxes in your analysis. Assume all cash flows occur at year-end except for initial investment amounts. Alto Clinic uses straight-line depreciation for its machines. Present Value of $1 table Present Value of Annuity of $1 table Future Value of $1 table Future Value of Annuity of $1 table Read the requirements. Requirements - X Requirement 1. Calculate net present value. (Use facto Enter the net present value of the investment rounded to the nearest whole dollar.) The net present value is $ 1. Calculate net present value. 2. Calculate internal rate of return. 3. Calculate accrual accounting rate of return based on net initial investment. 4. Calculate accrual accounting rate of return based on average investment. 5. You have the authority to make the purchase decision. Why might you be reluctant to base your decision on the DCF methods? Print Done Enter any number in the edit fields and then click Check Answer. 5 parts Clear All Check Answer remaining

Answer 1

a) NPV
a	Annual cash flow	$             35,000
b	PV Annuity Factor (9 years,10%)	5.759
c	PV of annual cash flow (a*b)	$         2,01,565
d	Salvage Value	$             20,500
e	PV Factor for 9th year	0.424
f	PV of Salvage Value (d*e)	$               8,692
g	Release of working capital	$             14,000
h	PV of Working Capital on 9th year	$               5,936
i	Initial Investment ($174000+14000)	$         1,88,000
j	NPV (c+f+h-i)	$             28,193
Alternative answer: $28197 ( if PV factor does not rounded off)
b)	Calculation of IRR
Let us calculate NPV at 16% rate
a) NPV
a	Annual cash flow	$             35,000
b	PV Annuity Factor (9 years,15%)	4.607
c	PV of annual cash flow (a*b)	$         1,61,245
d	Salvage Value	$             20,500
e	PV Factor for 9th year	0.26295
f	PV of Salvage Value (d*e)	$               5,390
g	Release of working capital	$             14,000
h	PV of Working Capital on 9th year	$               3,681
i	Initial Investment ($174000+14000)	$         1,88,000
j	NPV (c+f+h-i)	$           -17,683
IRR = 10% + 28193/(28193+17683) * 6%
=10%+ 3.69
=13.69% (approx)
=13.41% (extact answer using excel function)
Note: Prefer to the exact answer.
c)	Accounting Rate of return
	Depreciation = $174000-20500/9 years
	=$17055.56
	Net Income = $35000-17055.56
	=$17944.44
	Accounting rate of return = net income / initial investment
	=$17944.44/188000
	9.54%
d)	ARR based on average investment
	Average Investment = (188000+20500+14000)/2
	=$111250
	ARR = $17944.44/111250
	16.13%