Solution 1) Calculation of Payback period for each of Kambry Day’s Projects
Payback period for Project A
Year |
After tax Cash Flows |
Cumulative After tax Cash Flows |
1 |
6000 |
6000 |
2 |
8000 |
14000 |
3 |
10000 |
24000 |
4 |
10000 |
34000 |
5 |
10000 |
44000 |
As the Initial Investment is $20,000, the Payback period is between 2^{nd} and 3^{rd} Year.
PayBack Period
= Completed Number of Years + (Cash Inflows to be recovered / Cash inflows for the next Year)
= 2 + (20,000 – 14000)/ 10000
= 2.6 Years
Payback Period of Project A is 2.6 Years
Payback period for Project B
Year |
After tax Cash Flows |
Cumulative After tax Cash Flows |
1 |
6000 |
6000 |
2 |
8000 |
14000 |
3 |
10000 |
24000 |
4 |
3000 |
27000 |
5 |
3000 |
30000 |
As the Initial Investment is $20,000, the Payback period is between
2^{nd} and 3^{rd} Year.
PayBack Period
= Completed Number of Years + (Cash Inflows to be recovered / Cash inflows for the next Year)
= 2 + (20,000 – 14000)/ 10000
= 2.6 Years
Payback Period of Project B is 2.6 Years
Both the projects have
same payback period.
Solution 2) Calculation of Accounting Rate of Return for
Project A
Year |
After tax Cash Flows |
1 |
6,000.00 |
2 |
8,000.00 |
3 |
10,000.00 |
4 |
10,000.00 |
5 |
10,000.00 |
Total |
44,000.00 |
Calculation of Accounting Rate of Return
ARR = (Average Annual Profit After tax / Average Investment) x 100
Where, Average Investment = ½(Initial Cost + Installation Expenses – Salvage Value) + Salvage Value
Note: As information about Salvage value is mentioned, we
will assume that salvage value after 5years is nil.
Average Investment =1/2(20,000 + 0 – 0) + 0
= $10,000
Average Annual Profit After tax = $44,000 / 5 = $8,800
Therefore, ARR = $8,800 / $10,000 x 100
= 88%
ARR of Project A is 88%
Calculation of Accounting Rate of Return for Project
B
Year |
After tax Cash Flows |
1.00 |
6,000.00 |
2.00 |
8,000.00 |
3.00 |
10,000.00 |
4.00 |
3,000.00 |
5.00 |
3,000.00 |
Total |
30,000.00 |
Calculation of Accounting Rate of Return
ARR = (Average Annual Profit After tax / Average Investment) x 100
Where, Average Investment = ½(Initial Cost + Installation Expenses – Salvage Value) + Salvage Value
Note: As information about Salvage value is mentioned, we
will assume that salvage value after 5years is nil.
Average Investment =1/2(20,000 + 0 – 0) + 0
= $10,000
Average Annual Profit After tax = $30,000 / 5 = $6,000
Therefore, ARR = $6,000 / $10,000 x 100
= 60%
ARR of Project B is 60%
Based on Accounting Rate of Return, Project A should be selected
Solution 3) Calculation of the Present Value of $30,000 to be received for 20 year.
Following are the steps to be followed on Microsoft Excel to calculate the Present Value of the payments:
Step 1: Click on "FORMULAS" tab at the top of Microsoft
Excel
Step 2: Select the option "Financial"
Step 3: Under "Financial" select the option "PV"
Step 4: Insert Rate = 0.06 Nper = 20 PMT = -30000
PV = $344,097.64
As the Present value of the lump sum amount is higher, Wilma Golding should take the lump sum amount of $450,000.
Solution 4) Calculation of Net Present Value of the Investment
Year |
After tax Cash Flows |
Present Value Factor @ 8 % |
Present Value of After tax Cash Flows |
1 |
9,000.00 |
0.925926 |
8,333.33 |
2 |
9,000.00 |
0.857339 |
7,716.05 |
3 |
9,000.00 |
0.793832 |
7,144.49 |
4 |
9,000.00 |
0.735030 |
6,615.27 |
5 |
9,000.00 |
0.680583 |
6,125.25 |
6 |
9,000.00 |
0.630170 |
5,671.53 |
Total Present Value of After tax Cash Flows |
41,605.92 |
||
Less: Cost of the Equipment |
30,000.00 |
||
Net Present Value |
11,605.92 |
Therefore, the Net Present Value of the Equipment is $11,605.92. As the Net Present Value is positive, David Booth should invest in the equipment.
Solution 5) Calculation of Internal Rate of Return
Year |
After tax Cash Flows |
0 |
(4,00,000.00) |
1 |
75,000.00 |
2 |
75,000.00 |
3 |
75,000.00 |
4 |
75,000.00 |
5 |
75,000.00 |
6 |
75,000.00 |
7 |
75,000.00 |
8 |
75,000.00 |
9 |
75,000.00 |
10 |
75,000.00 |
Following are the steps to be followed on Microsoft Excel to calculate the IRR:
Step 1: Click on "FORMULAS" tab at the top of Microsoft
Excel
Step 2: Select the option "Financial"
Step 3: Under "Financial" select the option "IRR"
Step 4: Insert Values: (-400000; 75000; 75000; 75000; 75000; 75000;
75000; 75000; 75000; 75000; 75000)
IRR = 13.43%
The Internal Rate of Return of the equipment is 13.43%
As the Internal Rate of Return of the equipment is higher than the
required rate of return, Patsy should acquire the
equipment.
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