Answer:
1) Accounting rate of return is 8.2%
2) Payback period is 5.95 years
3) Net present value (NPV) is ($88,643.26)
4) Option B
Explanation:
Initial Investment = $720,000 , Useful life = 10 years , Salvage Value = $100,000
Annual Net Income generated = $59,040 , Cost of capital = 14%
Depreciation = ($720,000 - $100,000) ÷ 10 = $62,000
Annual Cash flows = $59,040 + $62,000 = $121,040
1) Accounting rate of return = (Annual Net Income ÷ Average Investment) × 100
= (59,040 ÷ 720,000) × 100
= 8.2%
2. Payback Period = Initial Investment ÷ Annual Cashflows
= 720,000 ÷ 121,040
= 5.95 years.
3. PV of cash flows = 121,040 × PVAF(14% for 10 years)
= 121,040 × 5.2161
= $631,356.74
Less: PV of cash outflow = $720,000
Net present value (NPV) = (88,643.26)
4. If IRR = Discount rate, then NPV = 0
If IRR < Discount Rate, Then NPV is negative
If IRR > Discount Rate, Then NPV is positive
Here NPV is negative, so IRR is less than discount rate i.e.14%
