Question

Vilas Company is considering a capital investment of $190,900 in additional production facilities. The new machinery is expected to have a useful life of 5 years with no salvage value. Depreciation is by the straight-line method. During the life of the investment, annual net income and net annual cash flows are expected to be $11,600 and $49,900, respectively. Vilas has a 12% cost of capital rate, which is the required rate of return on the investment.
Required:

1. Compute the cash payback period.

2. Compute the annual rate of return on the proposed capital expenditure.

3. Using the discounted cash flow technique, compute the net present value.

Answer 1

Answer:

See below.

Explanation:

For payback period we use,

Payback = Initial outlay / Annual cash flow

Payback = 190,900/49,900 = 3.82 years

Annual rate of return is calculated as follows,

Annual rate of return = Average profit / Initial outlay *100%

Annual Rate of return = 11600/190,900) *100% = 6.08%

To calculate the NPV we discount the cash flows.

12% annuity factor for 5 years = 3.6048

PV of cash flows = 49,900*3.6048 = $179,879.52

NPV = 179879.52 - 190,900 = -$11,020.48  (negative)

Hope that helps.