Question

River Wild is considering purchasing a water park in Charleston, South Carolina​, for $ 2,050,000. The new facility will generate annual net cash inflows of $ 520,000 for eight years. Engineers estimate that the facility will remain useful for eight years and have no residual value. The company uses​ straight-line depreciation. Its owners want payback in less than five years and an ARR of 10​% or more. Management uses a 12​% hurdle rate on investments of this nature.
Based on your reading, complete the given tasks:

1. Compute the payback period, the ARR, the NPV, and the approximate IRR of this investment.

2. Recommend whether the company should invest in this project.

Answer 1

Answer:

1. Payback period = 3.94 Years

The  ARR is $262,750

The NPV is $937,102,

The approximate IRR of this investment is 20.87%

2. The Company should invest in this project as it NPV is positive, payback period is lower than the required Payaback period, ARR is greater than the minimum ARR, IRR is greater than cost of capital

Explanation:

In order to calculate the Payback period ARR, the NPV, and the approximate IRR of this investment we would have to use the following formula:

Payback period = Initial Investment/Annual net Cash inflow

Payback period = $ 2,050,000/$ 520,000

Payback period = 3.94 Years

ARR = Average Net Income/Average Investment

Average Net Income = Annual net Cash Flow - Annual Depreciation

Average Net Income = $ 520,000-$ 2,050,000/8

Average Net Income = $262,750

Average Investment = ($ 2,050,000+0)/2 = $1,025,000

ARR = $262,750/1,025,000

ARR = 25.63%

NPV = -Initial Investment + Annual Cash Inflow *(1-(1+r)^-n)/r

NPV = -$ 2,050,000 +  $ 520,000*(1-(1+10%)^-8)/10%

NPV = 937,102.15

IRR = rate(nper,pmt,pv,fv)

IRR = rate(8, $ 520,000,-$ 2,050,000,0)

IRR = 20.87%

The Company should invest in this project as it NPV is positive, payback period is lower than the required Payaback period, ARR is greater than the minimum ARR, IRR is greater than cost of capital