Question

A company projects an increase in net income of $30000 each year for the next five years if it invests $300000 in new equipment. The equipment has a five-year life and an estimated salvage value of $100000. What is the annual rate of return on this investment?

Answer 1

Answer:

Annual rate of return = 13%

Explanation:

Since the firm's net income increases by $30,000 per year, the cash flows per year = net income + depreciation costs

Depreciation costs = ($300,000 - $100,000) / 5 = $200,000 / 5 = $40,000

The cash flows generated by this investment are as follows:

Year 0 = -$300,000

Year 1 = $70,000

Year 2 = $70,000

Year 3 = $70,000

Year 4 = $70,000

Year 5 = $170,000 (including salvage value)

To calculate the project's rate of return (RoR) we can use an excel spreadsheet and the IRR function

=IRR (values,[guess])

=IRR (-300000,70000,70000,70000,70000,170000)

= 13%