Surf Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income of $50,000. The equipment will have an initial cost of $600,000 and have an 8-year life. The equipment has no salvage value. The hurdle rate is 10%. Ignore income taxes. Answer the following:a. What is the accounting rate of return?b. What is the payback period?c. What is the net present value?d. What would the net present value be with a 15% hurdle rate?e. Based on the NPV calculations, in what range would the equipment's internal rate of return fall?
What will be an ideal response?
a. 8.33% = $50,000/$600,000
b. 4.8 years = $600,000/($50,000 + [($600,000 ? 0)/8])
c. $66,862.50 = {($50,000 + [($600,000 ? 0)/8]) × 5.3349} ? $600,000
d. ($39,087.50) = {($50,000 + [($600,000 ? 0)/8]) × 4.4873} ? $600,000
e. IRR is between 10% and 15% (13%)
Accounting rate of return is calculated by dividing annual net income by initial investment. Payback period is calculated by dividing the initial investment by the annual net cash flow when cash flows are equal. Net present value is calculated by discounting the annual cash flows and subtracting the initial investment. Internal rate of return is the rate where net present value equals zero. Net income = Annual cash flows ? Depreciation.
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