Question

Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter, he expects demand to stabilize. The following table presents the expected cash flows: Year of Operation Cash Inflow Cash Outf low $13,800 19,800 21,800 21,800 8,500 11,900 2019 2020 12,700 12,700 2021 2022 In addition to these cash flows, Aaron expects to pay $20,400 for the equipment. He also expects to pay $3,000 for a major overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $1,700 salvage value and a four year useful life. Aaron desires to earn a rate of return of 12 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Calculate the net present value of the investment opportunity. (Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal places.) b. Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and whether it should be accepted a. Net present value Will the return be above or below the cost of capital? b. Should the investment opportunity be accepted?

Answer 1

A) calculation of net cash inflow

= Cash out flow - cash inflow

2019 =13800 - 8500 = 5300

2020 =19800 - 11900 = 7900

2021= 21800 - 12700 = 9100

2022 = 21800 - 12700 = 9100

Present value of cash inflow

Year	cash inflow	PV factor	present value
2019	5300	0.893	4732.90
2020	7900	0.797	6296.30
2021	9100	0.712	6479.20
2022	9100	0.636	5787.60
			23296

Present value of cash outflow at the end of second year because of updating equipment = $3000*0.797 = $2391

Present value of salvage value = $1700 * 0.636 = 1081.20

Net present value

= PV of cash inflow for four years - PV of cash ouflow in second year - cash paid today + PV of salvage value

= 23296 - 2391 - 20400 + 1081.20

= 1586.20

B) since NPV is positive, it means return is above cost.

Hence investment opportunity should be accepted.

Note - since you have not given table I have used calculator to find the factors @ 12%.

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