Question

Rooney Auto Repair, Inc. is evaluating a project to purchase equipment that will not only expand the company's capacity but also improve the quality of its repair services. The board of directors requires all capital investments to meet or exceed the minimum requirement of a 10 percent rate of return. However, the board has not clearly defined the rate of return. The president and controller are pondering two different rates of return: unadjusted rate of return and internal rate of return. The equipment, which costs $105,000, has a life expectancy of six years. The increased net profit per year will be appraximately $6,300, and the increased cash inflow per year will be approximately $25,539. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a-1. Determine the unadjusted rate of return and (use average investment) to evaluate this project (Round your answer to 2 decimal places. (i.e., .2345 should be entered as 23.45)) a-2. Based on the unadjusted rate of return, should the company invest in the equipment? b-1. What is the approximate internal rate of return of this project? b-2. Based on the internal rate of return, should the company invest in the equipment? c. Which method is better for this capital investment decision? ces a-1. Unadjusted rate of return a-2. Should the company invest in the equipment? b-1. Intemal rate of return b-2. Should the company invest in the equipment? Which method is better for this capital investment decision? C.

Answer 1

Solution a1:

Unadjsuted rate of return = Net income / Average investment

Average investment = (Cost + salvage value) / 2 = $105,000 / 2 = $52,500

Unadjusted rate of return = $6,300 / $52,500 = 12%

Solution a2:

Yes, company should invest in the project.

solution b1:

Present value factor at IRR = Initial investment / Annual cash inflows = $105,000 / $25,539 = 4.111

Refer PV Factor table, this factor falls at IRR = 12%

Solution b2:

Yes, company should investment in the equipment

Solution c:

IRR method is better for capital investment decision.