Question

discount rate is zero percent? What if the discount rate is 5 percent? If it is 19 percent? 6. Calculating AAR (LO4) Youre trying to determine whether to expand your business by building a new manufacturing plant. The plant has an installation cost of $12 million, which will be depreciated straight-line to zero over its four-year life. If the plant has proiected net income of $1.854,300, $1,907.600, $1,876.000 and $1,329,500 over these four years, what is the project's average accounting return (AAR)? 7. Calculating IRR (LO5) A firm evaluates all of its projects by applying the IRR rule. If the required return is 16 percent, should the firm accept the following project? F Cash Flow -$28,000 12.000 15,000 11,000 Click here for a description of Table: Questions and Problems 7. ON 8. Calculating NPV (L01) For the cash flows in the previous problem, suppose the use the NPV decision rule. At a required return of 11 percent should the firm accept this project What if the required return was 25 percent? 9. Calculating NPV and IRR (L01, 5) A project that provides annual cash flows of $17.300

Answer 1

6.

Average Accounting Return = Average accounting profit/Initial investment

                                      = [($ 1,854,300 + $ 1,907,600 + $ 1,876,000 + $ 1,329,500)/4]/$ 12,000,000

                                      = ($ 6,967,400 /4)/ $ 12,000,000

                                      = $ 1,741,850 / $ 12,000,000

                                      = 0.1451541666667 or 14.52 %

AAR of the project is 14.52 %

7.

Let’s compute IRR using trial and error method.

Let’s compute NPV at discount rate of 17 %

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 17 % (F)	PV (C x F)
0	($28,000)	1/ (1+0.17)0	1	($28,000.00)
1	$12,000	1/ (1+0.17)1	0.85470085470086	$10,256.41
2	$15,000	1/ (1+0.17)2	0.73051355102637	$10,957.70
3	$11,000	1/ (1+0.17)3	0.62437055643280	$6,868.08
			NPV1	$82.19

As NPV is positive, let’s compute NPV at discount rate of 18 %

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 18 % (F)	PV (C x F)
0	($28,000)	1/ (1+0.18)0	1	($28,000.00)
1	$12,000	1/ (1+0.18)1	0.84745762711864	$10,169.49
2	$15,000	1/ (1+0.18)2	0.71818442976156	$10,772.77
3	$11,000	1/ (1+0.18)3	0.60863087267929	$6,694.94
			NPV2	($362.80)

IRR = R₁ + [NPV₁ x (R₂ -R₁) %/ (NPV₁ – NPV₂)

       = 17 % + [$ 82.19 x (18 % - 17 %)/ [$ 82.19 – (-$ 362.80)]

       = 17 % + ($ 82.19 x 0.01)/ ($ 82.19 + $ 362.80)

       = 17 % + ($ 0.8219/ $ 444.99)

       = 17 % + 0.001847008

       = 17 % + 0. 1847008 %

       = 17.18 %

IRR of the project is 17.18 %

The firm should accept the project for required return of 16 % as the required return is less than IRR and hence there will be profit from the project.

8.

NPV = PV of future cash flow – Initial investment

Computation of NPV at discount rate of 11 %:

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 11 % (F)	PV (C x F)
0	($28,000)	1/ (1+0.11)0	1	($28,000.00)
1	$12,000	1/ (1+0.11)1	0.90090090090090	$10,810.81
2	$15,000	1/ (1+0.11)2	0.81162243324406	$12,174.34
3	$11,000	1/ (1+0.11)3	0.73119138130095	$8,043.11
			NPV	$3,028.25

As NPV is positive at discount rate of 11 %, project should be accepted.

Computation of NPV at discount rate of 25 %:

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 25 % (F)	PV (C x F)
0	($28,000)	1/ (1+0.25)0	1	($28,000.00)
1	$12,000	1/ (1+0.25)1	0.800	$9,600.00
2	$15,000	1/ (1+0.25)2	0.640	$9,600.00
3	$11,000	1/ (1+0.25)3	0.512	$5,632.00
			NPV	($3,168.00)

As NPV is negative at discount rate of 25 %, project should not be accepted.