Question

ment sis phone tower, they use mu value method, the payback period metru, By using these methods, they can ensure a wise allocation UITJE time minimize the risks involved in the investment decision. LO3 Suppose that Neighborhood Communications is considering building a new cell phone tower and has gathered the following information: $600,000 Purchase price Residual value $100,000 Desired payback period 3 years Minimum rate of return 15% The cash flow estimates are as follows: Net Cash Projected Cash Year Net Income Cash Outflows Inflows Inflows $ 500,000 $260,000 $240,000 $115,000 450,000 240,000 210,000 85,000 400,000 220,000 180,000 55,000 200,000 150,000 25,000 Totals $1,700,000 $920,000 $780,000 $280,000 4 350,000

Answer 1

Answer is given below

ARR is calculated based on initial investment as well as average investment

1.a) Calculation of Net present value Year 1 $500,000 $260,000 $240,000 Year 2 $450,000 $240,000 $210,000 Cash revenues Cash expenses Net Cash inflow Salvage value Total Cash inflow PV factor of 15% Present value of cash inflows Less Initial investment Net present value Year 3 $400,000 $220,000 $180,000 | $180,000 0.6575 $118,353 Year 4 $350,000 $200,000 $150,000 $100,000 $250,000 0.5718 $142,938 Total $1,700,000 $920,000 $780,000| $100,000 $880,000 $240,000 0.8696 $208,696 $210,000 0.7561 $158,790 $628,777 $600,000 $28,777 Calculation of Cash inflows 1.b) Cash revenues Cash expenses Cash inflow Year 1 $500,000 $260,000 $240,000 Year 2 $450,000 $240,000 $210,000 Year 3 $400,000 $220,000 $180,000 Year 4 $350,000 $200,000 $150,000 Payback Calculation Year Year 1 Year 2 Year 3 Year 4 Cash Cumulative inflow Cash inflow $240,000 $240,000 $210,000 $450,000 $180,000 $150,000 Balance $150,000 Payback Initial investment $600,000 2.83 years 1.c) Accounting rate of return Year 1 $115,000 Year 2 $85,000 Year 3 $55,000 Year 4 $25,000 Total $280,000 Projected Net Income Average net income $70,000 ARR based on average investment Average Net Income $70,000 Average investment* $350,000 20.0% * Average investment = (Initial Investment +Scrap value)/2 ARR based on Initial Investment Average Net Income Initial Investment $70,000 $600,000 11.7% 2 Since NPV is positive and Payback period is less than 3 years the Investment can be made in the project ARR is also above the minimum desired rate of return