Question

Question2-covers CLO4 5 Marks) An investment of 10000 can be made in a project that will produce a uniform annual revenue of 5311 for five years and then have a market recovery value 2000. Annual expenses will be 3000 each year. The company is willing to accept any project that will earn 10% per year or more on all invested capital. Show whether this is a desirable investment by using the PW method.

Answer 1

Amount of investment = 10000

Uniform annual revenue = 5311

Annual cost = 3000

Market recovery = 2000

Life = 5 years.

Rate of interest = 10%

Net annual revenue = (5311 - 3000 ) = 2311

Present worth = - Initial investment + Net Annual revenue ( P/A, r, n ) + Market value ( P/F, r, n)

  

( P/A, r , n) = ( 1 + r )ⁿ - 1 / r ( 1 + r )ⁿ

( P/F , r , n) = 1 / ( 1 + r )ⁿ

Present worth ( PW)   = - 10000 + 2311 ( P/A, 10%, 5 ) + 2000 (P/F, 10%, 5 )

= -10000 + 2311 ( 3.791) + 2000 ( 0.621 )

= 3

Recommendation :- At the interest rate of 10% present worth is almost equal to the zero. which shows that present value of all the future benefit is equal to cost incurred today. To accept the investment future benefits should be higher. Hence investment is not desirable since there is no profit.