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 2019 2020 2021 2022 Cash Inflow $13,600 19,500 22,500 22,500 Cash Outflow $ 8,200 11,900 12,900 12,900 In addition to these cash flows, Aaron expects to pay $20,400 for the equipment. He also expects to pay $3,400 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 $1,200 salvage value and a four year useful life. Aaron desires to earn a rate of return of 8 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 b. Will the return be above or below the cost of capital? Should the investment opportunity be accepted?

Answer 1

Answer

a.	Net Present Value	$          3,759.94
b.	Will the return be above or below the cost of Capital	Above
	Should the investment opportunity be accepted	Yes

Detailed workings

Calculation of net cash flow per year

Year	0	2,019	2020	2021	2022
Initial Investment	$       (20,400)
Overhauling cost			$         (3,400)
Salvage Value					$      1,200
Cash Inflows		$             13,600	$         19,500	$   22,500	$   22,500
Cash Outflows		$             (8,200)	$       (11,900)	$ (12,900)	$ (12,900)
Net Cash inflow or Outflow	$       (20,400)	$                5,400	$            4,200	$      9,600	$   10,800

Calculation of Net Present Value
year	Cash Inflow (outflow)	PV factor@ 8%
0	$       (20,400)	1	$       (20,400)
2019	$            5,400	0.925926	$      5,000.00
2020	$            4,200	0.857339	$      3,600.82
2021	$            9,600	0.793832	$      7,620.79
2022	$         10,800	0.735030	$      7,938.32
Net Present Value			$      3,759.94

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