Question

Management of Skywards, Inc., an airline caterer, is purchasing refrigerated trucks at a total cost of $3.25 million. After-tax net income from this investment is expected to be $750,000 for the next five years. Annual depreciation expense will be $650,000. The cost of capital is 17 percent. a. What is the discounted payback period? b. Compute the ARR. c. What is the NPV of this investment? d. Calculate the IRR. SHOW ALL WORK.

Answer 1

Answer a
Calculation of discounted payback period
Year	Cash flow	Discount factor @ 17%	Discounted Cash flow	Cumulative Discounted Cash flow
0	-$3,250,000	1.000000	-$3,250,000	-$3,250,000
1	$1,400,000	0.854701	$1,196,581	-$2,053,419
2	$1,400,000	0.730514	$1,022,719	-$1,030,700
3	$1,400,000	0.624371	$874,119	-$156,581
4	$1,400,000	0.533650	$747,110	$590,529
5	$1,400,000	0.456111	$638,556	$1,229,085
Discounted payback period = 3 years + [$156581/$747110] = 3.21 years
Working
Operating cash flow per year = After-tax net income per year + Depreciation per year
Operating cash flow per year = $750000 + $650000 = $14,00,000
Answer b
Accounting rate of return (ARR) = After tax net income per year / Cost of refrigerated truck
Accounting rate of return (ARR) = $7,50,000 / $32,50,000 = 23.08%
Answer c
Calculation of NPV of investment
Year	Cash flow	Discount factor @ 17%	Discounted Cash flow
0	-$3,250,000	1.000000	-$3,250,000
1	$1,400,000	0.854701	$1,196,581
2	$1,400,000	0.730514	$1,022,719
3	$1,400,000	0.624371	$874,119
4	$1,400,000	0.533650	$747,110
5	$1,400,000	0.456111	$638,556
NPV of Investment			$1,229,085
Answer d
Calculation of IRR of investment
Year	Cash flow
0	-$3,250,000
1	$1,400,000
2	$1,400,000
3	$1,400,000
4	$1,400,000
5	$1,400,000
IRR of Investment	32.55%