Question

Fanning Auto Repair, Inc. is evaluating a project to purchase equipment that will not only expand the company's capacity but also improve the quality of its repair services. The board of directors requires all capital investments to meet or exceed the minimum requirement of a 10 percent rate of return. However, the board has not clearly defined the rate of return. The president and controller are pondering two different rates of return: unadjusted rate of return and internal rate of return. The equipment, which costs $104,000, has a life expectancy of six years. The increased net profit per year will be approximately $7,000, and the increased cash inflow per year will be approximately $23,184. (PV of S1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a-1. Determine the unadjusted rate of return and (use average investment) to evaluate this project. (Round your answer to 2 decimal places. (i.e, .2345 should be entered as 23.45).) a-2. Based on the unadjusted rate of return, should the company invest in the equipment? b-1. What is the approximate internal rate of return of this project? b-2. Based on the internal rate of return, should the company invest in the equipment? c. Which method is better for this capital investment decision? a-1. Unadjusled rate of retun a2. Should the company invest in the equipment? b-1. Intemal rate of return b-2. Should the company invest in the equipment? Which method is better for this capital investment decision? % c.

Answer 1

x fc al AB D E F G H I J cost of equipment average investment increased annual net profit increased annual cash inflow $ 104,000 $ 52,000 $7,000 $ 23,184 unadjusted rate of return 13.46% (increased annual net profit / average investment) based on unadjusted rate of return, should the company YES invest in the equipment? reason - because the unadjusted rate of return is higher than the minimum requirement of 10% year cash flow $ 104,000 $ 23,184 $ 23,184 $ 23,184 $ 23,184 $ 23,184 $ 23,184 internal rate of return = 9% based on internal rate of return, should the company NO invest in the equipment? reason - because the internal rate of return is less than the minimum requirement of 10% 61 which method is better for capital investment decision? internal rate of return reason - because it uses actual cash flows instead of net income and also it takes into account the time value of money

for formulas and calculations, refer to the image below -

B> X ✓ fx al A B H I J cost of equipment average investment increased annual net profit increased annual cash inflow 104000 =D2/2 7000 23184 unadjusted rate of return =D4/D3 (increased annual net profit/ average investment) based on unadjusted rate of return, should the company invest in the equipment? reason - because the unadjusted rate of return is higher than the minimum requirement of 10% YES year | cash flow |--D2 =$D$5 =$D$5 =$D$5 =$D$5 =$D$5 =$D$5 internal rate of return = =IRR(D12:D18) based on internal rate of return, should the company NO invest in the equipment? reason - because the internal rate of return is less than the minimum requirement of 10% 62 c which method is better for capital investment decision? internal rate of return (IRR) reason - because it uses actual cash flows instead of net income and also it takes into account the time value of money

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