Question

Lamar Company is studying a project that would have an 15 studying a project that would have an eight-year life and require a $1,600,000 invest- ment in equipment. At the quipment. At the end of eight years, the project would terminate and the equipment would have no salvage value. The project would provide net income each year as follows: $3,000,000 1.800,000 1,200,000 Sales.. Less: Variable expenses Contribution margin.... Less: Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs. Amortization Total fixed expenses... Net income.. $700,000 200,000 900.000 $ 300,000 The company's discount rate is 18%. Required: 1. Compute the net annual cash inflow from the project. 2. Compute the project's net present value. Is the project acceptable? .3. Compute the project's payback period. If the company requires a maximum payback of the the project acceptable? 4. Compute the project's simple rate of return.

Answer 1

1. Annual Cash Inflow from the project = Net Income + Non Cash expenses

= $300,000 + $200,000 (Amortization Expense)

= $500,000

2. Initial Investment = $1,600,000

Discount Rate = 18%

Cumulative discounting factor of 18% for 8 years = 4.07757

Annual Cash Inflow = $500,000

Net Present Value of project = (Annual Cash Inflow * Cumulative discounting factor of 18% for 8 years) - Initial Investment

= ($500,000 * 4.07757) - $1,600,000

= $2,038,785 - $1,600,000

= $438,785

3. Project's Pay Back period = Initial Investment / Net Annual Cash Inflows

= $1,600,000 / $500,000

= 3.2 years

The maximum pay back period as per question is not readable as it has been covered by the thumb of the student. I have calculated the pay back period of the project. So you can make out if the project is viable or not by comparing the pay back period with the maximum pay back period as per question

4.  Project's Simple Rate of Return = (Net Annual Income * 100) / Initial Investment

= $300,000 * 100) / $1,600,000

= 18.75%