| BUS 5110 Written Assignment 6 Solution |
| Required Rate of Return | 8% |
| Option 1 |
| $65,000 for equipment with useful life of 7 years and no salvage value. |
| Maintenance costs are expected to be $2,700 per year and increase by 3% in Year 6 and remain at that rate. |
| Materials in Year 1 are estimated to be $15,000 but remain constant at $10,000 per year for the remaining years. |
| Labor is estimated to start at $70,000 in Year 1, increasing by 3% each year after. |
| Revenues are estimated to be: | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 |
| - 0 | 75,000 | 100,000 | 125,000 | 150,000 | 150,000 | 150,000 |
| Cash Flows |
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 |
| Purchase Price | (65,000) | - 0 | - 0 | - 0 | - 0 | - 0 | - 0 | - 0 |
| Maintenance Costs | - 0 | (2,700) | (2,700) | (2,700) | (2,700) | (2,700) | (2,781) | (2,781) |
| Materials | - 0 | (15,000) | (10,000) | (10,000) | (10,000) | (10,000) | (10,000) | (10,000) |
| Added Labor | - 0 | (70,000) | (72,100) | (74,263) | (76,491) | (78,786) | (81,149) | (83,584) |
| Revenue | - 0 | - 0 | 75,000 | 100,000 | 125,000 | 150,000 | 150,000 | 150,000 |
| Net Cash Flows | (65,000) | (87,700) | (9,800) | 13,037 | 35,809 | 58,514 | 56,070 | 53,635 |
| NPV | IRR | Payback | ARR |
| (11,483) | 6% | Year 0 | (65,000) | Total Revenue | 750,000 |
| (1) | (2) | Year 1 | (152,700) | Total Expenses | (630,434) |
| Option has a | Option has an | Year 2 | (162,500) | Depreciation Expense | (65,000) | Because there is no salvage value, depreciation = purchase price |
| negative NPV, | IRR lower than | Year 3 | (149,463) | Total Profit | 54,566 |
| indicating no | the company's | Year 4 | (113,654) | Avg Annual Profit | 7,795 |
| return or profit. | required rate | Year 5 | (55,140) |
| of return, | Year 6 | 930 | ARR | 12% |
| indicating the | Year 7 | 54,566 | (4) |
| company | (3) |
| should not | Option has a payback period | Option has an ARR greater than |
| accept this | of >7 years without considering TVM. | the company's required rate |
| option. | of return without considering TVM |
| Option 2 | which indicates the project should |
| $85,000 for equipment with useful life of 7 years and a $13,000 salvage value | be accepted (versus IRR). |
| Maintenance costs are expected to be $3,500 per year and increase by 3% in Year 6 and remain at that rate. |
| Materials in Year 1 are estimated to be $20,000 but remain constant at $15,000 per year for the remaining years. |
| Labor is estimated to start at $60,000 in Year 1, increasing by 3% each year after. |
| Revenues are estimated to be: | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 |
| - 0 | 80,000 | 95,000 | 130,000 | 140,000 | 150,000 | 160,000 |
| Cash Flows |
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 |
| Purchase Price | (85,000) | - 0 | - 0 | - 0 | - 0 | - 0 | - 0 | 13,000 |
| Maintenance Costs | - 0 | (3,500) | (3,500) | (3,500) | (3,500) | (3,500) | (3,605) | (3,605) |
| Materials | - 0 | (20,000) | (15,000) | (15,000) | (15,000) | (15,000) | (15,000) | (15,000) |
| Added Labor | - 0 | (60,000) | (61,800) | (63,654) | (65,564) | (67,531) | (69,556) | (71,643) |
| Revenue | - 0 | - 0 | 80,000 | 95,000 | 130,000 | 140,000 | 150,000 | 160,000 |
| Net Cash Flows | (85,000) | (83,500) | (300) | 12,846 | 45,936 | 53,969 | 61,839 | 82,752 |
| NPV | IRR | Payback | ARR |
| 5,375 | 9% | Year 0 | (85,000) | Total Revenue | 755,000 |
| (5) | (6) | Year 1 | (168,500) | Total Expenses | (594,458) |
| Option has a | Option has an | Year 2 | (168,800) | Depreciation Expense | (72,000) |
| postive NPV, | IRR higher than | Year 3 | (155,954) | Total Profit | 88,542 |
| indicating | the company's | Year 4 | (110,018) | Avg Annual Profit | 12,649 |
| return or profit | required rate | Year 5 | (56,048) |
| will be made. | of return, | Year 6 | 5,790 | ARR | 15% |
| indicating the | Year 7 | 88,542 | (8) |
| company | (7) |
| should | Option has a payback period | Option has an ARR greater |
| accept this | of 7 years without considering TVM. | than the company's required |
| option. | rate of return without |
| considering TVM. |