ACCT552 Week 7 Homework Assignment
navingolyan
Accounting-8340370.xlsSheet1
| Three Rivers Company runs clothing stores in the Pittsburg area. Three Rivers’ management estimates that if it invests $250,000 in a new computer system, it can save $75,000 in annual cash operating costs. The system has an expected useful life of ten years and no terminal Disposal value. The required rate of return is 8%. Ignore income taxes and assume all cash flows occur at year-end except for initial investment amounts to calculate the following: | |||||
| 1. Net present value | |||||
| 2. Payback period | |||||
| 3. Discounted payback period | |||||
| 4. Internal rate of return (using the interpolation method) | |||||
| 5. Accrual accounting rate of return based on the net initial investment (assume straight-line depreciation) | |||||
| 6. What other factors should Three Rivers consider in deciding whether to purchase the new computer system? | |||||
| 7. Should they purchase the new system? Why or why not? | |||||
| 1. Net present value | |||||
| Year | Cash Flows | Pvf | Present Value Of Cash Flows | Cumulative of Cash Flows | Cumulative of Present Value of Cash Flows |
| 0 | -$250,000.00 | 1 | -$250,000.00 | -$250,000.00 | -$250,000.00 |
| 1 | $75,000.00 | 0.9259 | $69,444.44 | -$175,000.00 | -$180,555.56 |
| 2 | $75,000.00 | 0.8573 | $64,300.41 | -$100,000.00 | -$116,255.14 |
| 3 | $75,000.00 | 0.7938 | $59,537.42 | -$25,000.00 | -$56,717.73 |
| 4 | $75,000.00 | 0.7350 | $55,127.24 | $50,000.00 | -$1,590.49 |
| 5 | $75,000.00 | 0.6806 | $51,043.74 | $125,000.00 | $49,453.25 |
| 6 | $75,000.00 | 0.6302 | $47,262.72 | $200,000.00 | $96,715.97 |
| 7 | $75,000.00 | 0.5835 | $43,761.78 | $275,000.00 | $140,477.75 |
| 8 | $75,000.00 | 0.5403 | $40,520.17 | $350,000.00 | $180,997.92 |
| 9 | $75,000.00 | 0.5002 | $37,518.67 | $425,000.00 | $218,516.59 |
| 10 | $75,000.00 | 0.4632 | $34,739.51 | $500,000.00 | $253,256.10 |
| Net Present Value = Present Value of Cash Inflows - Cash Outflows | |||||
| Present Value of Cash Inflows = $(69444.44+64300.41+59537.42+55127.24+51043.74+47262.72+43761.78+40520.17+37518.67+34739.51) | |||||
| Present Value of Cash Inflows | $503,256.10 | ||||
| Cash Outflows | $250,000.00 | ||||
| Net Present Value | $253,256.10 | ||||
| 2.Payback Period | |||||
| Payback period = Period in which cash inflows meet the cash outflows | |||||
| From cumulative cash flows table it is visible that in Year 3 the infows are -$25,000.00 | |||||
| Also, in Year 4 the cash inflows are +$50,000.00 | |||||
| This implies that the payback period lies between Year 3 and Year 4 | |||||
| Payback period = Lower year + (value of cumulative cash flow in the lower year/value of total cash flow in the higher year | |||||
| = 3 + (25000/75000) | |||||
| = 3 + 0.3 | |||||
| Payback Period =3.3 years | |||||
| 3. Discounted Payback Period | |||||
| Discounted Payback period = Period in which discounted cash inflows meet the cash outflows | |||||
| From cumulative of present value of cash flows table it is visible that in Year 4 the infows are -$1,590.49 | |||||
| Also, in Year 5 the cumulative of present value of cash inflows are +$49453.25 | |||||
| This implies that the discounted payback period lies between Year 4 and Year 5 | |||||
| Discounted Payback period = Lower year + (value of cumulative of present value of cash flow in the lower year/value of total cash flow in the higher year | |||||
| = 4 + (1590.49/51043.74) | |||||
| = 4 + 0.03 | |||||
| Discounted Payback Period =4.03 years | |||||
| 4. Internal Rate of Return | |||||
| IRR | 27% | ||||
| Since IRR is 27% we will interpolate using 26% and 28% | |||||
| NPV at 26% | $9,860.46 | ||||
| NPV at 28% | -$4,831.24 | ||||
| Using interpolation | |||||
| IRR = Lower rate + (NPV at lower rate/NPV at lower rate - NPV at higher rate)* differnce between rates | |||||
| IRR | 27.34 | ||||
| 5. Accrual accounting rate of return | |||||
| Accrual accounting rate of return = (Yearly cash inflows-Depreciation)/Average investment | |||||
| Yearly cash inflows | $75,000.00 | ||||
| Average investment | $25,000.00 | ||||
| Depreciation | $25,000.00 | ||||
| Accrual accounting rate of return | 2.00 | ||||
| 6. Other factors to consider | |||||
| 1) Economic conditions | |||||
| 2) Industry analysis | |||||
| 3) Substitute machinery available | |||||
| 4) Latest Technology | |||||
| 7. Yes, the company should purchase the new equipment as the purchase of new equipment results in a postive Net Present Value of $253,256.10. | |||||
| Also the payback period and the discounted payback period both are less than the total time period of the project which implies that the initial cost will be recovered soo. | |||||
| Also the required rate of return ie 8% is much less than the internal rate of return ie 27.34%. | |||||
| Considering all these factors, the company should definitely purchase the new equipment. |
USING EXCEL
