DCF, accrual accounting rate of return, working capital, evaluation of performance, no income taxes. Laverty Clinic plans to purchase a new centrifuge machine for its New York facility. The machine costs $94,000 and is expected to have a useful life of 6 years, with a terminal disposal value of $9,000. Savings in cash operating costs are expected to be $24,900 per year. However, additional working capital is needed to keep the machine running efficiently. The working capital must continually be replaced, so an investment of $4,000 needs to be maintained at all times, but this investment is fully recoverable (will be “cashed in”) at the end of the useful life. Laverty Clinic’s required rate of return is 12%. Ignore income taxes in your analysis. Assume all cash flows occur at year-end except for initial investment amounts. Laverty Clinic uses straight-line depreciation for its machines.Required:1. Calculate net present value.2. Calculate internal rate of return.3. Calculate accrual accounting rate of return based on net initial investment.4. Calculate accrual accounting rate of return based on average investment.5. You have the authority to make the purchase decision. Why might you be reluctant to base your decision on the DCF methods?

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Asked Dec 22, 2019
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DCF, accrual accounting rate of return, working capital, evaluation of performance, no income taxes. Laverty Clinic plans to purchase a new centrifuge machine for its New York facility. The machine costs $94,000 and is expected to have a useful life of 6 years, with a terminal disposal value of $9,000. Savings in cash operating costs are expected to be $24,900 per year. However, additional working capital is needed to keep the machine running efficiently. The working capital must continually be replaced, so an investment of $4,000 needs to be maintained at all times, but this investment is fully recoverable (will be “cashed in”) at the end of the useful life. Laverty Clinic’s required rate of return is 12%. Ignore income taxes in your analysis. Assume all cash flows occur at year-end except for initial investment amounts. Laverty Clinic uses straight-line depreciation for its machines.
Required:

1. Calculate net present value.
2. Calculate internal rate of return.
3. Calculate accrual accounting rate of return based on net initial investment.
4. Calculate accrual accounting rate of return based on average investment.
5. You have the authority to make the purchase decision. Why might you be reluctant to base your decision on the DCF methods?

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Expert Answer

Step 1

Since you have posted a question with multiple sub-parts, we will solve first three subparts for you. To get remaining sub-part solved please repost the complete question and mention the sub-parts to be solved.

Net present value is calculated to find the present value of cash inflows that will be generated over certain period of time by investing the money today. It is the difference between present value of cash inflows & cash outflows over a period of time.

Step 2

Please see attached above the calculation of NPV. 

NPV= $ 10,954.9

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Calculation of NPV Amount of cash flows 12% rate of return Years Present value of cash flows Item Annual cash inflow (savings in operating *4.111=24900 x 4.111= |1-б уеars 24900 cost) 102363.9 Residual value of **0.507 = 9000 x 0.507 4563 equipment Release of working 6. 9000 **0.507 -4000 x 0.507 4000 capital 6. 2028 1=-94000 x 1 1= -4000 x 1 Cost of machine -94000 -94000 now Working capital needed now -4000 -4000 Net present value 10954.9 * Value from "present value of an annuity of $1 in arrears table". **Value from "present value of $1 table".

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Step 3

2. Attached are the working for internal ...

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Lets take two discount rates = 10% and 20% We shall now calculate the npv using these two rates Cash flows (A) Discount factor e 10% (B) Present value (A) x (B) Discount factor @ 20% Present value (A) x (C ) Period -94000 -94000 -94000 -4000 -4000 -4000 24900 0.909 22634.1 0.833 20741.7 24900 0.826 20567.4 0.694 17280.6 24900 0.751 18699.9 0.579 14417.1 17006.7 24900 0.683 0.482 12001.8 0.621 24900 15462.9 0.402 10009.8 37900 21375.6 0.564 6. 0.335 12696.5 Net present values= 17746.6 -10852.5 NPV1 x (R2 - R1)% Internal Rate of Return R1% (NPV1- NPV2) =10% + 17746.6 x (20- 10)% |(17746.6- (-10852.5) =10% + 17746.6 x 10% 17746.6 + 10852.5 =10% + 6.20% =16.20%

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