Chapter 21, Problem 21.37P

NPV and AARR, goal-congruence issues. Liam Mitchell, a manager of the Plate Division for the Harvest Manufacturing company, has the opportunity to expand the division by investing in additional machinery costing $495,000. He would depreciate the equipment using the straight-line method and expects it to have no residual value. It has a useful life of 9 years. The firm mandates a required after-tax rate of return of 14% on investments. Liam estimates annual net cash inflows for this investment of $130,000 before taxes and an investment in working capital of $5,000 that will be returned at the project’s end. Harvest’s tax rate is 30%.

1. 1. Calculate the net present value of this investment.

   Required

2. 2. Calculate the accrual accounting rate of return based on net initial investment for this project.
3. 3. Should Liam accept the project? Will Liam accept the project if his bonus depends on achieving an accrual accounting rate of return of 14%? How can this conflict be resolved?