Project 1 requires an original investment of $55,000. The project will yield cash flows of $15,000 per year for seven years

Project 1 requires an original investment of $55,000. The project will yield cash flows of $15,000 per year for seven years. Project 2 has a calculated net present value of $5,000 over a four-year life. Project 1 could be sold at the end of four years for a price of $38,000. (a) Determine the net present value of Project 1 over a four-year life, with residual value, assuming a minimum rate of return of 20%. (b) Which project provides the greatest net present value?

Answer:

a. Present value of $15,000 per year at 20% for 4 years*…………………………  $38,835 

Present value of $38,000 at 20% at the end of 4 years**………………………    18,316 

Total present value of Project 1…………………………………………………… $57,151 

Less total cost of Project 1……………………………………………………………   55,000 

Net present value of Project 1……………………………………………………… $  2,151 

* [$15,000 × 2.589 (Exhibit 2, 20%, 4 years)] 

** [$38,000 × 0.482 (Exhibit 1, 20%, 4 years)] 

b. Project 2. Project 1’s net present value of $2,151 is less than the net present 

value of Project 2, $5,000. 

Ray Zor Inc. is considering an investment in new equipment that will be used to manufacture a smartphone. The phone is expected to generate additional annual sales of 4,000

Ray Zor Inc. is considering an investment in new equipment that will be used to manufacture a smartphone. The phone is expected to generate additional annual sales of 4,000 units at $410 per unit. The equipment has a cost of $525,000, residual value of $75,000, and an eight-year life. The equipment can only be used to manufacture the phone. The cost to manufacture the phone is shown below.

Cost per unit:

Direct labor                                                  $ 30

Direct materials                                             280

Factory overhead (including depreciation)     40

Total cost per unit                                        $350

Determine the average rate of return on the equipment.

Answer:

Average Rate 

of Return  = 

= 

Average Annual Income 

Average Investment 

 

Average Revenues – Annual Product Costs* 

(Beginning Cost + Residual Value) ÷ 2 

($410 × 4,000 units) – ($350 × 4,000 units) 

= 

($525,000 + $75,000) ÷ 2 

= $240,000 

$300,000 

=  80% 

* The depreciation of the equipment is included in the factory overhead cost per unit.