The ABC Co. is considering the purchase of a $249,000 piece of equipment. This equipment is expected to produce cash ﬂows of $78,500, $149,000, and $80,000 over the next three years. The
Rate of return on this equipment is:
A) 9.88%
B) 11.26%
C) 12.50%
D) 15.23%
E) 23.49%

Question

Quizplus · Accepted Answer

We can calculate the rate of return using the formula: Rate of return = (Total present value of cash inflows - Initial cost) / Initial cost.

The present value of each cash flow can be calculated using the formula PV = CF / (1 + r)^n, where CF is the cash flow, r is the discount rate, and n is the number of periods.

Using a discount rate of 10%, we can calculate the present values of the cash flows as follows:

PV of cash flow 1 = $78,500 / (1 + 0.10)^1 = $71,363.64
PV of cash flow 2 = $149,000 / (1 + 0.10)^2 = $119,008.26
PV of cash flow 3 = $80,000 / (1 + 0.10)^3 = $57,778.15

The total present value of the cash inflows is $248,150.06, which is very close to the initial cost of $249,000.

Therefore, the rate of return is:

Rate of return = ($248,150.06 - $249,000) / $249,000 = -0.34%

This is a negative rate of return, which means that the investment would not be a good choice for the ABC Co. The best choice would be not to invest in this equipment.