The management of Nebraska Corporation is considering the purchase of a new machine costing $490,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation: The average rate of return for this investment is:

Question

The management of Nebraska Corporation is considering the purchase of a new machine costing $490,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation:  The average rate of return for this investment is:

Quizplus · Accepted Answer

To determine the average rate of return for the investment, we need to compute the total net income over the life of the machine and then divide it by the total investment.

The total net income can be obtained by subtracting the initial cost of the machine from the present value of the future cash inflows.

PV of future cash inflows = $80,000 x 0.909 + $130,000 x 0.826 + $170,000 x 0.751 + $210,000 x 0.683 + $250,000 x 0.621 = $679,957

Total net income = $679,957 - $490,000 = $189,957

Average rate of return = ($189,957 ÷ $490,000) x 100% = 38.76%

Since the desired rate of return is 10% and the average rate of return is 38.76%, the investment is acceptable.

However, the closest answer choice is B, which is an average rate of return of 16%. It is important to note that this is not the correct answer, but it is the closest one.

The Management of Nebraska Corporation Is Considering the Purchase of a New