The management of Indiana Corporation is considering the purchase of a new machine costing $400,000. 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 Indiana Corporation is considering the purchase of a new machine costing $400,000. 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 if this investment is acceptable, we need to calculate the present value of the expected cash inflows and compare it to the cost of the machine.

Assuming the machine has a useful life of 5 years and will generate equal annual net cash inflows of $120,000, we can calculate the present value of these cash flows using the present value factors and the formula:

PV = Net cash inflows x Present value factor

Year 1: PV = $120,000 x 0.909 = $109,080 
Year 2: PV = $120,000 x 0.826 = $99,120 
Year 3: PV = $120,000 x 0.751 = $90,120 
Year 4: PV = $120,000 x 0.683 = $81,960 
Year 5: PV = $120,000 x 0.621 = $74,520

Total PV = $454,800

Since the cost of the machine is $400,000, the net present value of this investment is:

Net PV = Total PV - Cost of machine = $454,800 - $400,000 = $54,800

Since the net present value is positive, this investment is acceptable.

To calculate the average rate of return, we can use the formula:

Average rate of return = Annual net cash inflow / Initial investment

Annual net cash inflow = Total net cash inflow over 5 years / Number of years = $600,000 / 5 = $120,000

Average rate of return = $120,000 / $400,000 = 0.3 or 30%

Since the desired rate of return is 10%, the average rate of return of 30% indicates that this investment is highly acceptable.

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