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 calculate the average rate of return of an investment, we use the formula:
Average Rate of Return = Total Annual Profit / Initial Investment
Total Annual Profit = Annual Cash Inflows - Annual Cash Outflows
In this case, we are given only the initial investment of $490,000 and the desired rate of return of 10%. We need to calculate the annual cash flows to find the total annual profit.

To calculate the annual cash flows, we use the formula:
Annual Cash Flow = (Revenue - Expenses) x Present Value Factor

We are not given the revenue and expenses, but we are given the present value factors. We can assume that the present value factors represent the present value of the cash inflows for each year. Therefore, we can use the present value factors and the initial investment to calculate the cash inflows for each year.

Year 1: $490,000 x 0.909 = $445,410
Year 2: $490,000 x 0.826 = $404,740
Year 3: $490,000 x 0.751 = $368,990
Year 4: $490,000 x 0.683 = $334,870
Year 5: $490,000 x 0.621 = $304,290

Now we can calculate the total annual profit and the average rate of return.

Total Annual Profit = (445,410 + 404,740 + 368,990 + 334,870 + 304,290) - 490,000 = $63,300
Average Rate of Return = $63,300 / $490,000 = 12.91% (rounded to 2 decimal places)

The average rate of return is higher than the desired rate of return of 10%, which means that the investment is acceptable. The best choice is B because it is the only option that comes closest to the calculated average rate of return.

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