Using payback, NPV, and profitability index to make capital investment decisions Splash City is considering purchasing a water park in Omaha, Nebraska, for $1,910,000. The new facility will generate annual net cash inflows of $487,000 for eight years. Engineers estimate that the facility will remain useful for eight years and have no residual value. The company uses straight-line depreciation, and its stockholders demand an annual return of 10% on investments of this nature. Requirements 1.) Compute the payback, the NPV, and the profitability index of this investment. 2.) Recommend whether the company should invest in this project.
| Using payback, NPV, and profitability index to make capital investment decisions | |||||||||||
| Splash City is considering purchasing a water park in Omaha, Nebraska, for $1,910,000. The new facility will generate | |||||||||||
| annual net cash inflows of $487,000 for eight years. Engineers estimate that the facility will remain useful for | |||||||||||
| eight years and have no residual value. The company uses straight-line depreciation, and its stockholders | |||||||||||
| demand an annual return of 10% on investments of this nature. | |||||||||||
| Requirements | |||||||||||
| 1.) | Compute the payback, the NPV, and the profitability index of this investment. | ||||||||||
| 2.) | Recommend whether the company should invest in this project. | ||||||||||
Related questions
Hearne Company has a number of potential capital investments.Because these projects vary in nature, initial investment, and timehorizon, management is finding it difficult to compare them. Assumestraight line depreciation method is used. |
| Project 1: RetoolingManufacturing Facility | ||||||||||||
This project would require an initial investment of $5,200,000.It would generate $928,000 in additional net cash flow each year.The new machinery has a useful life of eight years and a salvagevalue of $1,084,000. | ||||||||||||
| Project 2: PurchasePatent for New Product | ||||||||||||
The patent would cost $3,645,000, which would be fully amortizedover five years. Production of this product would generate $583,200additional annual net income for Hearne. | ||||||||||||
| Project 3: Purchase aNew Fleet of Delivery Trucks | ||||||||||||
| Hearne could purchase 25 new delivery trucks at a cost of$150,000 each. The fleet would have a useful life of 10 years, andeach truck would have a salvage value of $5,700. Purchasing thefleet would allow Hearne to expand its customer territory resultingin $600,000 of additional net income per year.
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Hearne Company has a number of potential capital investments.Because these projects vary in nature, initial investment, and timehorizon, management is finding it difficult to compare them. Assumestraight line depreciation method is used. |
| Project 1: RetoolingManufacturing Facility |
This project would require an initial investment of $5,200,000.It would generate $928,000 in additional net cash flow each year.The new machinery has a useful life of eight years and a salvagevalue of $1,084,000. |
| Project 2: PurchasePatent for New Product |
The patent would cost $3,645,000, which would be fully amortizedover five years. Production of this product would generate $583,200additional annual net income for Hearne. |
| Project 3: Purchase aNew Fleet of Delivery Trucks |
Hearne could purchase 25 new delivery trucks at a cost of$150,000 each. The fleet would have a useful life of 10 years, andeach truck would have a salvage value of $5,700. Purchasing thefleet would allow Hearne to expand its customer territory resultingin $600,000 of additional net income per year. |
| Required: | |||||||
| 1. | Determine each project's accounting rate of return.(Round your answers to 2 decimal places.)
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