Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter he expects demand to stabilize. The following table presents the expected cash flows: Year of Operation Year 1 Year 2 Year 3 Year 4 Cash Inflow Cash Outflow $40,000 $19,500 44,000 23,500 47,000 47,000 25,500 25,500 In addition to these cash flows, Aaron expects to pay $32,500 for the equipment. He also expects to pay $7,000 for a major overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $5,500 salvage value and a four-year useful life. Aaron desires to earn a rate of return of 7 percent. (PV of $1 and PVA of $1) Note: Use appropriate factor(s) from the tables provided. Required a. Calculate the net present value of the investment opportunity. Note: Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal places. b. Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and whether it should be accepted. a. Net present value b. Will the return be above or below the cost of capital? b. Should the investment opportunity be accepted?
Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter he expects demand to stabilize. The following table presents the expected cash flows: Year of Operation Year 1 Year 2 Year 3 Year 4 Cash Inflow Cash Outflow $40,000 $19,500 44,000 23,500 47,000 47,000 25,500 25,500 In addition to these cash flows, Aaron expects to pay $32,500 for the equipment. He also expects to pay $7,000 for a major overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $5,500 salvage value and a four-year useful life. Aaron desires to earn a rate of return of 7 percent. (PV of $1 and PVA of $1) Note: Use appropriate factor(s) from the tables provided. Required a. Calculate the net present value of the investment opportunity. Note: Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal places. b. Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and whether it should be accepted. a. Net present value b. Will the return be above or below the cost of capital? b. Should the investment opportunity be accepted?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will
enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the
service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter,
he expects demand to stabilize. The following table presents the expected cash flows:
Year of
Operation
Year 1
Year 2
Year 3
Year 4
Cash Inflow Cash Outflow
$40,000
$19,500
44,000
23,500
47,000
25,500
47,000
25,500
In addition to these cash flows, Aaron expects to pay $32,500 for the equipment. He also expects to pay $7,000 for a major overhaul
and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $5,500 salvage value
and a four-year useful life. Aaron desires to earn a rate of return of 7 percent. (PV of $1 and PVA of $1)
Note: Use appropriate factor(s) from the tables provided.
Required
a. Calculate the net present value of the investment opportunity.
Note: Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal
places.
b. Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and
whether it should be accepted.
a. Net present value
b. Will the return be above or below the cost of capital?
b. Should the investment opportunity be accepted?
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