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 Cash Inflow Cash Outflow $ 8,800 12,000 12,700 12,700 Operation Year 1 $14,100 Year 2 19,100 22,200 22,200 Year 3 Year 4 In addition to these cash flows, Aaron expects to pay $20,600 for the equipment. He also expects to pay $2,900 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 $1,700 salvage value and a four year useful life. Aaron desires to earn a rate of return of 10 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Calculate the net present value of the investment opportunity. (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.
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 Cash Inflow Cash Outflow $ 8,800 12,000 12,700 12,700 Operation Year 1 $14,100 Year 2 19,100 22,200 22,200 Year 3 Year 4 In addition to these cash flows, Aaron expects to pay $20,600 for the equipment. He also expects to pay $2,900 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 $1,700 salvage value and a four year useful life. Aaron desires to earn a rate of return of 10 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Calculate the net present value of the investment opportunity. (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.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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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
Cash Inflow
Cash Outflow
$14,100
19,100
$ 8,800
12,000
Year 2
22,200
22,200
12,700
12,700
Year 3
Year 4
In addition to these cash flows, Aaron expects to pay $20,600 for the equipment. He also expects to pay $2,900 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 $1,700 salvage value
and a four year useful life. Aaron desires to earn a rate of return of 10 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from
the tables provided.)
Required
a. Calculate the net present value of the investment opportunity. (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?
Should the investment opportunity be accepted?
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