Shooting Star, Inc. is considering a project that would have an eight-year life and would require a $2,000,000 investment in equipment. At the end of ten years, the project would terminate and the equipment would have no salvage value. The project would provide net income each year as follows: Sales Less: Variable Expenses Contribution Margin Less: Fixed Expenses Net Income $2,000,000 $1,600,000 $400,000 $200,000 $200,000 All of the above items, except for depreciation of $200,000 a year, represent cash flows. The depreciation is included in the fixed expenses. The company's required rate of return is 10%. (Ignore income taxes in this problem.) Required: 1. What is the project's net present value? 2. What is the project's internal rate of return? 3. What is the project's payback period? 4. What is the project's simple rate of return?
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
![### Project Evaluation for Shooting Star, Inc.
Shooting Star, Inc. is evaluating a project with an eight-year lifespan that necessitates a $2,000,000 investment in equipment. At the conclusion of the ten-year period, the equipment will have no salvage value. The projected annual net income for the project is outlined below:
| Item | Amount |
|------|--------|
| Sales | $2,000,000 |
| Less: Variable Expenses | $1,600,000 |
| Contribution Margin | $400,000 |
| Less: Fixed Expenses | $200,000 |
| **Net Income** | **$200,000** |
### Additional Information:
All the above figures, except for $200,000 in annual depreciation, represent cash flows. Depreciation is factored into the fixed expenses. The company’s required rate of return is 10%. (Note: Ignore income taxes in this scenario.)
### Required Calculations:
1. **Net Present Value (NPV):**
- Calculate the present value of the cash flows, discounted at the required rate of return (10%).
2. **Internal Rate of Return (IRR):**
- Determine the discount rate at which the present value of the cash flows equals the initial investment.
3. **Payback Period:**
- Calculate the time required for the project to earn back the initial investment from its net cash inflows.
4. **Simple Rate of Return:**
- Compute the return on investment based on the annual net income relative to the initial investment.
This evaluation will assist in making an informed decision regarding the feasibility and profitability of the proposed project.
[Note: It is recommended to use proper financial formulas and possibly spreadsheet software to accurately compute the required values.]](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F9b9d4688-d7d2-4904-9fe3-877af97ac226%2F7872f816-7dc8-4225-8e77-18f55c3b0cfd%2F0xmj0l_processed.jpeg&w=3840&q=75)
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