Chapter 16, Problem 16.38C

To determine

Concept Introduction:

ARR: Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  $ARR=\frac{AverageAccountingprofits}{AverageInvestment}$

Payback Period: Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project.

NPV: Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  $NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

IRR: Internal Rate of Return (IRR) is the rate at which the NPV of the project is 0 or we can say that IRR is the rate of return at which the project is at breakeven. IRR is calculated using excel or approximation method.

Requirement-a:

To Calculate:

The net present value of the investment

Answer to Problem 16.38C

The net present value of the investment is -$1,974

Explanation of Solution

The net present value of the investment is calculated as follows:

Sunset beach Inc.
	Year 2016 beginning	Year end 2016	Year end 2017	Year end 2018	Year end 2019
Net cash inflows from operation		$ 40,000	$ 50,000	$ 64,000	$ 46,000
Initial Investment	$(150,000)
Investment in working capital	$ (50,000)				$ 50,000
Salvage value of machinery					25000
Net Cash Flows (A)	$(200,000)	$ 40,000	$ 50,000	$ 64,000	$ 121,000
PV of $1 (@12%) (B)	1.00000	0.89286	0.79719	0.71178	0.63552
PV (C) = (A*B)	$(200,000)	$ 35,714	$ 39,860	$ 45,554	$ 76,898
NPV (Sum of C)	$ (1,974)

To determine

Concept Introduction:

ARR: Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  $ARR=\frac{AverageAccountingprofits}{AverageInvestment}$

Payback Period: Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project.

NPV: Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  $NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

IRR: Internal Rate of Return (IRR) is the rate at which the NPV of the project is 0 or we can say that IRR is the rate of return at which the project is at breakeven. IRR is calculated using excel or approximation method.

Requirement-b:

To Calculate:

The present value ratio of the investment

Answer to Problem 16.38C

The present value ratio of the investment is 0.99

Explanation of Solution

The present value ratio of the investment is calculated as follows:

Sunset beach Inc.
	Year 2016 beginning	Year end 2016	Year end 2017	Year end 2018	Year end 2019
Net cash inflows from operation		$ 40,000	$ 50,000	$ 64,000	$ 46,000
Investment in working capital					$ 50,000
Salvage value of machinery					25000
Cash inflows (A)	$ -	$ 40,000	$ 50,000	$ 64,000	$ 121,000
PV of $1 (@12%) (B)	1.00000	0.89286	0.79719	0.71178	0.63552
PV (C) = (A*B)	$ -	$ 35,714	$ 39,860	$ 45,554	$ 76,898
PV of Cash inflows (Sum of PVs) (D)	$ 198,026
Initial Investment (150000+50000) (E)	$ 200,000
Present value ratio (D/E)	0.99

To determine

Concept Introduction:

ARR: Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  $ARR=\frac{AverageAccountingprofits}{AverageInvestment}$

Payback Period: Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project.

NPV: Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  $NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

IRR: Internal Rate of Return (IRR) is the rate at which the NPV of the project is 0 or we can say that IRR is the rate of return at which the project is at breakeven. IRR is calculated using excel or approximation method.

Requirement-c:

To Calculate:

The Internal rate of return of the investment

Answer to Problem 16.38C

The Internal rate of return of the investment is 11.61%

Explanation of Solution

The Internal rate of return of the investment is calculated as follows:

Sunset beach Inc.
	Year 2016 beginning	Year end 2016	Year end 2017	Year end 2018	Year end 2019
Net cash inflows from operation		$ 40,000	$ 50,000	$ 64,000	$ 46,000
Initial Investment	$(150,000)
Investment in working capital	$ (50,000)				$ 50,000
Salvage value of machinery					25000
Net Cash Flows (A)	$(200,000)	$ 40,000	$ 50,000	$ 64,000	$ 121,000
IRR =	11.61%

To determine

Concept Introduction:

ARR: Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  $ARR=\frac{AverageAccountingprofits}{AverageInvestment}$

Payback Period: Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project.

NPV: Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  $NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

IRR: Internal Rate of Return (IRR) is the rate at which the NPV of the project is 0 or we can say that IRR is the rate of return at which the project is at breakeven. IRR is calculated using excel or approximation method.

Requirement-d:

To Calculate:

The Payback period of the investment

Answer to Problem 16.38C

The Payback period of the investment is 3.38 years

Explanation of Solution

The Payback period of the investment is calculated as follows:

Sunset beach Inc.
	Year 2016 beginning	Year end 2016	Year end 2017	Year end 2018	Year end 2019
Net cash inflows from operation		$ 40,000	$ 50,000	$ 64,000	$ 46,000
Initial Investment	$(150,000)
Investment in working capital	$ (50,000)				$ 50,000
Salvage value of machinery					25000
Net Cash Flows	$(200,000)	$ 40,000	$ 50,000	$ 64,000	$ 121,000
Cumulative Net Cash Flows	$(200,000)	$(160,000)	$(110,000)	$(46,000)	$ 75,000
Payback Period = 3 years + (1*46000/121000) =3.38 Years

To determine

Concept Introduction:

ARR: Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  $ARR=\frac{AverageAccountingprofits}{AverageInvestment}$

Payback Period: Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project.

NPV: Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  $NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

IRR: Internal Rate of Return (IRR) is the rate at which the NPV of the project is 0 or we can say that IRR is the rate of return at which the project is at breakeven. IRR is calculated using excel or approximation method.

Requirement-e:

To Indicate:

The decision for the investment

Answer to Problem 16.38C

The project should not be accepted

Explanation of Solution

The project has the following analytical results:

Sunset beach Inc.
NPV	$ (1,974)
PV Ratio	0.99
IRR	11.61%
Payback	3.38 Years

The project has negative NPV and IRR is less that the required rate 12%, hence the project should not be accepted.

To determine

Concept Introduction:

Decision making plays an important role in the management. The decisions taken by managers are called managerial decisions. Managerial Decisions are decisions taken by managers for the operations of a firm. These decisions include setting target growth rates, hiring or firing employees, and deciding what products to sell. Manager's decisions are taken on the basis of quantitative as well as the qualitative measures. The managerial decision includes the decisions like make or buy, accept or reject new offers, sell or further process etc. These decisions are taken on the basis of relevant costs.

Relevant costs are the costs that are relevant for any decision making. Relevant costs are helpful for take managerial decisions like make or buy, accept or reject new offers, sell or further process etc.

Two basic types of the relevant costs are as follows:

1. Out-of-pocket costs
2. Opportunity costs

Requirement-f:

To Indicate:

The key qualitative factors to be considered for the investment decision

Answer to Problem 16.38C

The key qualitative factors to be considered for the investment decision are as follows:

1. Quality of the Products to be sold
2. Effect on current Market share after accepting this order
3. Effect on current production after committing the additional production

Explanation of Solution

Decision making plays an important role in the management. The decisions taken by managers are called managerial decisions. Managerial Decisions are decisions taken by managers for the operations of a firm. These decisions include setting target growth rates, hiring or firing employees, and deciding what products to sell. Manager's decisions are taken on the basis of quantitative as well as the qualitative measures. The managerial decision includes the decisions like make or buy, accept or reject new offers, sell or further process etc. These decisions are taken on the basis of relevant costs.

The key qualitative factors to be considered for the investment decision are as follows:

1. Quality of the Products to be sold
2. Effect on current Market share after accepting this order
3. Effect on current production after committing the additional production