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Lamar Company is considering a project that would have an eight-year life and require a $2,400,000 investment in
equipment. At the end of eight years, the project would terminate and the equipment would have no salvage
value. The project would provide net operating income each year as follows:
Sales $ 3,000,000
Variable expenses 1,800,000
Contribution margin 1,200,000
Fixed expenses:
Advertising, salaries, and other
$700,000
fixed out-of-pocket costs
Depreciation 300,000
Total fixed expenses 1,000,000
Net operating income $ 200,000
Required:
a. Compute the annual net cash inflow from the project.
b. Compute the projects net present value. Is the project acceptable?
c. Find the projects internal rate of return to the nearest whole percent.
d. Compute the projects payback period.
e. Compute the projects simple rate of return.
1. The annual net cash inflow can be computed by deducting the cash expenses from sales:
Sales $ 3,000,000
Variable expenses 1,800,000
Contribution margin 1,200,000
Advertising, salaries, and other
700,000
fixed out-of-pocket costs
Net operating income $ 500,000
Or, the annual net cash inflow can be computed by adding depreciation back to net operating income:
Yes, the project is acceptable because it has a positive net present value.
3. The formula for computing the factor of the internal rate of return is:
Investment required
Factor of the internal rate of return =
Annual net cash inflow
$ 2,400,000.00
=
$ 500,000.00
= 4.8000
Looking in Time value table and scanning along the 8-period line, we find that a factor of 4.800 represents a rate
of return of about 13%.
Investment required
Payback period =
Annual net cash inflow
$ 2,400,000.00
=
$ 500,000.00
= 4.8 years
$ 200,000
=
$ 2,400,000
= 8.30%