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Homework answers / question archive / Water Planet is considering purchasing a water park in Atlanta, Georgia, for $2,050,000
Water Planet is considering purchasing a water park in Atlanta, Georgia, for $2,050,000. The new facility will generate annual net cash inflows of $530,000 for eight years. Engineers estimate that the facility will remain useful for eight years and have no residual value. The company uses straight-line depreciation. Its owners want payback in less than five years and an ARR of 10% or more. Management uses a 14% hurdle rate on investments of this nature.
Requirement 1. Compute the payback period, the ARR, the NPV, and the approximate IRR of this investment. (If you use the tables to compute the IRR, answer with the closest interest rate shown in the tables.) (Round the payback period to one decimal place.)
The payback period (in years) is (Round the percentage to the nearest tenth percent.) The ARR (accounting rate of return) is %. (Round your answer to the nearest whole dollar.) Net present value The IRR (internal rate of return) is between
Requirement 2. Recommend whether the company should invest in this project.
1) Computation of Payback Period, ARR, NPV and IRR:
Payback period = Initial Investment/Annual net Cash inflow
= 2050000/530000
= 3.87 Years
ARR = Average Net Income/Average Investment
Here,
Average Net Income = Annual net Cash Flow - Annual Depreciation = 530000- (2050000/8) = 530000-256250 = 273750
Average Investment = (2050000+0)/2 = 1025000
ARR = 273750/1025000 = 26.71%
NPV = -Initial Investment + (Annual Cash Inflow *PVAF (14%, 8 years)
NPV = -2050000 + 530000*4.639
NPV = 408,670
IRR = rate(nper,pmt,-pv,fv)
IRR = rate(8,530000,-2050000,0)
IRR = 19.73%
Decision : The Company should invest in this project as its NPV is positive, payback period is lower than the required Payback period, ARR is greater than the minimum ARR, IRR is greater than cost of capital.
