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BP Limited is considering an investment in a fixed asset which costs $295,000
BP Limited is considering an investment in a fixed asset which costs $295,000. The asset is expected to generate cash inflows of $118,000 each year for the next four years. The company intends to sell the asset at the end of year 4 for an estimated residual value of $22,000. The asset will be depreciated straight-line over the next four years. The discount rate for the project is 13%.
Calculate the accounting rate of return, and show your answer to the nearest 0.1%.
Calculate the net present value, and show you answer in thousands of dollars (for example, $123,456.67 should be shown as 123).
Calculate the payback period in years.
Expert Solution
(a)-Accounting rate of return
Annual net income = Annual cash flow – Straight line depreciation expenses
= $118,000 – [($295,000 - $22,000) / 4 Years]
= $118,000 - $68,250
= $49,750
Average Investment = (Initial cost + Salvage value) / 2
= ($295,000 + $22,000) / 2
= $317,000 / 2
= $158,500
Therefore, the Accounting rate of return = [Annual net income / Average investment] x 100
= [$49,750 / $158,500] x 100
= 31.4%
(b)-Net Present Value
Net Present Value = Present value of annual cash inflows – Initial investment
= $118,000(PVIFA 13%, 4 Years) - $295,000
= ($118,000 x 2.97447133) - $295,000
= $350,987.62 - $295,000
= $55,987.62 or
= $56 Thousand (Rounded to thousands of dollars)
(c)-Project’s Payback Period
Project’s Payback Period = Initial investment / Annual cash inflow
= $295,000 / $118,000
= 2.50 Years
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