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Capital Budgeting: NPV, IRR, payback, accounting rate

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The owner of a motor company is considering the addition of a paint and body shop to his auto dealership. Construction of a building and the purchase of necessary equipment is estimated to cost $1,000,000 and both the building and equipment will be depreciated over 10 years using the straight-line method. The building and equipment have zero estimated residual value at the end of 10 years. The owners required rate of return for this project is 12%. Net income related to each year of the investment is as follows:

Revenue: $420,000
Less:
Material Cost 65,000
Labor 140,000
Depreciation 70,000
Other 5,000
Income before taxes 140,000
Taxes at 40% 56,000
Net Income 84,000

a. Determine the net present value of the investment in the paint and body shop. Should the owner invest in the paint and body shop?

b. Calculate the internal rate of return of the investment (approximate).

c. Calculate the payback period of the investment.

d. Calculate the accounting rate of return.

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Solution Summary

Capital Budgeting: Investment is evaluated using Net present value(NPV), internal rate of return (IRR), payback period and accounting rate of return.

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The owner of a motor company is considering the addition of a paint and body shop to his auto dealership. Construction of a building and the purchase of necessary equipment is estimated to cost $1,000,000 and both the building and equipment will be depreciated over 10 years using the straight-line method. The building and equipment have zero estimated residual value at the end of 10 years. The owners required rate of return for this project is 12%. Net income related to each year of the investment is as follows:

Revenue: $420,000
Less:
Material Cost 65,000
Labor 140,000
Depreciation 70,000
Other 5,000
Income before taxes 140,000
Taxes at 40% 56,000
Net Income 84,000

a. Determine ...

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