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Metro Car Washes: Reviewing an Investment Proposal

Metro Car Washes, Inc. is reviewing an investment proposal. The initial cost as well as the estimate of the book value of the investment at the end of each year, the net after-tax cash flows for each year, and the net income for each year is presented in the following schedule. The salvage value of the investment at the end of each year is equal to its book value. There would be no salvage value at the end of the investment's life.

Management uses a 16 percent after-tax target rate of return for new investment proposals.

Year Initial cost and book value Annual net after-tax cash flows Annual net income
0 $105,000
1 $70,000 $50,000 $15,000
2 $42,000 $45,000 $17,000
3 $21,000 $40,000 $19,000
4 $7,000 $35,000 $21,000
5 0 $30,000 $23,000

1. Compute the project's payback period.
2. Calculate the accounting rate of return on the investment proposal. Base your calculation on the initial cost of the investment.
3. Compute the proposal's net present value.

Solution Summary

This is a tutorial on how to calculate the payback period, the accounting rate of return, and the net present value.