Practice for Test $2$

Part $1$ Question $2$

$2+$D$7$:L$19.$ Blink $281$ Corporation is considering an investment that will cost $$170,000$ and last for five years. The investment will be amortized on a straight$-$line basis over that period. Earnings generated by the investment before amortization and taxes over this period are as follows:

Year Earnings before amortization & taxes After$-$tax cash flows

$146000$ $$38,000$

$24900043,000$

$35800050,000$

$46000052,000$

$56500058,000$

Blink $281$ Corporation has a tax rate of $25$ percent.

a$.$ What is the AAR of this project?

b$.$ Compute the payback period in years, and the internal rate of return for the project

c$.$ Compute net present value of the project if WACC is $10$ percent.

d$.$ Should the project be undertaken if the investor expects $15\%$ AAR and $4$ years of payback? What is the decision if you use NPV and IRR as the decision criteria?

Gather the key facts and answer the questions above

Solution

Practice for Test $2$

Key Facts

Initial Investment $$170,000$ correct

Amortization wrong

Tax rate $25\%$ correct

Cost of Capital $\backslash$ wrong

Year Earnings before amortization & taxes After$-$tax cash flows

$1$ wrong wrong

$2$ wrong wrong

$3$ wrong wrong

$4$ wrong wrong

$5$ wrong wrong

Questions $($a$)$: AAR Calculation

Year Earnings before amortization & taxes Amortization Earnings before taxes Taxes Earnings After Tax Marks

$1$ $$46,000\mathrm{.}00$ wrong wrong wrong wrong

$2$ $$49,000\mathrm{.}00$ wrong wrong wrong wrong

$3$ $$58,000\mathrm{.}00$ wrong wrong wrong wrong

$4$ $$60,000\mathrm{.}00$ wrong wrong wrong wrong

$5$ $$65,000\mathrm{.}00$ wrong wrong wrong wrong

Average Earnings wrong

Calculating Average Investment Book Value

Year Amortization Net Book Value

$0$ correct wrong

$1$ wrong wrong

$2$ wrong wrong

$3$ wrong wrong

$4$ wrong wrong

$5$ wrong correct

Average Investment Book value wrong

Average Accounting Return wrong

Question $($b$)$ Computing Payback Period In Years & IRR

Year After$-$tax Cash Flow Cummulative Cash Flow

$0-$$$170,000$ wrong

$1$ $$0$ wrong

$2$ $$0$ wrong

$3$ $$0$ wrong

$4$ $$0$ correct

$5$ $$0$ correct

Number of Full Years Payback wrong

Partial Years wrong

Payback Period Years wrong

Internal rate of Return wrong

Question $($c$)$ Computeing Net Present Value

Year After$-$tax Cash Flow Present Value

$0-$$$170,000$ wrong

$1$ $$0$ wrong

$2$ $$0$ wrong

$3$ $$0$ wrong

$4$ $$0$ wrong

$5$ $$0$ wrong

Net Present value wrong

Question $($d$)$ Discuss whether or not this project should be undertaking based on AAR, Payback, IRR and NPV calculations above indicate the decision and why you chose that course of action

Based on AAR

Based on Payback

Based on IRR

Based on NPV