Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter, he expects demand to stabilize. The following table presents the expected cash flows: Year of Operation Year 1 Year 2 Year 3 Year 4 Cash Inflow Cash Outflow $ 9,400 11, 200 $14,000 18,800 21,600 21,600 13,400 13,400 In addition to these cash flows, Aaron expects to pay $20,400 for the equipment. He also expects to pay $3,400 for a major overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $1,200 salvage value and a four-year useful life. Aaron desires to earn a rate of return of 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Calculate the net present value of the investment opportunity. (Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal places.) b. Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and whether it should be accepted. a. Net present value b. Will the return be above or below the cost of capital? Should the investment opportunity be accepted?
Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter, he expects demand to stabilize. The following table presents the expected cash flows: Year of Operation Year 1 Year 2 Year 3 Year 4 Cash Inflow Cash Outflow $ 9,400 11, 200 $14,000 18,800 21,600 21,600 13,400 13,400 In addition to these cash flows, Aaron expects to pay $20,400 for the equipment. He also expects to pay $3,400 for a major overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $1,200 salvage value and a four-year useful life. Aaron desires to earn a rate of return of 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Calculate the net present value of the investment opportunity. (Negative amount should be indicated by a minus sign. Round intermediate calculations and final answer to 2 decimal places.) b. Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and whether it should be accepted. a. Net present value b. Will the return be above or below the cost of capital? Should the investment opportunity be accepted?
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text:Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will
enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the
service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter,
he expects demand to stabilize. The following table presents the expected cash flows:
Year of
Operation
Year 1
Year 2
Year 3
Year 4
Cash Inflow Cash Outflow
$ 9,400
11, 200
$14,000
18,800
21,600
21,600
13,400
13,400
In addition to these cash flows, Aaron expects to pay $20,400 for the equipment. He also expects to pay $3,400 for a major overhaul
and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $1,200 salvage value
and a four-year useful life. Aaron desires to earn a rate of return of 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from
the tables provided.)
Required
a. Calculate the net present value of the investment opportunity. (Negative amount should be indicated by a minus sign. Round
intermediate calculations and final answer to 2 decimal places.)
b. Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and
whether it should be accepted.
a.
Net present value
b. Will the return be above or below the cost of capital?
Should the investment opportunity be accepted?
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