Great Plains Railroad Inc. is considering acquiring equipment at a cost of $450,000.

Great Plains Railroad Inc. is considering acquiring equipment at a cost of $450,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $75,000. The company’s minimum desired rate of return for net present value analysis is 10%.

Compute the following:

a. The average rate of return, giving effect to straight-line depreciation on the investment. Round whole percent to one decimal place.

b. The cash payback period.

c. The net present value. Use the present value of an annuity of $1 table appearing in this chapter (Exhibit 2). Round to the nearest dollar.


Answer:

 a. Average rate of return on investment: $30,000 * 
($450,000 + $0) ÷ 2 
* The annual earnings are equal to the cash flow less the annual depreciation expense, 
shown as follows: 
$75,000 – ($450,000 ÷ 10 years) = $30,000 
b. Cash payback period: $
450,000 
$75,000 

=  6 years 
c. Present value of annual net cash flows ($75,000 × 6.145*)………………………… $460,875 
 Less amount to be invested……………………………………………………………   450,000 
 Net present value………………………………………………………………………… $ 10,875 
* Present value of an annuity of $1 at 10% for 10 periods from Exhibit 2.