Question

Top Growth Farms, a farming cooperative, is considering purchasing a tractor for $551,500. The machine has a 10-year life and an estimated salvage value of $36,000. Delivery costs and set-up charges will be $12,100 and $400, respectively. Top Growth uses straight-line depreciation. Top Growth estimates that the tractor will be used five times a week with the average charge to the individual farmers of $400. Fuel is $50 for each use of the tractor. The present value of an annuity of 1 for 10 years at 9% is 6.418. For the new tractor, compute the:
A) Calculate the payback period.
B) Calculate the net present value.
C) Calculate the accounting rate of return

Answer 1

Answer:

a. 6.2

b. $20,038

c. 12.73%

Explanation:

Initial investment = $551,500 + $12,100 + $400

Initial investment = $564,000

Annual cash flows = 5 * 52 * ($400 - $50)

Annual cash flows = $91,000

a. Payback period

Cash payback = Initial investment  / Annual cash flows

Cash payback =564000 / 91000

Cash payback = 6.2

b. Net present value

Net present value = Present value of cash flow - Capital investment

Where Present value of cash flow = Annual cash flows * PVA(1,10%,9)

Present value of cash flow = $91000*6.418

Present value of cash flow = $584,038

Capital investment = $564000  

Net present value =  $584,038 - $564000

Net present value = $20,038

c. Accounting rate of return

Average Investment= ($564,000 + $36,000) / 2

Average Investment = $300,000

Annual Net Income = $91,000 - ($564,000 - $36,000) / 10

Annual Net Income = $38,200

Accounting rate of return =  Annual Net Income / Average Investment

Average Investment = $38,200 / $300,000

Average Investment = 12.73%