Capital Budgeting Methods

Roosevelt Corporation is considering the acquisition of machinery and equipment at a cost of $500,000. No new working capital is required to support the new equipment. The equipment has an estimated useful life of five years and a salvage value of $0. Roosevelt Corporation uses the straight-line method of depreciation. The new equipment is expected to provide an annual net cash flow benefit of $170,000 per year during the five-year period of its useful life.

Required: Evaluate the investment using each of the four methods of capital budgeting:

(1) The net present value method. The companys desired minimum rate of return for discounted cash flow analysis is 18%. If there is a salvage value on the equipment purchased, do not forget to include that factor in your analysis.

(2) The internal rate of return method to the nearest whole percent. Calculate the factor, and then scan the appropriate line on the applicable table to state the answer to the nearest whole percent.

(3) The payback or cash payback method. Please state your answer in number of years, and round to two decimal places.

(4) The simple rate of return method (ARR). Remember to consider the effect of the depreciation on the net income from the investment. If the percentage return does not come out even, state your answer to the nearest tenth of a percent; that is, to three decimal places.