Lon Timur is an accounting major at a midwestern state university located approximately 60 miles from a major city. Many of the students attending the university are from the metropolitan area and visit their homes regularly on the weekends. Lon, an entrepreneur at heart, realizes that few good commuting alternatives are available for students doing weekend travel. He believes that a weekend commuting service could be organized and run profitably from several suburban and downtown shopping mall locations. Lon has gathered the following investment information. Five used vans would cost a total of $74,538 to purchase and would have a 3-year useful life with negligible salvage value. Lon plans to use straight-line depreciation. 1. Ten drivers would have to be employed at a total payroll expense of $48,200. Other annual out-of-pocket expenses associated with running the commuter service would include Gasoline $15,700, Maintenance $3,000, Repairs $4,100, Insurance $4,500, and Advertising $2,200 2. 3. Lon has visited several financial institutions to discuss funding. The best interest rate he has been able to negotiate is 15%. Use this rate for cost of capital. 4. Lon expects each van to make ten round trips weekly and carry an average of six students each trip. The service is expected to operate 30 weeks each year, and each student will be charged $12 for a round-trip ticket. 5. (a) Determine the annual (1) net income and (2) net annual cash flows for the commuter service. (Round answers to O decimal places, e.g. 125.) Net income $ Net annual cash flows (b) Compute (1) the cash payback period and (2) the annual rate of return. (Round answers to 2 decimal places, e.g. 10.50.) Cash payback period years Annual rate of return (c) Compute the net present value of the commuter service. (Round answer to 0 decimal places, e.g. 125. If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Net present value Brooks Clinic is considering investing in new heart-monitoring equipment. It has two options. Option A would have an initial lower cost but would require a significant expenditure for rebuilding after 4 years. Option B would require no rebuilding expenditure, but its maintenance costs would be higher. Since the Option B machine is of initial higher quality, it is expected to have a salvage value at the end of its useful life. The following estimates were made of the cash flows. The company's cost of capital is 6%. Option A Option B $171,000 $269,000 $70,500 $29,600 $48,900 Initial cost $81,500 Annual cash inflows $27,000 Annual cash outflows Cost to rebuild (end of year 4) $0 $0 $7,100 Salvage value Estimated useful life 7 years 7 years Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each option. (Hint: To solve for internal rate of return, experiment with alternative discount rates to arrive at a net present value of zero.) (lf the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). Round answers for present value and IRR to 0 decimal places, e.g. 125 and round profitability index to 2 decimal places, eg. 12.50. For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Net Present Value Profitability Index Internal Rate of Return Option A % Option B eTextbook and Media Which option should be accepted? should be accepted
