Vandelay International Is Planning a Project That Is Expected to Last

question 9

Essay

Vandelay International is planning a project that is expected to last for six years and generate annual net cash inflows of $75,000. The project will require the purchase of a $280,000 machine, which is expected to have a salvage value of $10,000 at the end of the six-year period. In addition to annual operating costs, the machine will require a $50,000 overhaul at the end of the fourth year. The company presently has a 12% minimum desired rate of return.
Based on this information, accountant Division Manager prepared the following analysis: Annual net cash inflow
Annual depreciation $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$$\$ 45,000$
Annual average cost of overhaul $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$$\underline {8.333}$
Average annual mcome
Return on investment $= \$ 21,667 \div \$ 280,000 = 7.74 \%$ The Division Manager recommends that the project be rejected because it does not meet the company's minimum desired rate of return. Ignore income taxes.
Required:
A. What criticism(s) would you make of the accountant's evaluation?
B. Use the net-present-value method and determine whether the project should be accepted.
C. Based on your answer in requirement "B," is the internal rate of return greater or less than 12%? Explain.

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