Question - Dutch Lumber Company is planning a project that is expected to last for eight years and generate annual net cash inflows of $85,000. The project will require the purchase of a $300,000 machine, which is expected to have a salvage value of $20,000 at the end of the eight year period. The machine will require a $65,000 overhaul at the end of the 5th year. The company presently has a 15% minimum desired rate of return.
Based on this information, an accountant prepared the following analysis:
Annual net cash inflow $85,000
Annual depreciation $35,000
Annual cost of overhaul 8,125 43,125
Average annual income $41,875
Return on investment=$41,875/300,00=13.96%
The accountant 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.