Problem - Aaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter, he expects demand to stabilize. The following table presents the expected cash flows:
|
Year of
Operation
|
Cash Inflow
|
Cash Outflow
|
|
2019
|
$13,400
|
$ 9,500
|
|
2020
|
19,600
|
11,300
|
|
2021
|
21,700
|
13,500
|
|
2022
|
21,700
|
13,500
|
In addition to these cash flows, Aaron expects to pay $21,600 for the equipment. He also expects to pay $3,000 for a major overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $1,700 salvage value and a four year useful life. Aaron desires to earn a rate of return of 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)
Required -
a. Calculate the net present value of the investment opportunity.
b. Indicate whether the investment opportunity is expected to earn a return that is above or below the desired rate of return and whether it should be accepted.