Question

River Wild is considering purchasing a water park in ​, for . The new facility will generate annual net cash inflows of for years. Engineers estimate that the facility will remain useful for years and have no residual value. The company uses​ straight-line depreciation. Its owners want payback in less than five years and an ARR of ​% or more. Management uses a ​% hurdle rate on investments of this nature.

Based on your reading, complete the given tasks:

a. Compute the payback period, the ARR, the NPV, and the approximate IRR of this investment.
b. Recommend whether the company should invest in this project?

Answer 1

The numbers are missing, so I looked for a similar question:

River Wild is considering purchasing a water park in Oakland, California, for $2,000,000. The new facility will generate annual net cash inflows of $510,000 for nine years. Engineers estimate that the facility will remain useful for nine years and have no residual value. The company uses straight-line depreciation. Its owners want payback in less than five years and an ARR of 12% or more. The management uses a 10% hurdle rate on investments of this nature.

a) Payback period = $2,000,000 / $510,000 = 3.92 years

ARR = net income / initial outlay

net income = net cash flow - depreciation expense = $510,000 - ($2,000,000/9) = $510,000 - $222,222 = $287,778

ARR = $287,778 / $2,000,000 = 0.1439 = 14.39%

NPV = -$2,000,000 + [$510,000 x 5.7590 (PV annuity factor, 10%, 9 periods)] = $937,090

using a financial calculator, the IRR = 20.87%

b) Since the NPV is positive, the payback period is less than 5 years, and the ARR is higher than expected, the project should be carried out.