Question

Splash Planet is considering purchasing a water park in​ Atlanta, Georgia, for $1,870,000. The new facility will generate annual net cash inflows of $472,000 for eight years. Engineers estimate that the facility will remain useful for eight years and have no residual value. The company uses​ straight-line depreciation, and its stockholders demand an annual return of 12​% on investments of this nature.

Requirements:

1. Compute the payback, the ARR, the NPV, the IRR, and the profitability index of this investment.

2. Recommend whether the company should invest in this project.

Answer 1

Payback period = 3.96 years

Rate of return = 9.34%

NPV = $474,725.97

IRR = 18.938%

Profitability index = 0.254

Step-by-step explanation:

Initial investment = $1,870,000

Annual cash inflow = $472,000

Number of years = 8

Annual return rate = 12%

Payback period = Initial investment / Annual cash inflows = $1,870,000 / $472,000 = 3.96 years

Rate of return = Net income / Initial investment = ($472,000 - $1,870,000/8) / $1,870,000 = 0.093 = 9.34%

Net present value (NPV) = $474,725.97 (using the NPV CALCULATOR)

Internal rate of return (IRR) = 18.938% (USING THE IRR CALCULATOR)

Profitability index = NPV / Initial Investment = $474,725.97 / $1,870,000 = 0.254