BUA 458 Accounting Seminar | Complete Solution

BUA 458, Accounting Seminar, Spring 2015

Given Data:

Today’s cost = 20 million

Assuming that the cash payment will begin 1 year after the agreement this is an Ordinary annuity = 3 million

Number of annuities 10

Cost of capital 16%.

Please Note: To group all the work as one document to facilitate reading and submission; all the Excel spreadsheets were inserted in this document and all the manual calculations were typed on it.

Implied Data and Conversion factors:

I =16 %, n = 10

Conversion factors, manually calculated

Present value of an ordinary annuity = =

Net present value of this ordinary annuity is 14,499,682.44 = 4.8332 x 3,000,000

Excel spreadsheet calculations:

Using Excel formulas:

The value of the annuity was entered as a negative number to comply with excel formula’s reference. The help function for this formula was consulted for clarification.

The Internal Rate of Returns is the interest rate that equates the cash outflows or cost of an investment with the cash inflows from that investment. For this particular case the IRR value is 8.1442 approximately 8.1%.

Calculating the IRR:

Manually,

Now I look on the tables for the Present value of an ordinary annuity of $1 with n= 10, the closest values to 6.66667.

In this case there is not an equal value but there are two close values that I can use to interpolate and find an exact IRR.

For 8% the PV factor is 6.71008, for 9% PV factor is 6.41766. The x is the difference between a known % and the exact %.

Therefore, my exact IRR is equals to 9 - 0.85154 = 8.14845 ≈ 8.1%

Using Excel,

Cash flow

I recommend the RRHOF not to invest under this scenario because:

1. The Net Present Value of the cash inflows is lower than the present value of the cash outflow (investment). In other words, 14.5 million is lower than 20 million, representing a loss of approximately 5.5 million.
2. The IRR is 8.1% almost half of the cost of capital (16%) meaning that they lose money faster than they could recover it.
3. The Profitability index for this scenario is 0.725, meaning that they will recover 72.5% of their investment.  See the calculations bellow,