Essay on Net Present Value and Average Accounting Rate

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Part 1 A Year Cash flow 1 2 3 4 5

$4,000

$4,000

$4,000

$4,000

$4,000

Net PPE $8,000 $6,000 $4,000 $2,000 $0

Depreciation $2,000

$2,000

$2,000

$2,000

$2,000

Income Tax
Net

Cash Flow Before Taxes （40%） Income after taxes $2,000

$800 $1,200

$3,200

$2,000

$800 $1,200

$3,200

$2,000

$800 $1,200

$3,200

$2,000

$800 $1,200

$3,200

$2,000

$800 $1,200

$3,200

PVIF（n, 10%)

PV

0.909091 0.826446 0.751315 0.683013 0.620921

$2,909 $2,645 $2,404 $2,186 $1,987 $12,131 $10,000 $2,131

Total PV Initial Investment NPV

PPE

Accum

Dep

$10,000 $2,000

$10,000 $4,000

$10,000 $6,000

$10,000 $8,000

$10,000 $10,000

Average

$4,000 Investment

Net Present value=$2, 131

Average accounting rate of return=Net income/Average Investment=$1, 200/$4, 000=30% At first, net present value of the venture is positive. In addition, average accounting rate of return is more than cost of capital. That means the accounting profit of the venture is larger than the cost of capital. In other words, the venture is profitable. So the company should undertake this joint venture. B Annual Depreciation=$10, 000/5=$2, 000

When the cash flows is $2, 000, net income is zero and the cash flow after tax is zero.

When the cash flows are $5, 000,

Net income=$5, 000-­‐2, 000=$3, 000, Tax=$3, 000*40%=$1, 200, Cash flow after taxes=$5, 000-­‐1, 200=$3, 800 Net present value=($2, 000*40%+$3, 800*60%)*3.790787-­‐$10, 000=$1, 675 C $2, 000/10%=$20, 000 Assuming you invest in a startup that stays afloat and makes a profit, it could be years before any of those profits come your way.

"A startup is going to need all the cash they can get. Earnings are usually plowed back into the business (for the first few years). Any return might not be for three to five years, and there is no guarantee," Coffman says.

If an investor has a particular targeted time frame for a return of capital and a yield they'd like to earn, Coffman says they should consider investing via a loan instead. Putting a large sum in a business based on trust and the hope for dividends later has no guarantee. But making an official loan to the entrepreneur or startup at a market-­‐based interest rate with a determined term can give the investor a steady income stream and a more guaranteed
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