CAPITAL INVESTMENT DECISION PROBLEMS

GROUP 1 AC 519 3:00 4:30 TTH

Exercises 14-26 to 14-29

p. 601

EXERCISE 14-26
Payback Period

Requirement 1
What is the payback period for Colby?

Original investment Payback Period = Annual Cash Flow

400,000 = = 3.33 years 120,000

Requirement 2
What is the payback period for Kylie? Year 1 2 3 Unrecovered Investment Annual Cash Time Needed for Flow Payback (years) 1 1 0.8

$ 1,400,000.00 $ 350,000.00 1,050,000.00 560,000.00 490,000.00 700,000.00

4 5

0 0

420,000.00 280,000.00

0 0

Payback period is 2.8 years.

Requirement 3
How much did Carsen invest in the project?

Original investment Payback Period = Annual Cash Flow

Investment 4 years= $ 960,000 Original Investment = $3,840,000

Requirement 3
How much cash did Rahn receive each year?

Original investment Payback Period = Annual Cash Flow

$ 1,300,000 2.5 years= Annual Cash Flow

Annual Cash Flow = $520,000

p. 601602

EXERCISE 14-27
Accounting Rate of Return

Requirement 1
Compute the ARR on the new equipment that Cobre Company is considering.

Average Net Income Accounting Rate of Return= Original investment

$ 480,000 = $ 3,600,000 Accounting Rate of Return= 13.33%

Requirement 1 (supporting)

Yearly Depreciation Expense: $ 3,600,000 =$ 720,000 5 Average Net Income: $6,000,000-4,800,000-720,000 = $480,000

Requirement 2

Conceptual Connection

ARR of Project A: Yearly Depreciation Expense: $75,000/5 = $15,000 Average Net Income: Year 1 Year 2 Year 3 Year 4 Year 5 $22,500-15,000 = $30,000-15,000 = $45,000-15,000 = $75,000-15,000 = $75,000-15,000 = $7,500 $15,000 $30,000 $60,000 $60,000 $172,500

$172,500/5 = $34,500 Accounting Rate of Return = $34,500/75,000 = 46%

Requirement 2

Conceptual Connection

ARR of Project B: Yearly Depreciation Expense = $15,000 Average Net Income: Year 1 $22,500-15,000 = Year 2 $30,000-15,000 = Year 3 $45,000-15,000 = Year 4 $22,500-15,000 = Year 5 $22,500-15,000 =

$7,500 $15,000 $30,000 $7,500 $7,500 $67,500

$67,500/5 = $13,500 Accounting Rate of Return = $13,500/75,000 = 18%

Requirement 2

Conceptual Connection

Based on the Accounting Rate of Return (ARR), Project A should be chosen because it has a higher ARR. Unlike the Payback Period, the ARR correctly signals the one project should be preferred over the other because it considers the profitability of the project, as reflected in the equation (numerator of average net income).

Requirement 3
How much cash did the company in Scenario c invest in the project?

Average Net Income Accounting Rate of Return= Original investment

$ 120,000 30% = Original Investment Original Investment= $ 400,000

Requirement 4
What is the average net income earned by the project in Scenario d?

Average Net Income Accounting Rate of Return = Original investment

Average Net Income 50% = $ 150,000 Average Net Income = $ 75,000

p. 602

EXERCISE 14-28
Net Present Value

Requirement 1
Compute the NPV for Southward Manufacturing, assuming a discount rate of 12%. Should the company buy the new welding system? CFt Net Present Value = -I t (1+i) $400,000 x 1 (1.12)10 1.12 = $ 2,260,089.211

$2,260,089.211 - 2,250,000 = $10,089.211 = NPV

Requirement 2

Conceptual Connection

NPV of Kaylin Day @ $ 35,000 per year:

$ 35,000 x

1 (1.08)6 1.08

= $ 161,800.7882

$161,800.7882 - 180,000 = ($18,199.21176) KaylinDay should not invest in the shop because the NPV is negative.

Requirement 2

Conceptual Connection

NPV of Kaylin Day Day:@ $ 45,000 per year:

10 11 (1.12) (1.08)6 1.12 1.08

45,000 $45,000 x x

==$$161,800.7882 208,029.5849

$161,800.7882 - 180,000 == ($18,199.21176) $208,029.5849 - 180,000 $28,029.58488 KaylinDay invest in the shop because KaylinDayshould shouldnot invest in the shop because thethe NPV NPVis isnegative. positive.

Requirement 2

Conceptual Connection

The two situations portray the impact of the periodic cash flows in determining the NPV, and consequently the acceptreject decision of the company. Investments with greater net periodic cash flows will have higher NPV than investments with low net periodic cash flows, ceteris paribus.

Requirement 3

What was the required investment for Goates Companys proje

6 1 (1.08) NPV = $21,300 - Required 45,000 x 1.08 = Investment

Required Investment: $ 240,071.6789 - 21,300 = $ 218,771.6789

p. 603 - 604

EXERCISE 14-29
Internal Rate of Return

Requirement 1
Calculate the IRR for Cuenca Company. Should the new equipment be purchased? 2,000,000 1 (1 + )5 $7,200,000 = x IRR = 12.0535% The new equipment should not be purchased because the IRR is less than the 16% cost of capital.

Requirement 2
Calculate Kathy Shorts IRR. Should she acquire the new system? 1 (1 + )10 240,000 x IRR = 14.0974% Kathy Shorts should acquire the new system because the IRR exceedsthe 10%cost of capital.

$1,248,000 =

Requirement 3
What should be Elmo Enterprises' expected annual cash flow from the plant? Annual Cash Flow x 1 (1.25)15 .25

$2,880,000 =

Annual Cash Flow = $ 746,256.5688

ABANGAN, SHAIRA ALLERA, ODESSA MARIE DY, JAECELLE GO, JAN JENSEN GO, SHAUN ANTHONY MANOLONG, JOHN MARJADAS, JAMAICA REBADOMIA, CHUMESCENE SARANA, PHOEBE LOU TIU, MATTHEW VILLAHERMOSA, GIAH
End. Thank you!!