Exam 21: Capital Investment Decisions and the Time Value of Money

If Billy Pierce invests $1,000 at the end of each year at 9% compounded annually, how many years will it take until his investment reaches above $10,000? Future Value of an Annuity of \ 1 4\% 5\% 6\% 7\% 8\% 9\% 1 1.000 1.000 1.000 1.000 1.000 1.000 2 2.040 2.050 2.060 2.070 2.080 2.090 3 3.122 3.153 3.184 3.215 3.246 3.278 4 4.246 4.310 4.379 4.440 4.506 4.573 5 5.416 5.526 5.637 5.751 5.867 5.985 6 6.631 6.802 6.976 7.153 7.336 7.523 7 7.898 8.142 8.394 8.654 8.929 9.200 8 9.214 9.549 9.897 10.26 10.64 11.03 9 10.58 11.03 11.49 11.98 12.49 13.02 10 12.01 12.58 13.18 13.82 14.49 15.19

A company is evaluating 3 possible investments. Each uses straight-line depreciation. See data below: Project A Project B Project C Investment \ 400,000 \ 20,000 \ 100,000 Salvage value \ 0 \ 2,000 \ 5,000 Net cash flows: Year 1 \ 100,000 \ 10,000 \ 40,000 Year 2 \ 100,000 \ 8,000 \ 25,000 Year 3 \ 100,000 \ 5,000 \ 30,000 Year 4 \ 100,000 \ 3,000 \ 10,000 Year 5 \ 100,00 \ 0 \ 0 - What is the rate of return for Project C?

MacNamara Development Company is evaluating a possible investment in a construction project. The cost will be $100,000, and it will generate cash flows as follows: Year 1 \ 10,000 Year 2 \ 20,000 Year 3 \ 30,000 Year 4 \ 40,000 Year 5 \ 35,000 The VP for construction believes this project has an internal rate of return somewhere in the range of 7% to 10%, but has asked the Controller to crunch the numbers. Using the trial and error method, and the PV factors shown here, determine what the IRR of this project is. Present Value of an Annuity of \1 5\% 6\% 7\% 8\% 9\% 10\% 1 0.952 0.943 0.935 0.926 0.917 0.909 2 0.907 0.890 0.873 0.857 0.847 0.826 3 0.864 0.840 0.816 0.794 0.771 0.751 4 0.823 0.792 0.763 0.735 0.708 0.683 5 0.784 0.747 0.713 0.681 0.650 0.621 Choose the rate below which comes closest to the actual IRR.

Which of the following describes the term time value of money?

Jim wants to invest $5,000 at the end of each year for the next 10 years to prepare for his retirement. He believes he can earn 7% on his investments. What will the value of his investment be at the end of 10 years? Future Value of an Annuity of \ 1 4\% 5\% 6\% 7\% 8\% 9\% 1 1.000 1.000 1.000 1.000 1.000 1.000 2 2.040 2.050 2.060 2.070 2.080 2.090 3 3.129 3.153 3.184 3.215 3.246 3.278 4 4.246 4.310 4.375 4.440 4.506 4.573 5 5.416 5.526 5.637 5.751 5.867 5.985 6 6.63 6.80 6.97 7.153 7.336 7.523 7 7.898 8.142 8.394 8.654 8.923 9.200 8 9.214 9.549 9.897 10.26 10.64 11.03 9 10.58 11.03 11.49 11.98 12.49 13.02 10 12.01 12.58 13.19 13.82 14.49 15.19

Atlantic Company is considering investing in specialized equipment costing $360,000. The equipment has a useful life of 5 years and a residual value of $45,000. Depreciation is calculated using the straight-line method. The expected net cash inflows from the investment are: Year 1 \ 160,000 Year 2 130,000 Year 3 100,000 Year 4 55,000 Year 5 40,000 \ 485,000 What is the rate of return on the investment?

Capital budgeting is:

The payback method is a very thorough and comprehensive way to choose the best investment among alternatives.

Logan, Inc. is evaluating two possible investments in depreciable plant assets. The company uses the straight-line method of depreciation. The following information is available: Investment A Investment B Initial capital investment \ 60,000 \ 90,000 Estimated useful life 3 year 3 years Estimated residual value -0- -0- Estimated annual net cash inflow for 3 years \ 25,000 \ 40,000 Reguired rate of retum 10\% 12\% - How long is the payback period for Investment A?

Using the NPV method of evaluating investments, a company should consider a project a good investment opportunity as long as the NPV of the total cash flows is positive.

If you invest $3,000 today at 7% interest, what is the value of the investment at the end of 5 years? Future Value of \ 1 4\% 5\% 6\% 7\% 8\% 9\% 1 1.040 1.050 1.060 1.070 1.080 1.090 2 1.082 1.103 1.124 1.145 1.166 1.188 3 1.125 1.158 1.191 1.225 1.260 1.295 4 1.170 1.216 1.262 1.311 1.360 1.412 5 1.217 1.276 1.338 1.403 1.469 1.539 6 1.265 1.340 1.419 1.501 1.587 1.677 7 1.316 1.407 1.504 1.606 1.714 1.828 8 1.369 1.477 1.594 1.718 1.851 1.993 9 1.423 1.551 1.689 1.838 1.999 2.172 10 1.480 1.629 1.791 1.967 2.159 2.367

Cantrell Company is considering investing $396,000 in high-tech communications equipment which would have an estimated life of 4 years and zero residual value. The technology manager says that it will return cash flows as shown below: Year 1 \ 100,000 Year 2 \ 200,000 Year 3 \ 100,000 Year 4 \ 50,000 The VP Finance points out that the project must pass the company's 7% hurdle rate, and asks one of the analysts to calculate the internal rate of return before they discuss the project further. Using the tables below, please calculate the IRR for this project. Present Value of \1 5\% 6\% 7\% 8\% 9\% 10\% 1 0.952 0.943 0.935 0.926 0.917 0.909 2 0.907 0.890 0.873 0.857 0.842 0.826 3 0.864 0.840 0.816 0.794 0.772 0.751 4 0.823 0.792 0.763 0.735 0.708 0.683 5 0.784 0.747 0.713 0.681 0.650 0.621 Please choose the percentage below that comes closest to the actual IRR.

Osterwitz Company is evaluating an investment of $1,000,000 which will yield cash flows of $142,400 per year for 10 years with no residual value. What is the internal rate of return? (Please choose the rate that is closest to the actual solution.) Present Value of an Annuity of \1 5\% 6\% 7\% 8\% 9\% 10\% 1 0.952 0.943 0.935 0.926 0.917 0.909 2 1.859 1.833 1.808 1.783 1.759 1.736 3 2.723 2.673 2.624 2.577 2.531 2.487 4 3.546 3.465 3.387 3.311 3.240 3.170 5 4.329 4.212 4.100 3.993 3.890 3.791 6 5.076 4.917 4.767 4.623 4.480 4.355 7 5.786 5.582 5.389 5.206 5.033 4.868 8 6.463 6.210 5.971 5.747 5.535 5.759 9 7.108 6.802 6.515 6.247 5.995 5.759 10 7.722 7.360 7.024 6.710 6.418 6.145

Your grandmother has promised to give you $2,000 at the end of each of the next four years if you earn Cs or better in all of your courses each year. Using a discount rate of 8% and the table below, what is the present value of the gift? Present Value of an Annuity of \ 1 5\% 6\% 7\% 8\% 9\% 10\% 1 0.95 0.943 0.935 0.926 0.917 0.909 2 1.859 1.833 1.808 1.783 1.759 1.736 3 2.723 2.673 2.624 2.577 2.531 2.487 4 3.546 3.465 3.387 3.312 3.240 3.170 5 4.329 4.212 4.100 3.993 3.890 3.791

When a company invests in lean manufacturing processes or "green" technologies, the efficiencies and elimination of waste are factors that should NOT be included when conducting a discounted cash flow analysis of the investment.

A company has policy to invest in new opportunities if the investment has a positive NPV. See data below: Initial investment \ 105,000 Yearly cash flows \ 30,000 Number. of years 4 Residual value \ 10,000 Present Value of an Annuity of \ 1 5\% 6\% 7\% 8\% 9\% 10\% 1 0.95 0.943 0.93 0.926 0.917 0.909 2 1.859 1.833 1.809 1.783 1.759 1.736 3 2.729 2.673 2.624 2.577 2.531 2.487 4 3.546 3.465 3.387 3.312 3.240 3.170 5 4.329 4.212 4.10d 3.993 3.890 3.791 Present Value of \ 1 5\% 6\% 7\% 8\% 9\% 10\% 1 0.952 0.943 0.935 0.92 0.917 0.909 2 0.907 0.890 0.873 0.857 0.84 0.826 3 0.864 0.840 0.816 0.794 0.777 0.751 4 0.823 0.792 0.763 0.733 0.70 0.683 5 0.784 0.747 0.713 0.681 0.650 0.621 If the company has a hurdle rate of 6%, this investment will yield a positive NPV and should be accepted.

Billy Pierce invests $1,000 at the end of each year for 5 years at 9%. What is the future value of the investment? Future Value of an Annuity of \ 1 4\% 5\% 6\% 7\% 8\% 9\% 1 1.000 1.000 1.000 1.000 1.000 1.000 2 2.040 2.050 2.060 2.070 2.080 2.090 3 3.122 3.153 3.184 3.215 3.246 3.278 4 4.246 4.310 4.379 4.440 4.506 4.573 5 5.416 5.526 5.637 5.751 5.867 5.985 6 6.631 6.802 6.976 7.153 7.336 7.523 7 7.898 8.142 8.394 8.654 8.929 9.200 8 9.214 9.549 9.897 10.26 10.64 11.03 9 10.58 11.03 11.49 11.98 12.49 13.02 10 12.01 12.58 13.18 13.82 14.49 15.19

Which of the following would be the best basis on which to accept an investment opportunity?

Which of the following BEST describes the term capital rationing?

All else being equal, investments with longer payback periods are more desirable.