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

Beta Company is considering an investment in a new storage facility that would require an initial outlay of $250,000, and would yield yearly cash flows of $48,000 for 8 years. Beta uses a discount rate of 7% What is the NPV of the investment? Present Value of an Annuity of \ 1 5\% 6\% 7\% 8\% 9\% 10\% 1 0.952 0.943 0.939 0.92 0.917 0.909 2 1.859 1.833 1.809 1.78 1.759 1.736 3 2.723 2.673 2.624 2.577 2.531 2.487 4 3.546 3.465 3.387 3.31 3.240 3.170 5 4.329 4.212 4.10 3.99 3.890 3.791 6 5.076 4.917 4.767 4.623 4.486 4.355 7 5.780 5.582 5.389 5.206 5.033 4.355 8 6.463 6.210 5.971 5.747 5.535 5.335 9 7.108 6.802 6.513 6.247 5.995 5.759 10 7.722 7.360 7.024 6.710 6.418 6.145

Allied Chemicals has a hurdle rate of 9% for new investments. The production manager suggests that an equipment upgrade costing $84,460 would yield net cash flows of $40,000 in the first year, $30,000 in the second year, $20,000 in the third year, and $10,000 in the fourth and final year. 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 The investment meets the company's hurdle rate requirement and should be adopted.

The payback method ignores cash flows after the payback period, whereas the rate of return includes them.

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. Present Value of an Annuity of \ 1 5\% 6\% 7\% 8\% 9\% 10\% 1 0.952 0.943 0.939 0.92 0.917 0.909 2 1.859 1.833 1.809 1.78 1.759 1.736 3 2.723 2.673 2.624 2.577 2.531 2.487 4 3.546 3.465 3.387 3.31 3.240 3.170 5 4.329 4.212 4.10 3.99 3.890 3.791 6 5.076 4.917 4.767 4.623 4.486 4.355 7 5.780 5.582 5.389 5.206 5.033 4.355 8 6.463 6.210 5.971 5.747 5.535 5.335 9 7.108 6.802 6.513 6.247 5.995 5.759 10 7.722 7.360 7.024 6.710 6.418 6.145 If Osterwitz has a hurdle rate of 6%, they should accept the investment because it has an internal rate of return greater than 6%.

Wilhelmina has just received an inheritance of $50,000, and she would like to put it into an investment portfolio for 20 years. To calculate the value of the investment at the end of the 20 year period, which of the following tables would be the best for her to use?

When evaluating a potential investment, managers should use more than one measure for making a sound investment decision.

Julio has just received a legal judgment in a civil court case which awards him a settlement of $24,000 to be received two years from now. In order to calculate the overall value of the award today, which of the following tables would be the best for him to use?

Which of the following best describes the term sensitivity analysis?

Wilhelmina has just received an inheritance of $50,000, and she would like to put it into an investment portfolio for 8 years. She believes she can earn 4% on the investment. What will the value of the investment be at the end of 8 years? Future Value of \ 1 4\% 5\% 6\% 7\% 8\% 9\% 1 1.040 1.050 1.069 1.070 1.08 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 1.269 1.311 1.369 1.412 5 1.217 1.276 1.338 1.40 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 1.719 1.851 1.993 9 1.423 1.551 1.689 1.839 1.999 2.172 10 1.480 1.629 1.791 1.967 2.159 2.367

Which of the following most accurately describes the discount rate used in NPV and IRR analyses?

John Doe wins the lottery and may pick from the following three choices: Take $750,000 now. Take $1,000,000 ten years from now. Take $90,000 at the end of this year, and at the end of each following year for ten installments In total. Assume that John Doe uses a discount rate of 5% to evaluate his choices. If he selects the third option, how much is the present value of that alternative? Present Value of an Annuity of \ 1 5\% 6\% 7\% 8\% 9\% 10\% 1 0.952 0.943 0.931 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 4.21 4.100 3.993 3.890 3.791 6 5.076 4.917 4.767 4.623 4.486 4.355 7 5.786 5.581 5.389 5.206 5.033 4.868 8 6.463 6.210 5.971 5.747 5.535 5.335 9 7.108 6.80 6.515 6.247 5.995 5.759 10 7.722 7.360 7.024 6.710 6.418 6.145

Which of the following is TRUE of discounted cash flow methods like NPV and IRR?