Exam 14: Capital Investment Decisions

A division manager is considering a project that requires a significant initial investment. The company's top management will NOT approve any project that does not return at least 12%. Which capital investment model will the manager most likely use?

What are some reasons why companies use the payback period model in capital investment decision making?

Cooper Industries is considering a project that would require an initial investment of $101,000. The project would result in cost savings of $62,000 in year 1 and $70,000 in year 2. What is the internal rate of return for the project?

An advantage of the payback period is that it considers the time value of money.

The two major approaches to capital investment decision are nondiscounting models and discounting models.

A company is evaluating a project that has a net present value of $0 when a discount rate of 10% is used. What will be the result of a discount rate of 8%?

In general, it is best if postaudits are done by company management, since they understand the actual operating conditions.

Refer to Cantar, Inc. What is the internal rate of return for the investment?

Refer to Present Value Tables. Pitcher Company is considering an investment costing $120,000. The investment would return $50,000 per year in each of three years. The company requires a minimum rate of return of 10%. Required: A. Calculate the payback period for the investment. B. Using the Present Value of an Annuity of $1 table, calculate the net present value of the investment. C. The internal rate of return is greater than __________________% and less than __________________%. D. Now assume that the investment includes equipment that can be sold at the end of the third year for $10,000. Calculate the present value of this investment.

The internal rate of return is the least widely used of the capital investment techniques.

Cary Swenson Cary Swenson is considering investing $30,000 in a project with the following cash revenues and expenses: Cash Expenses \& Revenues Depreciation Year 1 \ 10,000 \ 12,000 Year 2 \ 12,000 \ 11,000 Year 3 \ 15,000 \ 12,000 Year 4 \ 20,000 \ 12,000 Year 5 \ 22,000 \ 12,000 Year 6 \ 25,000 \ 15,000 Year 7 \ 25,000 \ 15,000 Year 8 \ 25,000 \ 15,000 -Refer to Cary Swenson. What is the accounting rate of return for the project?

The internal rate of return model consistently results in choices that maximize firm wealth.

Columbus Company Columbus Company has four mutually exclusive projects with the following information: $\begin{array}{lllll}&\text { Project } 1&\text { Project } 2&\text { Project } 3&\text { Project } 4\\\text { NPV } & \$(12,000) & \$ 80,000 & \$ 60,000 & \$ 20,000 \\\mathbb{R R R} & 7 \% & 10 \% & 12 \% & 9 \%\end{array}$ -Refer to Columbus Company. Which project is preferred?

Present Value Tables Present value of $1 Periads 4\% 6\% 8\% 10\% 12\% 14\% 1 0.962 0.943 0.926 0.909 0.893 0.877 2 0.925 0.890 0.857 0.826 0.797 0.769 3 0.889 0.840 0.794 0.751 0.712 0.675 4 0.855 0.792 0.735 0.683 0.636 0.592 5 0.822 0.747 0.681 0.621 0.567 0.519 6 0.790 0.705 0.630 0.564 0.507 0.456 7 0.760 0.665 0.583 0.513 0.452 0.400 8 0.731 0.627 0.540 0.467 0.404 0.351 9 0.703 0.592 0.500 0.424 0.361 0.308 10 0.676 0.558 0.463 0.386 0.322 0.270 Present value of an annuity of $1 Periads 4\% 6\% 8\% 10\% 12\% 14\% 1 0.962 0.943 0.926 0.909 0.893 0.877 2 1.886 1.833 1.783 1.736 1.690 1.647 3 2.775 2.673 2.577 2.487 2.402 2.322 4 3.630 3.465 3.312 3.170 3.037 2.914 5 4.452 4.212 3.993 3.791 3.605 3.433 6 5.242 4.917 4.623 4.355 4.111 3.889 7 6.002 5.582 5.206 4.868 4.564 4.288 8 6.733 6.210 5.747 5.335 4.968 4.639 9 7.435 6.802 6.247 5.759 5.328 4.946 10 8.111 7.360 6.710 6.145 5.650 5.216 -Refer to Present Value Tables. Ginger Company is considering a project with an initial investment of $124,450 that will yield annual net cash flows of $32,000 and will be depreciated at $20,742 per year over its six-year life. What is the internal rate of return?

What is NOT an advantage of the payback period?

What provides an absolute dollar measure?

For independent projects, net present value analysis and internal rate of return analysis will generally yield similar decisions.

Jackson Company is considering a project requiring an investment of $54,000. The project would generate an annual cash flow of $12,592 for the next seven years. The company uses the straight-line method of depreciation. What is the approximate internal rate of return for the project?

Ostead Company Ostead Company is considering an investment with the following data: Initial cost $200,000 Annual net cash inflows $ 25,000 Expected life 10 years Salvage value none Depreciation will be taken on a straight-line basis over the expected life of the investment.The company requires a minimum rate of return of 4%. The present value of an annuity of $1 in arrears for 4% for 10 years is as follows: Period 1 2 3 4 5 6 7 8 9 10 4\% 0.962 1.886 2.775 3.630 4.452 5.242 6.002 6.773 7.435 8.111 -Refer to Ostead Company. What is the net present value of the investment?

Because of the postaudit, managers are more likely to make capital investment decisions in the best interests of the firm.