Exam 14: Capital Investment Decisions

Both the net present value and the accounting rate of return ignore the time value of money.

Which term best reflects the earning of interest on interest?

Eagle Investments Eagle Investments is considering two projects: Project Project B Initial investment \ 150,000 \ 150,000 Cash inflow Year 1 \ 50,000 \ 40,000 Cash inflow Year 2 \ 50,000 \ 40,000 Cash inflow Year 3 \ 50,000 \ 40,000 Cash inflow Year 4 \ 50,000 \ 60,000 Cash inflow Year 5 \ 50,000 \ 80,000 -Refer to Eagle Investments. What is the payback period for Project B?

What term refers to the interest rate that sets the present value of a project's cash inflows equal to the present value of the project's cost?

Match each of the following terms with their correct description from the items listed below.* Each term may be used more than once, and it is possible that one or more of the classifications may not be used at all. -Comparison of actual benefits and costs of a project with the expected benefits and costs

In general terms, how much will a sound capital investment earn?

Falcons Investments Falcons Investments is considering two projects: Project I Project II Initial investment \ 60,000 \ 60,000 Cash inflow Year 1 \ 30,000 \ 15,000 Cash inflow Year 2 \ 30,000 \ 15,000 Cash inflow Year 3 \ 30,000 \ 30,000 Cash inflow Year 4 \ 30,000 \ 70,000 Cash inflow Year 5 \ 30,000 \ 70,000 -Refer to Falcons Investments. What is the payback period for Project I?

Refer to Present Value Tables. Eye Appeal is considering an investment costing $24,000. The investment would return $10,000 per year in each of three years. The company requires a minimum rate of return of 6%. Required: A. Calculate the payback period for the investment. B. Calculate the net present value of the investment. C. The internal rate of return is greater than __________________% and less than __________________%.

Refer to Present Value Tables. Monsoon Company is considering an investment that will have an initial cost of $1,000,000 yield annual net cash inflows of $260,000. Yearly depreciation will be $200,000. The equipment is expected to be useful for five years, at which point it will be scrapped with no salvage value. The company requires a minimum rate of return of 10%. Required: A. Calculate the accounting rate of return. B. Calculate the net present value. Is the investment acceptable? C. Now suppose that the company believes it can sell the equipment at the end of five years for $100,000. Calculate the net present value. Is the investment acceptable? D. What can you say about the IRR in the first case (no salvage value) versus the IRR in the second case ($100,000 salvage value)?

Refer to Present Value Tables. Rebecca Lindsay is considering investing $12,000 in a project with the following cash revenues and cash expenses: Revenues Expenses Year 1 \ 20,000 \ 18,000 Year 2 \ 22,000 \ 19,000 Year 3 \ 22,000 \ 20,000 Year 4 \ 22,000 \ 17,000 Year 5 \ 25,000 \ 17,000 Rebecca requires a minimum rate of return of 8%. Required: A. Calculate the net cash inflows in each of the five years. B. Calculate the payback period. C. Calculate the net present value of the investment.

Eagle Investments Eagle Investments is considering two projects: Project Project B Initial investment \ 150,000 \ 150,000 Cash inflow Year 1 \ 50,000 \ 40,000 Cash inflow Year 2 \ 50,000 \ 40,000 Cash inflow Year 3 \ 50,000 \ 40,000 Cash inflow Year 4 \ 50,000 \ 60,000 Cash inflow Year 5 \ 50,000 \ 80,000 -Refer to Eagle Investments. What is the payback period for Project A?

There are two types of capital budgeting projects: independent projects and mutually exclusive projects. Describe both types of projects.

Fill in the lettered blanks in the following table: Investment A Investment B Investment C Amount of investment \ 40,000 () \ 20,000 Economic life in years 10 5 8 Annual cash flow \ 5,000 (B) \ 2,500 Payback period in years () 4 (D) Present value of cash flows () \ 33,000 () Net present value \ 5,500 \ 3,000 (\ 1,000)

An investment of $4,000 provides an average net cash flow of $960 with zero salvage value. Depreciation is $80 per year. What is the accounting rate of return using the original investment?

Refer to Present Value Tables. A company is considering two modifications to its current manufacturing process. The after-tax cash flows associated with the two investments are: $\begin{array}{lrr}\text { Year } & \text { Project I } & \text { Project II } \\\hline 0 & \$(37,500) & \$(150,000) \\1 & -- & 91,075 \\2 & \$ 50,460 & 91,075\end{array}$ The company's cost of capital is 12%. Required: A. Calculate the net present value for each investment. B. Calculate the internal rate of return for each investment. C. Which project is better? Explain your reasoning.

What is characteristic of the measurement and use of indirect and intangible benefits in capital investment decision making?

What is NOT a benefit of postaudits of capital investments?

Runder Company is evaluating a proposal to purchase a new machine that would cost $100,000 and have a salvage value of $10,000 in four years. It would provide annual operating cash savings of $10,000, as follows: old Machine New Machine Salaries \ 40,000 \ 36,000 Supplies 7,000 5,000 Maintenance 9,000 5,000 Total \5 6,000 \4 6,000 If the new machine is purchased, the old machine will be sold for its current salvage value of $20,000. If the new machine is not purchased, the old machine will be disposed of in four years at a predicted salvage value of $2,000. The old machine's present book value is $40,000. If kept, in one year the old machine will require repairs predicted to cost $35,000. The company's cost of capital is 14%. Required: Should the new machine be purchased? Why or why not?

Which factor must a manager estimate when making a capital investment decision?

Who should usually perform a postaudit of a company's capital investment?