Exam 14: Capital Investment Decisions

Sarah Lindsay invested $300,000 in a project that pays her an even amount per year for 10 years. The payback period is 8 years. What are Sarah's yearly cash inflows from the project?

Boleyn Company Boleyn Company is considering two projects. Project A Project B Initial investment \ 100,000 \ 25,000 Annual cash flows \ 18,750 \ 8,580 Life of the project 8 years 4 years Depreciation per year \ 25,000 \ 6,250 Present value of an annuity of $1 in arrears Periads 8\% 10\% 12\% 14\% 1 0.926 0.909 0.893 0.877 2 1.783 1.736 1.690 1.647 3 2.577 2.487 2.402 2.322 4 3.312 3.170 3.037 2.914 5 3.993 3.791 3.605 4.433 6 4.623 4.355 4.111 3.889 7 5.206 4.868 4.564 4.288 8 5.747 5.335 4.968 4.639 9 6.247 5.759 5.328 4.946 10 6.710 6.145 5.650 5.216 -Refer to Boleyn Company. Suppose the company requires a minimum rate of return of 8%. Which project is higher in terms of net present value?

Shore Builders is considering a project with an internal rate of return of 16.5%. Shore Builders requires a minimum rate of return of 14%. What is the net present value of the project?

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. Nutmeg Company is considering an investment in new imaging equipment that will cost $400,000. The equipment is expected to yield cash inflows of $80,000 per year for a six-year period. At the end of the sixth year, the company expects to recover $150,000 from the sale of the equipment. The company has set a required rate of return at 10%. What is the net present value of the investment?

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. Coriander Company is considering a project with an initial investment of $426,800 in new equipment that will yield annual net cash flows of $80,000 and will be depreciated at $53,350 per year over its eight-year life. What is the internal rate of return?

In order to use the payback period model, the proposed investment must have even cash inflows.

Henkle Company is considering a project with an initial investment of $626,500 in new equipment that will yield annual net cash flows of $90,000 and will be depreciated at $55,000 per year over its nine-year life. What is the accounting rate of return on the investment?

What is a drawback of the payback period?

Companies considering projects with shorter lives are interested in longer payback periods.

What capital investment decision-making model assumes that each cash inflow is reinvested at the project's own rate of return?

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. -Can be used as a rough measure of risk and liquidity

Two discounting models for capital investment decision making are net present value and internal rate of return.

The maximum acceptable rate of return for a project is the required rate of return.

Which model of capital investment decision making is most widely used? Why?

A disadvantage of the payback period is that it ignores a project's total profitability.

Canadian Division The Canadian Division manager is choosing between two mutually exclusive projects. Project 123 Project 456 Net present value \ 235,000 \ 210,000 Internal rate of return 14\% 16\% The company requires any project to earn at least 13%. The manager believes that cash inflows from the project can be reinvested at the rate of 13%. -Refer to Canadian Division. Which project will the manager likely choose?

Payroll Inc. Office Services is considering the purchase of a new computer system to replace the one in operation. Data on the new computer system are as follows: Cost \ 12,000 Salvage value at the end of five years \ 1,000 Useful life, in years 5 Annual operating cost \ 4,000 If the existing computer system is kept and used, it would require the purchase of additional hardware a year from now costing $2,000. After the use of the system for five years, the salvage value would be $300. Additional information on the existing system is as follows: Additional years of use 5 Annual operating costs \ 9,000 Remaining book value \ 12,000 Current salvage value \ 3,000 Cost of capital 12\% The company uses the straight-line method of depreciation. Required: Should the new system be purchased? Why or why not?

Suppose the cash flows of a project are received evenly over the life of the project. What formula is used to calculate the payback period?

What are the limitations of Accounting Rate of Return?

Companies that perform postaudits of capital projects do NOT experience any benefits.