Exam 14: Capital Investment Decisions

An obvious advantage of postaudits is that the assumptions driving the original analysis my often be invalidated by changes in the actual operating environment.

A postaudit is an analysis of a capital project before it is implemented.

In what way does the payback period provide information to help managers?

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. Pepper Company is considering an investment that will cost $20,000 initially and return annual cash flows of $10,000 in each of three years. The company requires a minimum rate of return of 8%. What is the present value of the cash inflows?

Why is a discount factor in year 3 less than a discount factor in year 2?

Rose Henderson Rose Henderson invested in a project that required an initial amount of $1,560 and returned one cash inflow of $12,000 at the end of the 18th year. A partial table of the present value of an annuity of $1 in arrears is as follows: Year 2\% 4\% 6\% 8\% 10\% 12\% 14\% 16\% 18 0.700 0.494 0.350 0.250 0.180 0.130 0.095 0.069 -Refer to Rose Henderson. What is the internal rate of return for this investment?

Darth Company Darth Company is considering the purchase of new heavy construction equipment that will cost $2,000,000 and have a life of eight years with no expected salvage value. The expected cash flows associated with the project are as follows: Cash Cash Expenses \& Year Revenues Depreciation 1 \ 2,400,000 \ 1,900,000 2 \ 2,400,000 \ 1,900,000 3 \ 2,400,000 \ 1,900,000 4 \ 2,400,000 \ 1,900,000 5 \ 2,400,000 \ 1,900,000 6 \ 2,400,000 \ 1,900,000 7 \ 2,400,000 \ 1,900,000 8 \ 2,400,000 \ 1,900,000 -Refer to Darth Company. What is the average annual income for this project?

In capital investment decision making, it is usually assumed that managers should select projects that attempt to maximize the wealth of the owners of the firm.

Today Production Company is considering the purchase of a flexible manufacturing system. The annual cash benefits/savings associated with the system are as follows: Decreased waste \ 150,000 Increased quality 200,000 Decrease in operating costs 125,000 Increase in on-time deliveries 25,000 The system will cost $1,500,000 and will last 10 years. The company's cost of capital is 10%. Required: A. Calculate the payback period for the flexible manufacturing system. B. Calculate the NPV for the flexible manufacturing system.

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. Which of the two projects, A or B, has a higher internal rate of return?

One drawback to the internal rate of return model is that cash inflows must occur evenly over the life of the investment.

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. -The reduction of net income for tax purposes is allowed through CCA deductions, this creates a reduction in income taxes payable.

The interest rate that sets the present value of a project's cash inflows equal to the present values of the project's cost is called the accounting rate of return.

Which model is better for independent projects, net present value or internal rate of return? Which is better for mutually exclusive projects? Explain your reasoning for each case.

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. -Assumes that all future cash inflows earn the same rate of return as the project itself

In practice, managers often choose a discount rate that is less than the cost of capital.

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 II?

Which statements best describe payback method and the accounting rate of return method? Profitability Time Value of Money

One way to use the payback period is to set a maximum payback period for all projects and to reject any project that exceeds this level.

Suppose the net present value is negative. What would best describe the return on the investment?