Exam 14: Capital Investment Decisions

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. Assume a straight-line depreciation over eight years. What would be the payback period for the project?

If cash flows are uneven, the payback period assumes that the inflows during the last fraction of a year occur evenly.

Suppose that the actual cost of capital is 10%, but the firm chooses a discount rate of 18%. Managers of that company will be more likely to choose relatively short-term investments.

What is another term for the required rate of return when using the net present value model?

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 value that will accumulate by the end of an investment's life if the investment earns a specified compounded return.

Mutually exclusive projects are projects that, if accepted, preclude the acceptance of all other competing projects.

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 accounting rate of return for the project?

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. -Future cash flows expressed in present-value terms.

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. -Earning of interest on interest

Jerry Costansa has just invested $280,000 in a day spa. He expects to receive income of $70,000 a year and to have the investment for 10 years. What is the accounting rate of return?

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. Cinnamon 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. The company has set a required rate of return at 10%. What is the net present value 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. -Is the best method of discounting model to use for mutually exclusive competing projects

Joseph Giovine invested in a project with a payback period of six years. The project brings $40,000 per year for a period of twelve years. What was the initial investment?

Why would managers use the accounting rate of return to evaluate potential investment projects?

Which model is preferred for choosing the best of several competing projects?

Taxes are an important consideration in forecasting cash flows.

Which term refers to a series of equal future cash flows?

Evan Cram is considering an investment in a solar-powered irrigation system manufacturer. The initial investment is $200,000. He expects to receive cash income of $100,000 a year. What is the payback period?

Randy Ritchie Randy Ritchie is considering investing $20,000 in a project with the following annual cash revenues and expenses: Cash Cash Revenues Expenses Year 1 \ 8,000 \ 8,000 Year 2 \ 12,000 \ 8,000 Year 3 \ 15,000 \ 9,000 Year 4 \ 20,000 \ 10,000 Year 5 \ 20,000 \ 10,000 Depreciation will be $4,000 per year. -Refer to Randy Ritchie. What is the accounting rate of return on 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. -Assumes that all future cash inflows earn the minimum rate of return