Exam 14: Capital Investment Decisions

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

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.

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 is the term for the earning of interest on interest?

Which payback period will managers want when the risk of obsolescence is high?

Suppose the net present value is negative.Which of the following would best describe the return on the investment?

Present value of $1 Present value of an annuity of $1 Periods 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 Periods 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 the Figure.Jan Rigby is considering an investment that will cost $20,000 initially and return annual cash flows of $10,000 in each of three years.Jan requires a minimum rate of return of 8%.What is the present value of the cash inflows? (Note: there may be a rounding error depending on the table you use to compute your answer.Choose the answer closest to the result you calculate.)

The Picture Company is considering the purchase of a new machine for $68,754.The machine would generate an annual cash flow of $21,000 for five years.At the end of five years,the machine would have no salvage value.The company's cost of capital is 12%.The company uses straight-line depreciation. What is the internal rate of return for the machine (rounded to the nearest percent)?

A firm 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?

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

Less objective results are obtainable if an independent party performs the postaudit of a capital investment.

Boleyn Company is considering two projects. Present value of an annuity of $1 in arrears Project Project 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 Periods 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 the Figure.Which of the two projects,A or B,has a higher internal rate of return?

Present value of $1 Present value of an annuity of $1 Periods 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 Periods 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 the Figure.Gibb Clinical Practice 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 firm expects to recover $150,000 from the sale of the equipment.Gibb set a required rate of return at 10%.What is the net present value of the investment? (Note: there may be a rounding error depending on the table you use to compute your answer.Choose the answer closest to the result you calculate.)

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?

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: What is the internal rate of return for this investment? 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

Match each item with the correct statement below. -Future cash flows expressed in present-value terms.

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

A company is considering two projects. Project A 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 the Figure.What is the payback period for Project A?

Projects that do NOT affect the cash flows of other projects are called mutually exclusive projects.

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