Exam 14: Capital Investment Decisions

The Columbus Company has four mutually exclusive projects with the following information: Which project is preferred? $\begin{array}{lrrrr}&\text { Project } 1&\text { Project } 2&\text { Project } 3&\text { Project } 4\\\text { NPV } & \$(12,000) & \$ 80,000 & \$ 60,000 & \$ 20,000 \\\text { IRR } & 7 \% & 10 \% & 12 \% & 9 \%\end{array}$

What are some reasons why firms use the payback period model in capital investment decision making?

Match each item with the correct statement below. -Is the best method discounting model to use for mutually exclusive competing projects

Name two nondiscounting capital investment models.What is meant by "nondiscounting"?

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

Which of the following is NOT a benefit of postaudits of capital investments?

Which statement about payback method and the accounting rate of return method are correct? Profitability Time Value of Money i Ignored by both methods Ignored by both methods ii Ignored by both methods Used in accounting rate of return; ignored by payback method iii Considered by accounting method, not by Ignored by both methods payback iv Considered by accounting method, not by Considered by both methods payback

Net present value analysis and internal rate of return analysis can sometimes produce erroneous choices because they ignore the time value of money.

Which is the most widely used non-discounting model for capital investment decision making?

Ostead Company is considering an investment with the following data: Depreciation will be taken on a straight-line basis over the expected life of the investment. Initial cost \ 200,000 Annual net cash inflows \ 25,000 Expected life 10 years Salvage value none -Refer to the Figure.The company requires a minimum rate of return of 4%.The present value of an annuity of $1 in arrears for 4% for 10 years is as follows: What is the net present value of the investment? Period 1 2 3 4 5 6 7 8 9 10 4\% 0.962 1.886 2.775 3.630 4.452 5.242 6.002 6.773 7.435 8.111

When investing in automated systems,which of the following intangible or indirect benefit is important to consider?

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.Suppose that Boleyn Company requires a minimum rate of return of 8%.Which project is higher in terms of net present value?

Figure 14-11 Present value of an annuity of $1 in arrears 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 4.433 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 Figure 14-11.Mattress Firm is considering an investment in equipment that will have an initial cost of $600,000 yielding annual net cash inflows of $110,000.Yearly depreciation will be $60,000.The equipment is expected to be useful for 10 years,then it will be scrapped.Mattress Firm requires a minimum rate of return of 10%. A. What is the payback period? B. What is the accounting rate of return? C. What is the net present value? D. What is the approximate internal rate of return?

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?

Which of the following is a drawback of the payback period?

What is the definition of the 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.Gibb set a required rate of return at 10%.What is the net present value of the investment?

Because of the postaudit,managers are more likely to make capital investment decisions in the best interests of the firm.

Figure 14-10 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 Figure 14-10.Rebecca Lindsay is considering investing $12,000 in a project with the following cash revenues and expenses: Rebecca requires a minimum rate of return of 8%. 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 A. Calculate the net cash inflows in each of the five years. B. What is the payback period? C. What is the net present value of the investment?

The internal rate of return is the least widely used of the capital investment techniques.