Question Details

CHAPTER 24 PLANNING FOR CAPITAL INVESTMENTS BRIEF EXERCISES QUESTION PART 9



BE  158
Diamond Company is considering investing in new equipment that will cost $1,400,000 with a 10-year useful life. The new equipment is expected to produce annual net income of $90,000 over its useful life. Depreciation expense, using the straight-line rate, is $140,000 per year.
Instructions
Compute the cash payback period.



BE  159
Madeline Company is proposing to spend $200,000 to purchase a machine that will provide annual cash flows of $38,000. The appropriate present value factor for 10 periods is 5.65.
Instructions
Compute the proposed investment- net present value and indicate whether the investment should be made by Madeline Company.


BE  160
LakeFront Company is considering investing in a new dock that will cost $560,000. The company expects to use the dock for 5 years, after which it will be sold for $300,000. LakeFront anticipates annual cash flows of $110,000 resulting from the new dock. The company- borrowing rate is 8%, while its cost of capital is 10%.
Instructions
Calculate the net present value of the dock and indicate whether LakeFront should make the investment.



BE  161
Mobil Company has hired a consultant to propose a way to increase the company- revenues. The consultant has evaluated two mutually exclusive projects with the following information provided for each project:
	Project Turtle	Project Snake
Capital investment	$1,105,000	$625,000
Annual cash flows	180,000	105,000
Estimated useful life	10 years	10 years

Mobil Company uses a discount rate of 9% to evaluate both projects.

Instructions
(a)	Calculate the net present value of both projects.
(b)	Calculate the profitability index for each project.
(c)	Which project should Mobil accept?

Ex. 162
Carlson Bottling Corporation is considering the purchase of a new bottling machine. The machine would cost $300,000 and has an estimated useful life of 8 years with zero salvage value. Management estimates that the new bottling machine will provide net annual cash flows of $52,500. Management also believes that the new bottling machine will save the company money because it is expected to be more reliable than other machines, and thus will reduce downtime. How much would the reduction in downtime have to be worth in order for the project to be acceptable? Assume a discount rate of 9% 

Ex. 163
Stanton Company is performing a post-audit of a project completed one year ago. The initial estimates were that the project would cost $490,000, would have a useful life of 9 years, zero salvage value, and would result in net annual cash flows of $90,000 per year. Now that the investment has been in operation for 1 year, revised figures indicate that it actually cost $510,000, will have a useful life of 11 years, and will produce net annual cash flows of $77,000 per year. Evaluate the success of the project. Assume a discount rate of 10%

BE  164
Mint Company is contemplating an investment costing $135,000. The investment will have a life of 8 years with no salvage value and will produce annual cash flows of $25,305.

Instructions
What is the approximate internal rate of return associated with this investment?


BE  165
Salt Company is considering investing in a new facility to extract and produce salt. The facility will increase revenues by $220,000, but it will also increase annual expenses by $160,000. The facility will cost $980,000 to build, and it will have a $20,000 salvage value at the end of its useful life.

Instructions
Calculate the annual rate of return on this facility.



EXERCISES
Ex. 166
Corn Doggy, Inc. produces and sells corn dogs. The corn dogs are dipped by hand. Austin Beagle, production manager, is considering purchasing a machine that will make the corn dogs. Austin has shopped for machines and found that the machine he wants will cost $215,000. In addition, Austin estimates that the new machine will increase the company- annual net cash inflows by $33,000. The machine will have a 12-year useful life and no salvage value.

Instructions
(a)	Calculate the cash payback period. 
(b)	Calculate the machine- internal rate of return.
(c)	Calculate the machine- net present value using a discount rate of 10%.
(d)	Assuming Corn Doggy, Inc.- cost of capital is 10%, is the investment acceptable? Why or why not?


Ex. 167
Cepeda Manufacturing Company is considering three new projects, each requiring an equipment investment of $22,000. Each project will last for 3 years and produce the following cash inflows.

	Year	     AA    		    BB    		    CC    	
	1	$  7,000	$  9,500	$11,000
	2	9,000	9,500	  10,000
	   3   	  15,000	    9,500	    9,000
	Total	$31,000	$28,500	$30,000

The equipment's salvage value is zero. Cepeda uses straight-line depreciation. Cepeda will not accept any project with a payback period over 2 years. Cepeda's minimum required rate of return is 12%.

Instructions
(a)	Compute each project's payback period, indicating the most desirable project and the least desirable project using this method. (Round to two decimals.)
(b)	Compute the net present value of each project. Does your evaluation change? (Round to nearest dollar.)


Ex. 168
Gantner Company is considering a capital investment of $300,000 in additional productive facilities. The new machinery is expected to have a useful life of 5 years with no salvage value. Depreciation is computed by the straight-line method. During the life of the investment, annual net income and cash inflows are expected to be $27,000 and $87,000, respectively. Gantner has a 12% cost of capital rate, which is the minimum acceptable rate of return on the investment.

Instructions
(Round to two decimals.)
(a)	Compute (1) the annual rate of return and (2) the cash payback period on the proposed capital expenditure.
(b)	Using the discounted cash flow technique, compute the net present value.



Ex. 169
Top Growth Farms, a farming cooperative, is considering purchasing a tractor for $551,500. The machine has a 10-year life and an estimated salvage value of $36,000. Delivery costs and set-up charges will be $12,100 and $400, respectively. Top Growth uses straight-line depreciation.

Top Growth estimates that the tractor will be used five times a week with the average charge to the individual farmers of $400. Fuel is $50 for each use of the tractor. The present value of an annuity of 1 for 10 years at 9% is 6.418.

Instructions
For the new tractor, compute the:
(a)	cash payback period.
(b)	net present value.
(c)	annual rate of return.

Ex. 170
Tom Bat became a baseball enthusiast at a very early age. All of his baseball experience has provided him valuable knowledge of the sport, and he is thinking about going into the batting cage business. He estimates the construction of a state-of-the-art building and the purchase of necessary equipment will cost $840,000. Both the facility and the equipment will be depreciated over 12 years using the straight-line method and are expected to have zero salvage values. His required rate of return is 9% (present value factor of 7.1607). Estimated annual net income and cash flows are as follows:
	Revenue		$350,500
	Less:	
		Utility cost	40,000
		Supplies	8,000
		Labor	141,000
		Depreciation	70,000
		Other	  38,500	  297,500
	Net income		$  53,000
Instructions
For this investment, calculate:
(a)	The net present value.
(b)	The internal rate of return.
(c)	The cash payback period.

Ex. 171
Mimi Company is considering a capital investment of $275,000 in new equipment. The equipment is expected to have a 5-year useful life with no salvage value. Depreciation is computed by the straight-line method.  During the life of the investment, annual net income and cash inflows are expected to be $25,000 and $80,000, respectively. Mimi's minimum required rate of return is 10%. The present value of 1 for 5 periods at 10% is .621 and the present value of an annuity of 1 for 5 periods at 10% is 3.791.

Instructions
Compute each of the following:
(a)	cash payback period.
(b)	net present value.
(c)	annual rate of return.



Ex. 172
Savanna Company is considering two capital investment proposals. Relevant data on each project are as follows:
	Project Red	Project Blue
Capital investment	$440,000	$640,000
Annual net income	25,000	60,000
Estimated useful life	8 years	8 years

Depreciation is computed by the straight-line method with no salvage value. Savanna requires an 8% rate of return on all new investments. The present value of 1 for 8 periods at 8% is .540 and the present value of an annuity of 1 for 8 periods is 5.747.

Instructions
(a)	Compute the cash payback period for each project.
(b)	Compute the net present value for each project.
(c)	Compute the annual rate of return for each project.
(d)	Which project should Savanna select?

Ex. 173
Yappy Company is considering a capital investment of $320,000 in additional equipment. The new equipment is expected to have a useful life of 8 years with no salvage value.  Depreciation is computed by the straight-line method.  During the life of the investment, annual net income and cash inflows are expected to be $22,000 and $62,000, respectively. Yappy requires a 10% return on all new investments.
		Present Value of an Annuity of 1	
	Period	  8%		  9%		 10%		 11%		 12%		 15%	
	8	5.747	5.535	5.335	5.146	4.968	4.487

Instructions
(a)	Compute each of the following:
	1.	Cash payback period.
	2.	Net present value.
	3.	Profitability index.
	4	Internal rate of return.
	5.	Annual rate of return.
(b)	Indicate whether the investment should be accepted or rejected.


Ex. 174
Laramie Service Center just purchased an automobile hoist for $16,900. The hoist has a 5-year life and an estimated salvage value of $1,250. Installation costs were $3,770, and freight charges were $960. Laramie uses straight-line depreciation.
The new hoist will be used to replace mufflers and tires on automobiles. Laramie estimates that the new hoist will enable his mechanics to replace four extra mufflers per week. Each muffler sells for $85 installed. The cost of a muffler is $46, and the labor cost to install a muffler is $13.

Instructions
(a)	Compute the payback period for the new hoist.
(b)	Compute the annual rate of return for the new hoist. (Round to one decimal.)

Ex. 175
Sophie- Pet Shop is considering the purchase of a new delivery van. Sophie Smith, owner of the shop, has compiled the following estimates in trying to determine whether the delivery van should be purchased:

	Cost of the van	$35,000
	Annual net cash flows	6,000
	Salvage value	4,000
	Estimated useful life	8 years
	Cost of capital	10%
	Present value of an annuity of 1	5.335
	Present value of 1	.467

Sophie's assistant manager is trying to convince Sophie that the van has other benefits that she hasn't considered in the initial estimates. These additional benefits, including the free advertising the store's name painted on the van's doors will provide, are expected to increase net cash flows by $500 each year.

Instructions
(a)	Calculate the net present value of the van, based on the initial estimates. Should the van be purchased?
(b)	Calculate the net present value, incorporating the additional benefits suggested by the assistant manager. Should the van be purchased?
(c)	Determine how much the additional benefits would have to be worth in order for the van to be purchased.


Ex. 176
Vista Company is considering two new projects, each requiring an equipment investment of $97,000. Each project will last for three years and produce the following cash inflows:

	Year	   Cool		     Hot	
	1	$  38,000	$  42,000
	2	43,000	42,000
	3	    48,000	    42,000
		$129,000	$126,000

The equipment will have no salvage value at the end of its three-year life. Vista Company uses straight-line depreciation and requires a minimum rate of return of 12%.

Present value data are as follows:

		Present Value of 1		Present Value of an Annuity of 1
	Period	12%		Period	 12%	
	1	.893	1	.893
	2	.797	2	1.690
	3	.712	3	2.402

Instructions
(a)	Compute the net present value of each project.
(b)	Compute the profitability index of each project.
(c)	Which project should be selected?  Why?

 
Ex. 177
KSU Corp. is considering purchasing one of two new diagnostic machines.  Either machine would make it possible for the company to bid on jobs that it currently isn't equipped to do. Estimates regarding each machine are provided below.

		Machine A	Machine B
	Original cost	$106,000	$  175,000
	Estimated life	8 years	8 years
	Salvage value	-0-	-0-
	Estimated annual cash inflows	$30,000	$45,000
	Estimated annual cash outflows	$10,000	$15,000

Instructions

Calculate the net present value and profitability index of each machine. Assume a 9% discount rate. Which machine should be purchased?

Ex. 178
Santana Company is considering investing in a project that will cost $151,000 and have no salvage value at the end of its 5-year life. It is estimated that the project will generate annual cash inflows of $40,000 each year. The company requires a 9% rate of return and uses the following compound interest table:

Present Value of an Annuity of 1
	Period	  6% 		  8% 		   9%		 10%		 11%		 12%		 15%	
	5	4.212	3.993	3.890	3.791	3.696	3.605	3.352

Instructions
(a)	Compute (1) the net present value and (2) the profitability index of the project.
(b)	Compute the internal rate of return on this project.
(c)	Should Santana invest in this project?

Ex. 179
Johnson Company is considering purchasing one of two new machines. The following estimates are available for each machine:
	Machine 1	Machine 2
	Initial cost	$152,000	$169,000
	Annual cash inflows	50,000	60,000
	Annual cash outflows	15,000	20,000
	Estimated useful life	6 years	6 years

The company's minimum required rate of return is 9%.

		Present Value of an Annuity of 1	
	Period	  8%		  9%		 10%		 11%		 12%		 15%	
	6	4.623	4.486	4.355	4.231	4.111	3.784

Instructions
(a)	Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each machine.
(b)	Which machine should be purchased?

Ex. 180
Platoon Company is performing a post-audit of a project that was estimated to cost $420,000, have a useful life of 6 years with a zero salvage value, and result in net cash inflows of $100,000 per year. After the investment was in operation for a year, revised figures indicate that it actually cost $470,000, will have a 9-year useful life, and will produce net cash inflows of $77,000. The present value of an annuity of 1 for 6 years at 10% is 4.355 and for 9 years is 5.759.

Instructions
Determine whether the project should have been accepted based on (a) the original estimates and then on (b) the actual amounts.