CHAPTER 15 CAPITAL BUDGETING
[Pages:6]CHAPTER 15
CAPITAL BUDGETING
21. a. Payback = $3,000,000 ? $600,000 per year = 5 years
b. Year 1 2 3 4 5 6 7 8 9 10
Amount $300,000 300,000 300,000 300,000 300,000 400,000 400,000 400,000 400,000 400,000
Cumulative Amount $ 300,000 600,000 900,000 1,200,000 1,500,000 1,900,000 2,300,000 2,700,000 3,100,000 3,500,000
The payback is eight years plus [(3,000,000 ? 2,700,000) ? 400,000] or 8.75 years.
22. a. Investment = $140,000 + $180,000 = $320,000
Year Amount
Cumulative Amount
1
$70,000
$ 70,000
2
78,000
148,000
3
72,000
220,000
4
56,000
276,000
5
50,000
326,000
6
48,000
374,000
7
44,000
418,000
Payback = 4 years + [($320,000 ? $276,000) ? $50,000] = 4.9 years
Based on the payback criterion, Houston Fashions should not invest in the proposed product line.
b. Yes. Houston Fashions should also use a discounted cash flow technique so as to consider both the time value of money and the cash flows that occur after the payback period.
23. Point in Time Cash Flows PV Factor
Present Value
0
$(1,800,000)
1.0000
$(1,800,000)
1
280,000
0.8929
250,012
2
280,000
0.7972
223,216
3
340,000
0.7118
242,012
4
340,000
0.6355
216,070
5
340,000
0.5674
192,916
6
288,800
0.5066
146,306
7
288,800
0.4524
130,653
8
288,800
0.4039
116,646
9
260,000
0.3606
93,756
426
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10 NPV
260,000
0.3220
83,720 $ (104,693)
Based on the NPV, this is an unacceptable investment.
24. a. The contribution margin of each part is $1 (or $7.50 ? $6.50) Contribution margin per year = $1 100,000 = $100,000
Point in Time 0
1?8 1?8 NPV
Cash Flows $(500,000)
(20,000) 100,000
PV Factor 1.0000 5.5348 5.5348
Present Value $(500,000) (110,696) 553,480 $ (57,216)
b. Based on the NPV, this is not an acceptable investment.
c. Other considerations would include whether refusing to produce this part for the customer would cause a loss of other business from that customer. The company should also consider going back to the customer and asking for a higher price that would cause the project to have a positive NPV.
25. PI = PV of cash inflows ? PV of cash outflows = ($18,000 + $240,000) ? $240,000 = 1.08
26. a. PV of inflows: $91,000 6.4177 = $584,011 PV of investment: $600,000 PI = $584,011 ? $600,000 = 0.97
b. Cedar City Public Transportation should not add the bus route because the PI is less than 1.00.
c. To be acceptable, a project must generate a PI of at least 1; a PI greater than 1 equates to an NPV > 0.
27. a. PV = Discount factor ? Annual cash inflow $700,000 = Discount factor $144,000 Discount factor = $700,000 ? $144,000 = 4.8611 The IRR is 13 percent (rounded to the nearest whole percent).
b. Yes. The IRR on this proposal is greater than the firm's hurdle rate of 7 percent.
c. $700,000 = 5.9713 Annual cash flow Annual cash flow = $700,000 ? 5.9713 Annual cash flow = $117,227
28. a. PV = Discount factor ? Annual cash inflow $1,800,000 = Discount factor $300,000 Discount factor = $1,800,000 ? $300,000 = 6.0000 The IRR is 10.5 percent (rounded to the nearest half percent).
The project is acceptable because the IRR exceeds the discount rate.
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Chapter 15
b. The main qualitative factors would be the effect of the technology on the perceived quality of the food that is processed by the new machinery. An additional consideration would be the effect of the technology on employees, particularly if the investment would cause layoffs.
29. Investment cost = $375,000 ? Discount factor for 14%, 7 years = $375,000 ? 4.2883 = $1,608,113
NPV = $375,000 ? Discount factor (10%, 7 years) ? $1,608,113 = ($375,000 ? 4.8684) ? $1,608,113 = $217,537
30. a. Annual depreciation = $1,000,000 ? 8 years = $125,000 per year Tax benefit = $125,000 0.30 = $37,500 PV = $37,500 5.7466 = $215,498
b. Accelerated method $1,000,000 0.30 0.40 0.9259 $600,000 0.30 0.40 0.8573 $360,000 0.30 0.40 0.7938 $216,000 0.30 0.40 0.7350 $129,600* 0.30 0.6806 Total
= $111,108 = 61,726 = 34,292 = 19,051 = 26,462
$252,639
*In the final year, the remaining undepreciated cost is expensed.
c. The depreciation benefit computed in (b) exceeds that computed in (a) solely because of the time value of money. The depreciation method in (b) allows for faster recapture of the cost; therefore, there is less discounting of the future cash flows.
35. a NPV
Film studios
$3,578,910
Cameras & equipment 1,067,920
Land improvement
2,250,628
Motion picture #1
1,040,276
Motion picture #2
1,026,008
Motion picture #3
3,197,320
Corporate aircraft
518,916
PI
IRR
1.18
13.03%
1.33
18.62
1.45
19.69
1.06
12.26
1.09
14.09
1.40
21.32
1.22
18.15
b. Ranking according to: NPV
1. Film studios 2. MP #3 3. Land improvement 4. Cameras & equip. 5. MP #1 6. MP #2 7. Corp. aircraft
PI Land improvement MP #3 Cameras & equip. Corp. aircraft Film studios MP #2 MP #1
IRR MP #3 Land improvement Cameras & equip. Corp. aircraft MP #2 Film studios MP #1
c. Suggested purchases: 1. Motion picture #3 @ $8,000,000 2. Land improvement @ $5,000,000
NPV $3,197,320 2,250,628
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3. Cameras & equipment @ $3,200,000 4. Corporate aircraft @ $2,400,000
Total NPV
1,067,920 518,916
$7,034,784
35. a. Project Name Film studios Cameras & equipment Land improvement Motion picture #1 Motion picture #2 Motion picture #3 Corporate aircraft
NPV $3,578,910
1,067,920 2,250,628 1,040,276 1,026,008 3,197,320
518,916
PI
IRR
1.18
13.03%
1.33
18.62
1.45
19.69
1.06
12.26
1.09
14.09
1.40
21.32
1.22
18.15
d. Ranking according to: NPV
8. Film studios 9. MP #3 10. Land improvement 11. Cameras & equip. 12. MP #1 13. MP #2 14. Corp. aircraft
PI Land improvement MP #3 Cameras & equip. Corp. aircraft Film studios MP #2 MP #1
IRR MP #3 Land improvement Cameras & equip. Corp. aircraft MP #2 Film studios MP #1
e. Suggested purchases: 5. Motion picture #3 @ $8,000,000 6. Land improvement @ $5,000,000 7. Cameras & equipment @ $3,200,000 8. Corporate aircraft @ $2,400,000 Total NPV
NPV $3,197,320 2,250,628 1,067,920
518,916 $7,034,784
45. a. ($000s omitted)
Investment New CM Oper. costs Cash flow
t0 ?(190)
0 ?(190)
t1 t2 t3 t4 t5 t6 t7 t8
60 60 60 60 60 60 60 60 ?20 ?27 ?27 ?27 ?30 ?30 ?30 ?33 40 33 33 33 30 30 30 27
b. Year 1 2 3 4 5 6
Cash Flow $40,000 33,000 33,000 33,000 30,000 30,000
Cumulative Cash Flow $ 40,000 73,000 106,000 139,000 169,000 199,000
Payback = 5 + [($190,000 ? $169,000) ? $30,000] = 5.7 years
c. Time 0 1
Cash Flow $(190,000)
40,000
PV Factor for 8% 1.0000 0.9259
Present Value $(190,000)
37,036
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2 3 4 5 6 7 8 NPV
33,000 33,000 33,000 30,000 30,000 30,000 27,000
0.8573 0.7938 0.7350 0.6806 0.6302 0.5835 0.5403
28,291 26,195 24,255 20,418 18,906 17,505 14,588 $ (2,806)
46. a. Time:
t0
t1
t2
t3
t4
t5
t6
t7
Amount: ($41,000) $5,900 $8,100 $8,300 $8,000 $8,000 $8,300 $9,200
b. Year 1 2 3 4 5 6
Cash Flow $5,900 8,100 8,300 8,000 8,000 8,300
Cumulative $ 5,900 14,000 22,300 30,300 38,300 46,600
Payback = 5 years + [($41,000 ? $38,300) ? $8,300] = 5.3 years
c. Cash Flow Description
Purchase the truck Cost savings Cost savings Cost savings Cost savings Cost savings Cost savings Cost savings NPV
Time
t0 t1 t2 t3 t4 t5 t6 t7
Amount $(41,000)
5,900 8,100 8,300 8,000 8,000 8,300 9,200
Discount Factor 1.0000 0.9259 0.8573 0.7938 0.7350 0.6806 0.6302 0.5835
Present Value $(41,000) 5,463 6,944 6,589 5,880 5,445 5,231 5,368 $ (80)
44.
47. a. Year
Cash Flow
PV Factor
PV
0
$(5,000,000)
1.0000
$(5,000,000)
1?7
838,000
5.5824
4,678,051
7
400,000
0.6651
266,040
NPV
$ (55,909)
b. No, the NPV is negative; therefore this is an unacceptable project.
c. PI = ($4,678,051 + $266,040) ? $5,000,000 = 0.99
d. PV of annual cash flows = $5,000,000 ? $266,040 PV of annual cash flows = $4,733,960
PV of annual cash flows = Annual cash flow 5.5824 $4,733,960 = Annual cash flow 5.5824
Annual cash flow = $4,733,960 ? 5.5824 = $848,015
Minimum labor savings = $848,015 + Operating costs
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= $848,015 + $112,000 = $960,015
e. The company should consider the quality of work performed by the machine compared to the quality of work performed by the individuals; the reliability of the mechanical process compared to the manual process; and perhaps most importantly, the effect on worker morale and the ethical considerations in displacing 14 workers.
48. a. Payback period = $140,000 ? ($47,500 ? $8,500) = 3.6 years The project does not meet the payback criterion.
b. Discount factor = Investment ? Annual cash flow = $140,000 ? $39,000 = 3.5897
Discount factor of 3.5897 indicates IRR 4 % This is an unacceptable IRR.
c. Foster should consider two main factors: (1) the effect of the computer system on tax return accuracy and quality of service delivered to clients and (2) the effect of firing one employee on both the dismissed employee and the remaining employees.
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