Chapter 26 Exercises Capital Investment Decisions.

Chapter 26

Exercises

Capital Investment Decisions

Payback PeriodPayback PeriodPayback PeriodPayback Period

• In-Class Exercises (Form groups and work exercises):

Exercise No. Page E26-18 1633 Payback Period (Even)

E26-19 1633 Payback Period (Uneven)

• In-Class Exercises (Form groups and work exercises):

Exercise No. Page E26-18 1633 Payback Period (Even)

E26-19 1633 Payback Period (Uneven)

• In-Class Exercise:

Exercise No. Page E26-18 1633 Payback Period (Even)

• In-Class Exercise:

Exercise No. Page E26-18 1633 Payback Period (Even)

Payback PeriodPayback PeriodPayback PeriodPayback Period

Payback PeriodPayback PeriodPayback PeriodPayback Period

Exercise E26-18:

Preston Co. is considering acquiring a manufacturing plant.

The purchase price is $1,100,000.

The owners believe the plant will generate net cash inflows of $297,000 annually.

The plant will have to be replaced in six years.

Requirement: Use the payback method to determine whether Preston should purchase this plant. Round answer to one decimal place.

Exercise E26-18:

Preston Co. is considering acquiring a manufacturing plant.

The purchase price is $1,100,000.

The owners believe the plant will generate net cash inflows of $297,000 annually.

The plant will have to be replaced in six years.

Requirement: Use the payback method to determine whether Preston should purchase this plant. Round answer to one decimal place.

Payback PeriodPayback PeriodPayback PeriodPayback Period

End of ExerciseEnd of Exercise

Payback PeriodPayback PeriodPayback PeriodPayback Period

• In-Class Exercise:

Exercise No. Page E26-19 1633 Payback Period (Uneven)

• In-Class Exercise:

Exercise No. Page E26-19 1633 Payback Period (Uneven)

Payback PeriodPayback PeriodPayback PeriodPayback Period

Payback PeriodPayback PeriodPayback PeriodPayback Period

Exercise E26-19:

Robinson Hardware is adding a new product line that will require an investment of $1,454,000.

Managers estimate that this investment will have a 10-year life.

The investment will generate the following net cash flows: Year 1……… $ 300,000 Year 2……… 270,000 Years 3-10… 260,000 (each of the eight years)

Requirement: Compute the payback period.

Exercise E26-19:

Robinson Hardware is adding a new product line that will require an investment of $1,454,000.

Managers estimate that this investment will have a 10-year life.

The investment will generate the following net cash flows: Year 1……… $ 300,000 Year 2……… 270,000 Years 3-10… 260,000 (each of the eight years)

Requirement: Compute the payback period.

Payback PeriodPayback PeriodPayback PeriodPayback Period

Payback PeriodPayback PeriodPayback PeriodPayback Period

The proposed $1,454,000 investment would be The proposed $1,454,000 investment would be recovered in approximately 5.4 years.recovered in approximately 5.4 years.

The proposed $1,454,000 investment would be The proposed $1,454,000 investment would be recovered in approximately 5.4 years.recovered in approximately 5.4 years.

Payback PeriodPayback PeriodPayback PeriodPayback Period

Fractional year computationFractional year computationFractional year computationFractional year computation

Payback PeriodPayback PeriodPayback PeriodPayback Period

Fractional year computationFractional year computationFractional year computationFractional year computation

Payback PeriodPayback PeriodPayback PeriodPayback Period

Fractional year computationFractional year computationFractional year computationFractional year computation

Payback PeriodPayback PeriodPayback PeriodPayback Period

Fractional year computationFractional year computationFractional year computationFractional year computation

Payback PeriodPayback PeriodPayback PeriodPayback Period

Fractional year computationFractional year computationFractional year computationFractional year computation

Payback PeriodPayback PeriodPayback PeriodPayback Period

Fractional year computationFractional year computationFractional year computationFractional year computation

End of ExerciseEnd of Exercise

Payback PeriodPayback PeriodPayback PeriodPayback Period

• In-Class Exercise (Form groups and work exercise):

Exercise No. Page E26-20 1633 Accounting Rate of Return

• In-Class Exercise (Form groups and work exercise):

Exercise No. Page E26-20 1633 Accounting Rate of Return

Accounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of Return

Exercise E26-20:

Use the information from Exercise E26-19.

Assume that the project has no residual value. Therefore, the project’s investment cost of $1,454,000 will be fully depreciated over its useful life.

The operating (useful) life is 10 years.

Requirement: Compute the Accounting Rate of Return (ARR) for the investment. Round your answer to two decimal places.

Exercise E26-20:

Use the information from Exercise E26-19.

Assume that the project has no residual value. Therefore, the project’s investment cost of $1,454,000 will be fully depreciated over its useful life.

The operating (useful) life is 10 years.

Requirement: Compute the Accounting Rate of Return (ARR) for the investment. Round your answer to two decimal places.

Accounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of Return

Accounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of Return

Net Cash Outflows from Exercise E26-19Net Cash Outflows from Exercise E26-19Net Cash Outflows from Exercise E26-19Net Cash Outflows from Exercise E26-19

Accounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of Return

Accounting Rate of Return

Average annual operating Income

Average amount invested=

Formulas for Exercise E26-20Formulas for Exercise E26-20Formulas for Exercise E26-20Formulas for Exercise E26-20

Average Investment =

Asset Cost + Residual Value

2

Accounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of Return

Computation of Annual Operating IncomeComputation of Annual Operating IncomeComputation of Annual Operating IncomeComputation of Annual Operating Income

From Exercise E26-19From Exercise E26-19From Exercise E26-19From Exercise E26-19

Accounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of Return

Computation of Annual Operating IncomeComputation of Annual Operating IncomeComputation of Annual Operating IncomeComputation of Annual Operating Income

Accounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of Return

Average Investment =

Asset Cost + Residual Value

2

Average Investment =

$1,454,000 + $ 0

2= $727,000

First, calculate the average investment.First, calculate the average investment.First, calculate the average investment.First, calculate the average investment.

Accounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of Return

Accounting Rate of Return

Average annual operating Income

Average amount invested=

Accounting Rate of Return

$119,600

$727,000= = 16.45%

Next, calculate the accounting rate of return.Next, calculate the accounting rate of return.Next, calculate the accounting rate of return.Next, calculate the accounting rate of return.

End of ExerciseEnd of Exercise

Accounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of ReturnAccounting Rate of Return

• In-Class Exercise (Form groups and work exercise):

Exercise No. Page E26-24 1635 Net Present Value & Probability

Index

• In-Class Exercise (Form groups and work exercise):

Exercise No. Page E26-24 1635 Net Present Value & Probability

Index

Net Present ValueNet Present ValueNet Present ValueNet Present Value

Net Present ValueNet Present ValueNet Present ValueNet Present Value

Exercise E26-24:

Use the NPV method to determine whether Kyler Products should invest in the following projects.

(1) Project A: Costs $260,000 and offers seven annual net cash inflows of $57,000. Kyler requires an annual return of 16% on investments of this nature.

(2) Project B: Costs $375,000 and offers ten annual net cash inflows of $75,000. Kyler demands an annual return of 14% on investments of this nature.

Requirements:(1) What is the NPV of each project? Assume neither project has a residual value. Round your answer to two decimal places.

(2) What is the maximum acceptable price to pay for each project?

(3) What is the profitability index of each project? Round to 2 places.

Exercise E26-24:

Use the NPV method to determine whether Kyler Products should invest in the following projects.

(1) Project A: Costs $260,000 and offers seven annual net cash inflows of $57,000. Kyler requires an annual return of 16% on investments of this nature.

(2) Project B: Costs $375,000 and offers ten annual net cash inflows of $75,000. Kyler demands an annual return of 14% on investments of this nature.

Requirements:(1) What is the NPV of each project? Assume neither project has a residual value. Round your answer to two decimal places.

(2) What is the maximum acceptable price to pay for each project?

(3) What is the profitability index of each project? Round to 2 places.

Net Present ValueNet Present ValueNet Present ValueNet Present Value

Present value of annuity (Table B-2)Present value of annuity (Table B-2)(Period 7, 16% column)(Period 7, 16% column)

Present value of annuity (Table B-2)Present value of annuity (Table B-2)(Period 7, 16% column)(Period 7, 16% column)

Net Present ValueNet Present ValueNet Present ValueNet Present Value

Net Present ValueNet Present ValueNet Present ValueNet Present Value

Present value of annuity (Table B-2)Present value of annuity (Table B-2)(Period 10, 14% column)(Period 10, 14% column)

Present value of annuity (Table B-2)Present value of annuity (Table B-2)(Period 10, 14% column)(Period 10, 14% column)

Net Present ValueNet Present ValueNet Present ValueNet Present Value

Net Present ValueNet Present ValueNet Present ValueNet Present Value

Maximum acceptable priceMaximum acceptable priceMaximum acceptable priceMaximum acceptable price

Profitability IndexProfitability IndexProfitability IndexProfitability Index

End of ExerciseEnd of Exercise

Net Present ValueNet Present ValueNet Present ValueNet Present Value

• In-Class Exercise (Form groups and work exercise):

Exercise No. Page E26-25 1635 Internal Rate of Return

• In-Class Exercise (Form groups and work exercise):

Exercise No. Page E26-25 1635 Internal Rate of Return

Internal Rate of ReturnInternal Rate of ReturnInternal Rate of ReturnInternal Rate of Return

Internal Rate of ReturnInternal Rate of ReturnInternal Rate of ReturnInternal Rate of Return

Project AProject AProject AProject A

Computation of the IRR using data from Exercise E26-24.

Computation of the IRR using data from Exercise E26-24.

Internal Rate of ReturnInternal Rate of ReturnInternal Rate of ReturnInternal Rate of Return

PV Table B-2 - (PV of an Annuity):

7 Years (12% column) > 4.564 IRR = Approx. 12%

$260,000 $57,000

PV Factor = = 4.561

Calculated PV Factor:

PV Factor =

Investment Amount Annual Cash FlowPV Factor =

Internal Rate of ReturnInternal Rate of ReturnInternal Rate of ReturnInternal Rate of Return

PV Table B-2 - (PV of an Annuity):

7 Years (12% column) > 4.564 IRR = Approx. 12%

$260,000 $57,000

PV Factor = = 4.561

Calculated PV Factor:

PV Factor =

Investment Amount Annual Cash FlowPV Factor =

Internal Rate of ReturnInternal Rate of ReturnInternal Rate of ReturnInternal Rate of Return

PV Table B-2 - (PV of an Annuity):

7 Years (12% column) > 4.564 IRR = Approx. 12%+

$260,000 $57,000

PV Factor = = 4.561

Calculated PV Factor:

PV Factor =

Investment Amount Annual Cash FlowPV Factor =

Since Smart Touch requires a 16% return, the Since Smart Touch requires a 16% return, the project would not be acceptable.project would not be acceptable.

Since Smart Touch requires a 16% return, the Since Smart Touch requires a 16% return, the project would not be acceptable.project would not be acceptable.

(Compared to)

Internal Rate of ReturnInternal Rate of ReturnInternal Rate of ReturnInternal Rate of Return

Project BProject BProject BProject B

Computation of the IRR using data from Exercise E26-24.

Computation of the IRR using data from Exercise E26-24.

Internal Rate of ReturnInternal Rate of ReturnInternal Rate of ReturnInternal Rate of Return

PV Table B-2 - (PV of an Annuity):

10 Years (15% column) > 5.019 IRR = Approx. 15%+

$375,000 $75,000

PV Factor = = 5.000

Calculated PV Factor:

PV Factor =

Investment Amount Annual Cash FlowPV Factor =

Internal Rate of ReturnInternal Rate of ReturnInternal Rate of ReturnInternal Rate of Return

PV Table B-2 - (PV of an Annuity):

10 Years (15% column) > 5.019 IRR = Approx. 15%+

$375,000 $75,000

PV Factor = = 5.000

Calculated PV Factor:

PV Factor =

Investment Amount Annual Cash FlowPV Factor =

Internal Rate of ReturnInternal Rate of ReturnInternal Rate of ReturnInternal Rate of Return

PV Table B-2 - (PV of an Annuity):

10 Years (15% column) > 5.019 IRR = Approx. 15%+

$375,000 $75,000

PV Factor = = 5.000

Calculated PV Factor:

PV Factor =

Investment Amount Annual Cash FlowPV Factor =

Since Smart Touch requires a minimum return of 14%, the Since Smart Touch requires a minimum return of 14%, the project is considered acceptable and is the best investment.project is considered acceptable and is the best investment.

Since Smart Touch requires a minimum return of 14%, the Since Smart Touch requires a minimum return of 14%, the project is considered acceptable and is the best investment.project is considered acceptable and is the best investment.

(Compared to)

End of ExerciseEnd of Exercise

Internal Rate of ReturnInternal Rate of ReturnInternal Rate of ReturnInternal Rate of Return