Chp 26 HW - Carter Company is considering three investment...

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Unformatted text preview: Carter Company is considering three investment opportunities with the following payback periods: Project A Project B Project C Payback period 2.? years 6.4 years 3.8 years Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being equal. [1 I most desriable and 3 = least desirable.) Project Ran II: Project A 1 Project B 3 Project C 2 Carter Company is considering three investment opportunities with the following accounting rates of return: Project X Project Y Project Z ARR 1 3.25% 6.58% 10.4?% Use the decision rule for ARR to rank the projects from most desirable to least desirable. Carter Company's required rate of return is 8%. [1 = most desriable and 3 = least desirable. Select whether each project should be accepted or rejected.) Project Rank Acceth'Rej ect Project X 1 Accept Project Y 3 Reject Project 2 2 Accept Consider how Stenback ‘v'alley Snow Park Lodge could use capital budgeting to decide whether the $1 1,000,000 Snow Park Lodge expansion would be a good investment. Assume Stenback Valley's managers developed the following estimates concerning the expansion: @ [Click the icon to view the estimates.) Read the rguirements. Requirement 1. Compute the average annual net cash inflow from the expansion. The average annual net cash inflow from the expansion is $ 2,687,256. Requirement 2. Compute the average annual operating income from the expansion. ‘ The average annual operating income from the expansion is $ 1,387,256 . Consider how Stenback ‘v'alley Snow Park Lodge could use capital budgeting to decide whether the $1 1,000,000 Snow Park Lodge expansion would be a good investment. Assume Stenback Valley's managers developed the following estimates concerning the expansion: E [Click the icon to view the estimates.) Assume that Stenback Valley uses the straight—line depreciation method and expects the lodge expansion to have a residual value of $600,000 at the end of its eight—year life. The average annual net cash inflow from the expansion is expected to be $2,687,256. Compute the payback for the expansion project. Round to one decimal place. Amount invested I Expected annual net cash inflow = Payback ‘ ‘ ‘ $ 11 ,000,000 J $ 2,687,256 = 4.1 years Consider how Stenback ‘v'alley Snow Park Lodge could use capital budgeting to decide whether the $1 1,000,000 Snow Park Lodge expansion would be a good investment. Assume Stenback Valley's managers developed the following estimates concerning the expansion: E [Click the icon to view the estimates.) Assume that Stenback ‘v'alley uses the straight—line depreciation method and expects the lodge expansion to have a residual value of $600,000 at the end of its eight—year life. The average annual operating income from the expansion is $1 ,38?,256 and the depreciation has been calculated as $1,300,000. Calculate the ARR. Round to two decimal places. ‘ ‘ Average annual operating income 1' Average amount invested ARR ‘ ‘ $ 1 387,256 1’ $ 5,800,000 = 2382‘ ‘51: Consider how Stenback ‘v'alley Snow Park Lodge could use capital budgeting to decide whether the $1 1,000,000 Snow Park Lodge expansion would be a good investment. Assume Stenback Valley's managers developed the following estimates concerning the expansion: g [Click the icon to view the estimates.) Under the assumption that the expansion would have a residual value of $600,000, the managers calculated the payback period to be 4.1 years, the ARR to be 23.82%, the average annual operating income to be $1,387,256, the average amount invested to be $5,800,000, and the average annual net cash inflow to be $2,68?,256. Assume that Stenback Valley uses the straight—line depreciation method and now expects the lodge expansion to have zero residualI value at the end of its eight-year life. Read the rfiuirements. Requirement 1. Will the payback change? Explain your answer. Recalculate the payback if it changes. Round to one decimal place. Select the formula to calculate the payback period. Amount invested ! Expected annual net cash inflow = Payback The payback will continue to be 4.1‘years. The residual value does not afiect the computation of the payback and the payback method does not consider cash flows that occur after the payback period. Requirement 2. Will the project's ARR change? Explain your answer. Recalculate ARR if it changes. Round to two decimal places. Select the formula to calculate the ARR. ‘ ‘ Average annual operating income 1' Average amount invested ARR ‘ "he ARR will now be 23.86‘%. "he ARR changes when the residual value changes to zero. The average annual operating income [numerator]: will be lower because the depreciation expense is higher . Additionally, the average investment (denominator) is lower when the asset does not have a residual value. Requirement 3. Assume Stenback Valley screens its potential capital investments using the following decision criteria: Maximum payback period 5.0 years Minimum accounting rate of return 18.00 % Will Stenback Valley consider this project further or reject it? The payback period is sinner than the 50—year maximum, and the ARR is higher than the 18.00% minimum. Since the investment meets both decision criteria, Stenback Valley will want to consider this investment further. Use the Present Value of $1 table to determine the present value of $1 received one year from now. Assume a 12% interest rate. Use the same table to find the present value of $1 received two years from now. Continue this process for a total of five years. Round to three decimal places. 5 [Click the icon to view the Present Value of $1 table.) Requirements 1. What is the total present value of the cash flows received over the five—year period? 2. Could you characterize this stream of cash flows as an annuity? Why or why not? 3. Use the Present Value of Annuity of $1 table to determine the present value of the same stream of cash flows. Compare your resuits to your answer to Requirement 1. 4. Explain your findings. Requirement 1. What is the total' present value of the cash flows received over the five—year period? Calculate the total present value of $1 received each year. [Round to three decimal places, XJOOL} Present Value One year from now $ {1893‘ E "wo years from now 0.79?" "hree years from now {1712‘ Four years from now 0.636‘ Five years fro m n ow 0.56?" Total present value $ 3505‘ Requirement 2. Could you characterize this stream of cash flows as an annuity? Why or why not? The stream of cash flows is an annuity because it is a stream of equal cash payments made at equal time intervals. Requirement 3. Use the Present Value of Annuity of $1 table to determine the present value of the same stream of cash flows. Compare your results to your answer to Requirement 1. [Round to three decimal places, XXXX.) 3 [Click the icon to view the Present Value of Annuity of $1 table.) The present value of an annuity of $1 received each year for five years, at 12% per year is $ 3.605‘. The sum of the present values in Requirement 1 equals (except for a possible slight rounding difierence)‘ the present value calculated with the Present Value of Annuity of $1 table. Requirement 4. Explain your findings. This exercise shows how Annuity PV factors are the sums of the PV factors found in the Present Value of $1 tables. Your grandfather would like to share some of his fortune with you. He offers to give you money under one of the following scenarios {you get to choose): 1. $8,550 per year at the end of each of the next seven years 2. $48,350 [lump sum) now 3. $100,250 [lump sum) seven years from now 5 [Click the icon to view the Present Value of $1 table.) 5 [Click the icon to view the Present Value of Annuity of $1 table} Requirement 1. Calculate the present value of each scenario using an 8% discount rate. Which scenario yields the highest present value? Round to the nearest whole dollar. 2. Would your preference change if you used a 12% discount rate? Requirement 1. Calculate the present value of each scenario using an 8% discount rate. Which scenario yields the highest present — value? [Round the factors to three decimal places, Km. Round the present value to the nearest whole dollar.) Present Value Scenario 1: $ 44,511 Scenario 2: $ 48,350 Scenario 3: $ 58,446 ‘ Scenario 3 appears to be the best option. Based on an 8% interest rate, its present value is the highest . Requirement 2. Would your preference change if you used a 12% discount rate? Compute the present value of each scenario using a 12% discount rate. [Round the factors to three decimal places, XXXX. Round the — present value to the nearest whole dollar.) Present Value Scenario 1: $ 39,022 Scenario 2: $ 48,350 Scenario 3: $ 45,313 Scenariofl appears to be the best option. Based on a 12% interest rate, its present value is the highest . Consider how Stenback ‘v'alley Snow Park Lodge could use capital budgeting to decide whether the $1 1 ,000, 000 Snow Park Lodge expansion would be a good investment. Assume Sten back Valley's managers developed the following estimates concerning the expansion: @ [Click the icon to view the estimates.) Assume that Stenback Valley uses the straight—line depreciation method and expects the lodge expansion to have a residual value of $600,000 at the end of its eight—year life. They have already calculated the average annual net cash inflow per year to be $2,68?,256. flmlick the icon to view the Present Value of $1 table.) flmlick the icon to view the Present Value of Ordinary Annuity of $1 table.) What is the project's NF’VIr (round to nearest dollar)? Is the investment attractive? Why or why not? Calculate the net present value of the expansion. [Enter any factor amounts to three decimal places, XXXX. Round to the nearest whole dollar.) Net Cash Annuity PV Factor P‘v‘ Factor Present Years Inflow [i=12‘1/n, n=3} [i=12%, n=3} Value 1 — 8 Present value of annuity $ 2,687,256‘ 4368‘ $ 13,350,288‘ 8 Present value of residual value 600,000‘ 0404‘ 242.400‘ Total W of cash inflows 13,592,688‘ 0 Initial investment [11 900.000; Net present value of expansion $ 2,592,681; The expansion is an attractive project because its NW is positive . Consider how Stenback Valley Snow Park Lodge could use capital budgeting to decide whether the $1 1,000,000 Snow Park Lodge expansion would be a good investment. Assume Stenback Valley's managers developed the following estimates concerning the expansion: E [Click the icon to view the estimates.) Assume that Stenback Valley uses the straight—line depreciation method and expects the lodge expansion to have no residual value at the end of its eight—year life. The project's average annual net cash inflow per year is expected to be $2,68?,256. a [Click the icon to view the Present Value of $1 table.) a [Click the icon to view the Present Value of Ordinary Annuity of $1 table.) What is the project's NF”\ir [round to nearest dollar)? Is the investment attractive? Why or why not? Calculate the net present value of the expansion. {Enter the factor to three decimal places, XXXX. Round your calculations to the nearest whole dollar.) Net Cash Annuity PV Factor PV Factor Present Years Inflow [i=12'n., n=3} [i=12%, n=8} Value 1 — 8 Present value of annuity $ 2,687,256‘ 4968‘ $ 13,350,288‘ 0 Initial investment [11 $00900)" Net present value of expansion $ 2,350,288‘ When the residual value is zero, the expansion is an attractive project because its NW is positive Consider how Stenback Valley Snow Park Lodge could use capital budgeting to decide whether the $11,000,000 Snow Park Lodge expansion would be a good investment. Assume Stenback Valley's managers developed the following estimates concerning the expansion: a {Click the icon to view the estimates.) Assume that Stenback Valley uses the straight—line depreciation method and expects the lodge expansion to have no residual value at the end of its eight—year life. The project is expected to have an average annual net cash inflow of $2,613 7,256. The NPV of the expansion is expected to be $2,350,288. 3 (Click the icon to view the Present Value of $1 table.) flflllick the icon to view the Present Value of Ordinary Annuity of $1 table.) What is the project's IRR? Is the investment attractive? Why or why not? "he internal rate of return (IRR) of the expansion is 16—18%‘. "he project is attractive since it will earn a higher return than the company's 12% hurdle rate. Castle is considering an investment opportunity with the following expected net cash inflows: Year 1, $230,000; Year 2, $1 T0,000; Year 3, $1 10,000. The company uses a discount rate of 9% and the initial investment is $345,000. a [Click the icon to view the Present Value of $1 table.) 5 [Click the icon to view the Present Value of Annuity of $1 table.) Calculate the NPV of the investment. Should the company invest in the project? Why or why not? Use the following table to calculate the net present value of the project. [Enter any factor amounts to three decimal places, XXXX.) Net Cash PV Factor Present Years Inflow [i = 9%} Value Present value of each year's inflow: 1 [n = 1} $ 230,000‘ 0.917‘ $ 210,910‘ 2 [n = 2) 170,000‘ (1842‘ 143,140‘ 3 [n = 3) 110,000‘ 0172‘ 84.920‘ Total PV of cash inflows 438,970‘ 0 Initial investment (345.900; Net present value of the project $ 93:97'3‘ Using the NPV as the basis of its decision, Castle should consider the investment because its NPV is positive Fill in each statement with the appropriate capital investment analysis method: Payback, ARR, NPV, or lRR. Some statements may have more than one answer. ‘ a. NPV and IRR is {are} more appropriate for long—term investments. b. Payback ‘ highlights risky investments. c. ARR ‘ shows the effect of the investment on the company's accrual—based income. :1. IRR ‘is the interest rate that makes the NPV of an investment equal to zero. e. NPV ‘ requires management to identify the discount rate when used. f. Payback ‘provides management with information on how fast the cash invested will be recouped. g. IRR is the rate of return, using discounted cash flows, a company can expect to earn by investing in the asset. h. Payback ‘does not consider the asset's profitability. ‘ i. ARR uses accrual accounting rather than net cash inflows in its computation. Consider the following three projects. All three have an initial investment of $500,000. fl [Click the icon to view the investments.) Requirements 1. Determine the payback period of each project. Rank the projects from most desirable to least desirable based on payback. 2. Are there other factors that should be considered in addition to the payback period? Requirement 1. Determine the payback period of each project. Rank the projects from most desirable to least desirable based on payback. [Enter the payback period as a numeral.) Project Payback period Project N ‘ 2‘years Project M ‘ 4‘years Project L ‘ 5‘years Requirement 2. Are there other factors that should be considered in addition to the payback period? No. "he payback period is the only qualitative factor necessary for a comparison of investments. No. "he payback period is the only quantitative factor necessary for a comparison of investments. 0.03.3" Yes. The company should consider which projects will generate cash flows after the payback period. In addition, the company should rank the projects based on the resuits of other evaluation methods [e.g., accounting rate of return, net present value, prof .ability index, and internal rate of return) and possible qualitative factors. Rapp Hardware is adding a new product line that will require an investment of $1 ,41 8,000. Managers estimate that this investment will have a 10—year life and generate net cash inflows of $31 0, 000 the first year, $290,000 the second year, and $250,000 each year thereafter for eight years. Compute the payback period. Round to one decimal place. The payback is 5.3‘years. Rapp Hardware is adding a new product line that will require an investment of $1 ,41 8,000. Managers estimate that this investment will have a 10—year life and generate net cash inflows of $31 0,000 the first year, $290,000 the second year, and $250,000 each year thereafter for eight years. Assume the project has no residual value. Compute the ARR for the investment. Round to two places. Select the formula, then enter the amounts to calculate the ARR [accounting rate of return) for the new product line. {Round ARR to the nearest hundredth percent [two decimal places], X.XX%.) V V Average ann ual operating inco me 1' Average amount invested V ‘ $ 1 1 8,200 1' $ 709,000 ARR 16.6?" 91: Sharon wants to take the next five years off work to travel around the world. She estimates her annual cash needs at $34,000 [if she needs more, she will work odd jobs). Sharon believes she can invest her savings at 8% until she depletes her funds. a [Click the icon to view the Present Value of $1 table.) 5 [Click the icon to view the Present Value of Annuity of $1 table.) 5 [Click the icon to view the Future Value of $1 table.) a [Click the icon to view the Future Value of Annuity of $1 table.) Requirements 1. How much money does Sharon need now to fund her travels? 2. After speaking with a number of banks, Sharon learns she will only be able to invest her funds at 6%. How much does she need now to fund her travels? Requirement 1. How much money does Sharon need now to fund her travels? [Round your answer to the nearest whole dollar.) With the 8% interest rate, Sharon needs $ 135,?62‘. Requirement 2. After speaking with a number of banks, Sharon learns she will only be able to invest her funds at 6%. How much does she need now to fund her travels? [Round your answer to the nearest whole dollar.) With a 6% interest rate, Sharon would need $ 143,208‘. if Sharon's savings are earning a lower interest rate [6%), she will need to save more‘ to be able to withdraw $34,000 per year. Congratulations! You have won a state lottery. The state lottery offers you the following [after—tax) payout options: Option #1: $1 1,000,000 a'.er five years Option #2: $2,000,000 per year for five years Option #3: $10,000,000 a'.er three years 5 [Click the icon to view the Present Value of $1 table.) a [Click the icon to view the Present Value of Annuity of $1 table.) a [Click the icon to view the Future Value of $1 table.) 3 [Click the icon to view the Future Value of Annuity of $1 table.) Assuming you can earn 10% on your funds, which option would you prefer? The present value of the payout is: [Round your answers to the nearest whole dollar.) Option #1: $ 6,831 ,000‘ Option #2: $ 7,532,000‘ Option #3: $ 7,510,000‘ [Enter your answer as a numeral—e.g., 1.) Payout Option # E‘has the highest present value using the 10% discount rate. Therefore, it appears to be the most favorable option. Eon Industries is deciding whether to automate one phase of its production process. The manufacturing equipment has a six-year life and will cost $920,000. Projected net cash inflows are as follows: a [Click the icon to view the projected net cash inflows.) a [Click the icon to view the Present Value of $1 table.) a [Click the icon to view the Present Value of Annuity of $1 table.) Read the rguirements. Requirement 1. Compute this project's NP‘v' using Eon's 16% hurdle rate. Should Eon invest in the equipment? Use the following table to calculate the net present value of the project. [E nter any factor amounts to three decimal places, XXXX. Use parentheses or a minus sign for a negative net present value.) Net Cash PV Factor Present Years Inflow [i =1B'rti} Value Present value of each year's inflow: 1 [n = 1) 5 261,000: 0862‘ 5 224,382‘ 2 [n = 2} 254,000‘ 0743‘ 188,722‘ 3 [n = 3} 227,000‘ 0541‘ 145,507‘ 4 [n = 4) 211 ,000‘ 0552‘ 116,472‘ 5 [n = 5) 201 ,000‘ 0476‘ 95,676‘ 6 [n = 5} 175,000‘ 0410‘ 71,750‘ Total Pv of cash inflows 843,109“ 0 Initial investment (920.000; Net present value of the project 5 [75.891]: . V . . . Eon Industries should not invest in the eqUIpment. Require...
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