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Unformatted text preview: EXERCISE 14—1 Net Present Value Method The management of Kunkel Company is considering the purchase of a $40,000 machine that
would reduce operating costs by $7,000 per year. At the end of the machine's eight—year useful life, it will have zero scrap value. The company's required rpate of return is 12%.
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(Ignore income taxes.) k f /
1. Determine the net present value of the investment in the machine. L’- - "3 - 2. . so.) , l :5” / '1 I i f 2,327‘ ‘ £7 :7 girl "1"‘1: ZTQL
(thrifty ;. '1‘? ""‘ UM)" ”“ ‘r’ ’U',’x”§' . . ' . .
lit/lilir/ 1’” ' ’ 2. What is the difference between the total, undiscounted cash 1nﬂows and cash outflows V 9; over the entire life of the machine? mall/V 0/69 1/ @001?” > Lil-ll? I
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EXERCISE 14—10 Net Present Value Analysis of Two Alternatives
Perit Industries has $100,000 to invest. The company is trying to decide between two alternative
uses of the funds. The alternatives are:
Proiect A Project 8
Cost of equipment required . . . . . . . . . . . , 8100.000 50
Working capital investment required . . . . . SO SIOOOOO
Annual cash inflows . . . . . . . . . . . . . . . . . . 82t.OOO $16,000
Salvage value of equipment m Sax years . . 88.000 80
Life of the project . . . . . . . _ . . . . . . . , . . . . 6 years 6 years
The working capital needed for project B will be released at the end of six years for investment
elsewhere. Perit Industries' discount rate is 14%.
(Ignore income taxes.) Which investment alternative (if either) would you recommend that the
company accept? Show all computations using the net present value format. Prepare separate
computations for each project.
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i " I”; " EXERCISE 14—2 Internal Rate of Return Wendell's Donut Shoppe is investigating the purchase ofa new $18,600 donut-making machine.
The new machine would permit the company to reduce the amount of part—time help needed, at a
cost savings of $3,800 per year. In addition, the new machine would allow the company to
produce one new style of donut, resulting in the sale of 1,000 dozen more donuts each year. The
company realizes a contribution margin of$l.20 per dozen donuts sold. The new machine would
have a six—year useful life. Required:
(Ignore income taxes.) 1 . What would be the total annual cash inﬂows associated with the new machine for capital
budgeting purposes? 2. Find the internal rate of return promised by the new machine to the nearest whole
percent. 3. In addition to the data given previously, assume that the machine will have a $9,125
salvage value at the end of six years. Under these conditions, compute the internal rate of
return to the nearest whole percent. (Hint: You may ﬁnd it helpful to use the net present
value approach; ﬁnd the discount rate that will cause the net present value to be closest to zero.) [A V9 v. 'i
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- Winter '10