Chapter 12 Planning for Capital Investments(FILEminimizer)

# Chapter 12 Planning for Capital Investments(FILEminimizer)...

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Exercises: Set B 1 EXERCISES: SET B E12-1B Burns Corporation is considering purchasing a new delivery truck. The truck has many advantages over the company’s current truck (not the least of which is that it runs). The new truck would cost \$48,000. Because of the increased capacity, reduced maintenance costs, and increased fuel economy, the new truck is expected to generate cost savings of \$8,000. At the end of 8 years the company will sell the truck for an estimated \$24,000. Traditionally the company has used a rule of thumb that a proposal should not be accepted unless it has a pay- back period that is less than 70% of the asset’s estimated useful life. Sam Leyland, a new manager, has suggested that the company should not rely solely on the payback approach, but should also employ the net present value method when evaluating new projects. The company’s cost of capital is 8%. Instructions (a) Compute the cash payback period and net present value of the proposed investment. (b) Does the project meet the company’s cash payback criteria? Does it meet the net present value criteria for acceptance? Discuss your results. E12-2B Santos Manufacturing Company is considering three new projects, each requiring an equipment investment of \$24,000. Each project will last for 3 years and produce the following cash inflows. Year AA BB CC 1 \$ 7,000 \$ 9,500 \$13,000 2 9,000 9,500 9,000 3 12,000 9,500 10,000 Total \$28,000 \$28,500 \$32,000 The equipment’s salvage value is zero. Santos uses straight-line depreciation. Santos will not ac- cept any project with a payback period over 2.5 years. Santos’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.) E12-3B ASU Corp. is considering purchasing one of two new diagnostic machines. Either ma- chine 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 \$98,000 \$170,000 Estimated life 8 years 8 years Salvage value – 0 – – 0 – Estimated annual cash inflows \$25,000 \$40,000 Estimated annual cash outflows \$5,000 \$12,000 Instructions Calculate the net present value and profitability index of each machine. Assume a 9% discount rate.Which machine should be purchased? E12-4B Duncan Corporation is involved in the business of injection molding of plastics. It is considering the purchase of a new computer-aided design and manufacturing machine for \$425,000. The company believes that with this new machine it will improve productivity and in- crease quality, resulting in an increase in net annual cash flows of \$115,000 for the next 5 years. Management requires a 12% rate of return on all new investments.

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## This note was uploaded on 10/25/2011 for the course ACCOUNTING 343 taught by Professor Javad during the Winter '04 term at Al-Quds University.

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Chapter 12 Planning for Capital Investments(FILEminimizer)...

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