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C HAPTER 11 M ANAGING L ONG -L IVED R ESOURCES : C APITAL B UDGETING SOLUTIONS 11-2 The time value of money arises because a dollar today is worth more than a dollar tomorrow. Time value of money is important for project evaluation as cash inflows and outflows occur at different points in time – thus, we need to put these different cash flows on equal footing to compare them. 11-5 (1) Initial outlay, (2) estimated life and salvage value, (3) timing and amounts of operating cash flows, and (4) cost of capital. 11-6 Net present value is the total present value of all cash inflows and outflows. We compute net present value by discounting future cash inflows and outflows (using present value tables for our selected discount rate) back into today’s dollars. E_11-31 Treating each row of the table independently compute missing information. For each setting, we use the appropriate present value factors from the tables in Appendix B. The relevant table and the factor are given in parentheses for each setting. Setting Initial outlay Life (years) Discount rate (compounded annually) Future value (at the end of life) 1 $225,000 5 10% $362,475 (Table 2: Factor 1.611) 2 $128,800 (Table 1: Factor 0.322) 10 12% $400,000 3 $157,950 8 14% 450,000 4 $150,000 8 12% $371,400 E_11-38 a. By the definition of the internal rate of return, the net present value from investing in injection molding machine should be zero. Referring to the solution to 11.37, the present values of annuities of $90,600 over 10 years discounted at this rate should equal $500,000. In other words, $90,600 × annuity factor = $500,000, or annuity factor = 5.52. Using the RATE(10, 90600, -500000) function of the Excel Spreadsheet, this annuity factor corresponds to a discount rate of 12.58% (rounded ). We also can use the trial and error method and the table in the Appendix to determine that the rate is between 12 and 13%. This rate is less than 14%, and, as per company policy, this project would be rejected.
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b. No, it will not. The company has to go by what is the best alternative use of the funds. The only other use for the funds, as given in 11.37, is to invest the money in shares to earn an expected return of 12%. And, as we saw in 11.37, investing in the injection molding machine is a better option. Therefore, sticking to the company policy and rejecting the project is not in the company’s best interest. E_11-42
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