10-16B - Using Present Value Techniques To Evaluate Alternative Investment Opportunities

Perry Automobile Repair Inc. currently has three repair shop in Boston. Jerry Perry, the president and chief executive officer, is facing a pleasant dilemma: the business has continued to grow rapidly and major shareholders are arguing about different ways to capture more business opportunities. The company requires a 12 percent rate of return for its investment projects and uses the straight-line method of depreciation for all fixed assets.

One group of shareholders wants to open another shop in a newly developed suburban community. This project would require an initial investment of $600,000 to acquire all the necessary equipment, which has a useful life of 5 years with a salvage value of $200,000. Once the shop begins to operate, another $150,000 of working capital would be required; it would be recovered at the end of the fifth year. The expected net cash inflow from the new shop follows:

Year 1 - $75,000

Year 2 - $125,000

Year 3 - $190,000

Year 4 - $240,000

Year 5 - $300,000

A second group of shareholders prefers to invest $500,000 to acquire new computerized diagnostic equipment for existing shops.The equipment is expected to have a useful life of five years with a salvage value of $100,000. Using this state-of-the-art equipment, mechanics would be able to pinpoint automobile problems more quickly and accurately.Consequently, it would allow the existing shops to increase their service capacity and revenue by $156,250 per year. The company would need to train mechanics to use the equipment, which would cost $56,250 at the beginning of the first year.

REQUIRED:

Round your computations to two decimal points.

A: Determine the net present value of the two investment alternatives.

B: Calculate the present value index for each alternative.

C: Indicate which investment alternative you would recommend. Explain your choice.

10-17B-Applying The Net Present Value Approach With And Without Tax Considerations

Craig Pike, the president of Craig's Moving Services Inc. is planning to spend $800,000 for new trucks. He expects the trucks to increase the company's cash inflow as follows:

Year 1 - $206,250

Year 2 - $225,000

Year 3 - $245,000

Year 4 - $300,000

The company's policy stipulates that all investments must earn a minimum rate of return of 10 percent.

REQUIRED:

Round financial figures to nearest whole dollar.

A: Compute the net present value of the proposed purchase. Should Mr. Pike purchase the trucks?

B: Tammy Buckly, the controller, is wary of the cash flow forecast and points out that Mr. Pike failed to consider the depreciation on trucks used in the project will be tax deductible. The depreciation is expected to be $187,500 per year for the four year period. The company's income tax rate is 30% per year. Use this information to revise the company's expected cash flow from this purchase.

C: Compute the net present value of the purchase based on the revised cash flow forecast. Should Mr. Pike purchase the trucks?

10-19B- Using Net Present Value And Internal Rate of Return to Evaluate Investment Opportunities

Dale Thomas rich uncle gave him $100,000 cash as a gift for his 40^th Birthday. Unlike his spoiled cousins who spend money carelessly. Mr. Thomas wants to invest the money for his future retirement.After an extensive search , he is considering one of two investment opportunities. Project 1 would require an immediate cash payment of $75,000; Project 2 needs only a $37,500 cash payment at the beginning. The expected cash inflows are $22,500 per year for Project 1, and $11,500 per year for Project 2. Both projects are expected to provide cash flow benefits for the next four years. Mr. Thomas found that interest rate for a four year certificate of deposit is about 5 percent. He decided that this is his required rate of return.

REQUIRED:

Rounded indexes to six decimal points and other figures to two decimal points.

A: Compute the net present value of each project. Which project should Mr. Thomas adopt based on the net present value approach?

B: Compute the approximate internal rate of return of each project.Which project should Mr. Thomas adopt based on the internal rate of return approach?

C: Compare the net present value approach with the internal rate of return approach. Which method is better in the given circumstances?

10-21B- Using Net Present Value and Payback Period To Evaluate Investment Opportunities

Wonda Munro just won a lottery and received a cash award of $450,000 net of tax. She is 61 years old and would like to retire in four years. Weighing this important fact, she found two possible investments, both of which require an immediate cash payment of $360,000. The expected cash inflows from the two investment opportunities are as follows:

Year 1 Year 2 Year 3 Year 4

Opportunity A $190,000 $125,000 $64,000 $67,200

Opportunity B $47,000 $62,500 $140,000 $290,000

Ms. Munro decided that her required rate of return should be 10 percent.

REQUIRED:

Round your computations to two decimal points.

A: Compute the net present value of each opportunity. Which should Ms. Munro choose based on the net present value approach?

B: Compute the payback period of each opportunity. Which should Ms. Munro choose based on the payback approach?

C: Compare the net present value approach with the payback approach.Which method is better in the given circumstances?