QUESTION 1

Net Present Value Method

The management of Threader Company, a wholesale distributor of cracker products, is considering the purchase of a $30,000 machine that would reduce operating costs in its warehouse by $5,000 per year. At the end of the machine's eight-year useful life, it will have no scrap value. The company's required rate of return is 11%.

Required:

(Ignore income taxes.)

1. Determine the net present value of the investment in the machine.
2. What is the difference between the total undiscounted cash inflows and cash outflows over the entire life of the machine?

Initial Cash Outflow = $30,000 Annual Cash Inflow = $5,000 Useful Life = 8 years Rate of Return = 11%

Present Value of Cash Inflows = $5,000 * PVA of $1 (11%, 8) Present Value of Cash Inflows = $5,000 * (1 - (1/1.11)^8) / 0.11 Present Value of Cash Inflows = $5,000 * 5.1461 Present Value of Cash Inflows = $25,730.50

Net Present Value = Present Value of Cash Inflows - Initial Cash Outflow Net Present Value = $25,730.50 - $30,000 Net Present Value = -$4,269.50

Answer 2

Total Cash Inflows = 8 * $5,000 Total Cash Inflows = $40,000

Difference = $40,000 - $30,000 Difference = $10,000

QUESTION 2

Internal Rate of Return

Billy Brown, owner of Billy's Ice Cream On-the Go is investigating the purchase of a new $45,000 delivery truck that would contain specially designed warming racks. The new truck would have a six-year useful life. It would save $5,400 per year over the present method of delivering pizzas. In addition, it would result in the sale of 1,800 more litres of ice cream each year. The company realizes a contribution margin of $2 per litre.

Required:

(Ignore income taxes.)

1. What would be the total annual cash inflows associated with the new truck for capital budgeting purposes?
2. Find the internal rate of return promised by the new truck to the nearest whole percent point.
3. In addition to the data above, assume that due to the unique warming racks, the truck will have a $13,000 salvage value at the end of six years. Under these conditions, compute the internal rate of return to the nearest whole percentage point. (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.

QUESTION 3

Uncertain Future Cash Flows

Jannsen Limited is investigating the purchase of solar panels that would save $100,000 each year in electricity costs. This solar panels cost $750,000 and is expected to have a 10-year useful life with no salvage value. The company requires a minimum 15% rate of return on all equipment purchases. This equipment would provide intangible benefits (such as greater flexibility and higher-quality output) that are difficult to estimate and yet are quite significant.

Required:

(Ignore income taxes.)

What dollar value per year would the intangible benefits have to be worth in order to make the solar panels an acceptable investment?

QUESTION 4

Preference Ranking

Information on four investment proposals is given below:

Investment Proposal

A B C D

Investment required $(85,000) $(200,000) $(90,000) $(170,000)

Present value of cash flows 119,000 250,000 135,000 221,000

Net present value $34,000 $50,000 $45,000 $51,000

Life of the project 5 years 7 years 6 years 6 years

Required:

1. Compute the project profitability index for each investment proposal.
2. Rank the proposals in terms of preference.

QUESTION 5

Payback Method

The management of Deitrich Inc., a civil engineering design company, is considering an investment in a high-quality blueprint printer with the following cash flows:

Year Investment Cash Inflow

1 $28,000 $2,000

2 $4,000 $3,000

3 $6,000

4 $8,000

5 $9,000

6 $8,000

7 $6,000

8 $5,000

9 $4,000

10 $4,000

Required:

1. Determine the payback period of the investment.
2. Would the payback period be affected if the cash inflow in the last year was several times larger?

QUESTION 6

Simple Rate of Return Method

The management of Stillford Micro Brew is considering the purchase of an automated bottling machine for $80,000. The machine would replace an old piece of equipment that costs $33,000 per year to operate. The new machine would cost $10,000 per year to operate. The old machine currently in use could be sold now for a scrap value of $5,000. The new machine would have a useful life of 10 years with no salvage value.

Required:

Compute the simple rate of return on the new automated bottling machine.