Answer and explain (show solution) from exercise 12-8 to 12-12
EXERCISE 12-8 Payback Period and Simple Rate of Return LO12-1, LO12-6 Nick's Novelties, Inc., is considering the purchase of new electronic games to place in its amusement houses. The games would cost a total of $300,000, have an eight-year useful life, and have a total salvage Capital Budgeting Decisions 595 value of $20,000. The company estimates that annual revenues and expenses associated with the games would be as follows: Revenues ... . . . . . . . . . . . .... $200,000 Less operating expenses Commissions to amusement houses $100,000 Insurance . . 7,000 Depreciation . .. 35,000 Maintenance 18,000 160,000 Net operating income . ... $ 40,000 Required: 1. What is the payback period for the new electronic games? Assume that Nick's Novelties, Inc., will not purchase new games unless they provide a payback period of five years or less. Would the company purchase the new games? 2. What is the simple rate of return promised by the games? If the company requires a simple rate of return of at least 12%, will the games be purchased? EXERCISE 12-9 Net Present Value Analysis and Simple Rate of Return LO12-2, LO12-6 Derrick Iverson is a divisional manager for Holston Company. His annual pay raises are largely determined by his division's return on investment (ROD), which has been above 20% each of the last three years. Derrick is considering a capital budgeting project that would require a $3,000,000 investment in equipment with a useful life of five years and no salvage value. Holston Company's discount rate is 15%. The project would provide net operating income each year for five years as follows: Sales . . . . . . . . . . . .. . . . .. $2,500,000 Variable expenses 1,000,000 Contribution margin . . . .. . . . . . .. .. 1,500,000 Fixed expenses: Advertising, salaries, and other fixed out-of-pocket costs - . . . . $600,000 Depreciation .. 600,000 Total fixed expenses 1,200,000 Net operating income . . . . . . . . . . . . . . . . ... ... $ 300,000 Required: 1. Compute the project's net present value. 2. Compute the project's simple rate of return. 3 Would the company want Derrick to pursue this investment opportunity? Would Derrick be inclined to pursue this investment opportunity? Explain. EXERCISE 12-10 Net Present Value Analysis LO12-2 Kathy Myers frequently purchases stocks and bonds, but she is uncertain how to determine the rate of return that she is earning. For example, three years ago she paid $13,000 for 200 shares of Malti Company's common stock. She received a $420 cash dividend on the stock at the end of each year for three years. At the end of three years, she sold the stock for $16,000. Kathy would like to earn a return of at least 14% on all of her investments. She is not sure whether the Malti Company stock provide a 14% return and would like some help with the necessary computations. Required: 1. Compute the net present value that Kathy earned on her investment in Malti Company stock. Round your answer to the nearest whole dollar. 2. Did the Malti Company stock provide a 14% return? 596 Chapter 12 EXERCISE 12-11 Preference Ranking of Investment Projects LO12-5 Oxford Company has limited funds available for investment and must ration the funds among four competing projects. Selected information on the four projects follows: Life of Net the Internal Investment Present Project Rate of Project Required Value (years) Return A.. .. . .......... $160,000 $44,323 18% B $135,000 $42,000 12 16% C $100,000 $35,035 20% w - D. . . . . . ......... $175,000 $38,136 22% The net present values above have been computed using a 10% discount rate. The company wants your assistance in determining which project to accept first, second, and so forth. Required: Compute the project profitability index for each project. 2. In order of preference, rank the four projects in terms of: a. Net present value. b. Project profitability index. c. Internal rate of return. 3. Which ranking do you prefer? Why? EXERCISE 12-12 Uncertain Cash Flows LO12-4 The Cambro Foundation, a nonprofit organization, is planning to invest $104,950 in a project that will last for three years. The project will produce net cash inflows as follows: Year 1 . ... - . . . . . .... $30,000 Year 2 $40.000 Year 3 . . . . . . . . .. Required: Assuming that the project will yield exactly a 12% rate of return, what is the expected net cash inflow for Year 3
