CHAP 26

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2)

Ben Paul is an accounting major at a western university located approximately 60 miles from a major city. Many of the students attending the university are from the metropolitan area and visit their homes regularly on the weekends. Ben, an entrepreneur at heart, realizes that few good commuting alternatives are available for students doing weekend travel. He believes that a weekend commuting service could be organized and run profitably from several suburban and downtown shopping mall locations. Ben has gathered the following investment information.

1. Five used vans would cost a total of $90,000 to purchase and would have a 3-year useful life

with negligible salvage value. Ben plans to use straight-line depreciation.

2. Ten drivers would have to be employed at a total payroll expense of $43,000.

3. Other annual out-of-pocket expenses associated with running the commuter service would

include Gasoline $26,000, Maintenance $4,000, Repairs $5,300, Insurance $4,500,

Advertising $2,200.

4. Ben desires to earn a return of 15% on his investment.

5. Ben expects each van to make ten round trips weekly and carry an average of six students

each trip. The service is expected to operate 32 weeks each year, and each student will be

charged $15 for a round-trip ticket.

Instructions

(a) Determine the annual:

(1) net income and

(2) net annual cash flows for the commuter service.

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3)

E26-11 Drake Corporation is reviewing an investment proposal. The initial cost and esti- mates of the book value of the investment at the end of each year, the net cash flows for each year, and the net income for each year are presented in the schedule below. All cash flows are assumed to take place at the end of the year. The salvage value of the investment at the end of each year is equal to its book value. There would be no salvage value at the end of the investment's life. Investment Proposal Initial Cost Annual Annual Year and Book Value Cash Flows Net Income $105,000 70,000 $45,000 $10,000 42,000 40,000 12,000 21,000 35,000 14,000 7,000 30,000 16,000 25,000 18,000 Drake Corporation uses an 11% target rate of return for new investment proposals. Instructions (a) What is the cash payback period for this proposal? (b) What is the annual rate of return for the investment? (c) What is the net" present value of the investment? (a) Cash payback period is: (b-1) Average Investment is: (b-2) Annual Rate of Return is: (c) Net Cash Flows: Year # Present Value Discount Factor 11% 0.90090 Amount $ 45,000 2 Total Present value cash inflows Less: ?? Net Present Value (a) (1) Annual (2) Annual Net Income Cash Flow 144,000 144,000 Sales Expenses: Payroll Gas Total Expenses Net Income Cash Inflow BEG-8 (a) What is the present value of a single amount of $25,000 due 9 years from now, discounted at 10%. (b) What is the present value of a series of $25,000 payments, to be received at the end of each of 6 years, discounted at 9%? BRIEF EXERCISE ... BEG - 8 (a) (b)