Exercises related to Chapter 13 Ex. 1 A capital investment project requires an investment of 350,000. It has an expected life of ten years with annual cash flows of 50,000 received at the end of each year. a. Compute payback for the project. b. Determine the accounting rate of return for the project, based on the initial capital investment. c. Compute the internal rate of return for the project. d. Compute the net present value of the project using a 14 per cent discount rate. e. Would you recommend this project be accepted? Why or why not? Ex.2 Mitchell, Inc., is considering two mutually exclusive projects. Project 1 requires an investment of 80,000, while Project 2 requires an investment of 90,000. Cash revenues and cash costs for each project are shown below: YEAR __L_ Revenues 30,000 Variable costs 8,000 Fixed costs 12,000 YEAR __j__ Revenues 65,000 Variable costs 15,000 Fixed costs 5,000 The company estimates that at the end of the fourth year Project 1 would have a salvage value 7,7311 IE 1 iiiiiiiiiiiii 2, ,3 __ 50,000 70,000 90,000 12,000 20,000 25,000 10,000 10,000 10,000 PR IE 2 __2_ _3____ ___4___ 30,000 50,000 40,000 30,000 14,000 12,000 20,000 10,000 8,000 of 10,000 and Project 2 would have a salvage value of 5,000. Determine the net present value of EACH project using an 8 per cent discount rate. Ex.3 Dale Davis Company is evaluating a proposal to purchase a new machine that would cost 100,000 and have a salvage value of 10,000 in four years. It would provide annual operating cash savings of 10,000, as follows: Old Machine New Machine Salaries 40,000 36,000 Supplies 7,000 5,000 Maintenance 9,000 5.000 Total M M If the new machine is purchased, the old machine will be sold for its current salvage value of 20,000. If the new machine is not purchased, the old machine will be disposed of in four years at a predicted salvage value of 2,000. The old machine's present book value is 40,000. If kept, in one year the old machine will require repairs predicted to cost 35,000. Dale Davis's cost of capital is 14 per cent. Reguired: Should the new machine be purchased? Why or why not? Ex. 4 Payback, accounting rate of return and net present value calculations plus a discussion of qualitative factors. The following information relates to three possible capital expenditure projects. Because of capital rationing only one project can be accepted. Project | A | B C gInitial cost |200 000 |230 000,180 000 Expected life I 5 yearsl 5 years 4 years scrap value expected | 10 000| 15 000 8000 1331360th 03811 inowSl ()l ()l () isndyearl | 30000| 100000 55000 " 2 | 70000| 70000 65 000 | | 3 65000I 50000 95 000 4 60000| 50000 100 000 . 5 l 55000| 50000 The company estimates its cost of capital is 18 per cent. Calculate: (a) The payback period for each project. (b) The accounting rate of return for each project. (1:) The net present value of each project. (d) Which project should be accepted - give reasons. Ex. 5 Calculation of payback, NPV and ARR for mutually exclusive projects. Your company is considering investing in its own transport fleet. The present position is that carriage is contracted to an outside organization. The life of the transport fleet would be five years, after which time the vehicles would have to be disposed of. The cost to your company of using the outside organization for its carriage needs is f250 000 for this year. This cost, it is projected, will rise 10 per cent per annum over the life of the project. The initial cost of the transport fleet would be f750 000 and it is estimated that the following costs would be incurred over the next five years: Drivers' Costs (f) Repairs & Maintenance (f) Other Costs (f) Year 1 33 000 8000 130 000 Year 2 35 000 13 000 135 000 Year 3 36 000 15 000 140 000 Year 4 38000 16 000 136 000 Year 5 40 000 18000 142 000 Other costs include depreciation. It is projected that the fleet would be sold for f150 000 at the end of year 5. It has been agreed to depreciate the fleet on a straight line basis. To raise funds for the project your company is proposing to raise a long-term loan at 12 per cent interest rate per annum. You are told that there is an alternative project that could be invested in using the funds raised, which has the following projected results: Payback = 3 years Accounting rate of return = 30% Net present value = f140 000 As funds are limited, investment can only be made in one project. Note: The transport fleet would be purchased at the beginning of the project and all other expenditure would be incurred at the end of each relevant year. Required: (a) Prepare a table showing the net cash savings to be made by the firm over the life of the transport fleet project. (b) Calculate the following for the transport fleet project: (i) Payback period (ii) Accounting rate of return (iii) Net present value (c) Clearly state the reasons whether investment should be committed to the transport fleet or the alternative project outlined