Question 1

Net Present Value Method, Present Value Index, and Analysis for a service company

Continental Railroad Company is evaluating three capital investment proposals by using the net present value method. Relevant data related to the proposals are summarized as follows:

	Maintenance Equipment	Ramp Facilities	Computer Network
Amount to be invested	$653,998		$396,814		$217,985
Annual net cash flows:
	Year 1	322,000		225,000		151,000
	Year 2	299,000		203,000		104,000
	Year 3	274,000		180,000		76,000

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Required:

1. Assuming that the desired rate of return is 20%, prepare net present value analysis for each proposal. Use the present value of $1 table above. If required, use the minus sign to indicate a negative net present value. If required, round to the nearest dollar.

	Maintenance Equipment	Ramp Facilities	Computer Network
Total present value of net cash flow	$fill in the blank 1	$fill in the blank 2	$fill in the blank 3
Amount to be invested	fill in the blank 4	fill in the blank 5	fill in the blank 6
Net present value	$fill in the blank 7	$fill in the blank 8	$fill in the blank 9

2. Determine a present value index for each proposal. If required, round answers to two decimal places.

	Present Value Index
Maintenance Equipment	fill in the blank 10
Ramp Facilities	fill in the blank 11
Computer Network	fill in the blank 12

3. The

maintenance equipmentramp facilitiescomputer network

has the largest present value index. Although

maintenance equipmentramp facilitiescomputer network

has the largest net present value, it returns less present value per dollar invested than does the

maintenance equipmentramp facilitiescomputer network

, as revealed by the present value indexes. The present value index for the

maintenance equipmentramp facilitiescomputer network

is less than 1, indicating that it does not meet the minimum rate of return standard.

Question 2

Cash Payback Period, Net Present Value Method, and Analysis for a Service Company

Social Circle Publications Inc. is considering two new magazine products. The estimated net cash flows from each product are as follows:

Year	Sound Cellar	Pro Gamer
1		$65,000			$70,000
2	60,000	55,000
3	25,000	35,000
4	25,000	30,000
5	45,000	30,000
Total	$220,000	$220,000

Each product requires an investment of $125,000. A rate of 10% has been selected for the net present value analysis.

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Required:

1a.Compute the cash payback period for each product.

	Cash Payback Period
Sound Cellar	1 year2 years3 years4 years5 years
Pro Gamer	1 year2 years3 years4 years5 years

1b. Compute the net present value for each product. Use the present value of $1 table above. If required, round to the nearest dollar.

	Sound Cellar	Pro Gamer
Total present value of net cash flow	$fill in the blank 3	$fill in the blank 4
Amount to be invested	fill in the blank 5	fill in the blank 6
Net present value	$fill in the blank 7	$fill in the blank 8

2. Because of the timing of the receipt of the net cash flows, the

Pro GamerSound Cellar

magazine expansion offers a higher

net cash flownet present value

.

Question 3

Average Rate of Return Method, Net Present Value Method, and analysis for a Service Company

The capital investment committee of Ellis Transport and Storage Inc. is considering two investment projects. The estimated operating income and net cash flows from each investment are as follows:

	Warehouse			Tracking Technology
Year	Operating Income		Net Cash Flow	Operating Income		Net Cash Flow
1	$ 61,400		$135,000			$ 34,400		$108,000
2	51,400	125,000	34,400	108,000
3	36,400	110,000	34,400	108,000
4	26,400	100,000	34,400	108,000
5	(3,600)	70,000	34,400	108,000
Total	$172,000	$540,000	$172,000	$540,000

Each project requires an investment of $368,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% for purposes of the net present value analysis.

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Required:

1a.Compute the average rate of return for each investment. If required, round answers to one decimal place.

	Average Rate of Return
Warehouse	fill in the blank 1%
Tracking Technology	fill in the blank 2%

1b.Compute the net present value for each investment. Use the present value of $1 table above. If required, use the minus sign to indicate a negative net present value. If required, round to the nearest dollar.

	Warehouse	Tracking Technology
Total present value of net cash flow	$fill in the blank 3	$fill in the blank 4
Amount to be invested	fill in the blank 5	fill in the blank 6
Net present value	$fill in the blank 7	$fill in the blank 8

2. The

tracking technologywarehouse

net present value exceeds the selected rate established for discounted cash flows (15%), while the

tracking technologywarehouse

does not. Thus, considering only quantitative factors, the

tracking technologywarehouse

investment should be selected.

Question 4

Average Rate of ReturnNew Product

Hana Inc. is considering an investment in new equipment that will be used to manufacture a smartphone. The phone is expected to generate additional annual sales of 3,400 units at $170 per unit. The equipment has a cost of $379,400, residual value of $28,600, and an 8-year life. The equipment can only be used to manufacture the phone. The cost to manufacture the phone follows:

Cost per unit:
	Direct labor	$27.00
	Direct materials	105.00
	Factory overhead (including depreciation)	18.20
		Total cost per unit	$150.20

Determine the average rate of return on the equipment. If required, round to the nearest whole percent.

fill in the blank 1 %

Question 5

Net Present Value Method for a Service Company

Carnival (CCL) has recently placed into service some of the largest cruise ships in the world. One of these ships, the Carnival Breeze, can hold up to 3,600 passengers, which can cost $750 million to build. Assume the following additional information:

• There will be 340 cruise days per year operated at a full capacity of 3,600 passengers.
• The variable expenses per passenger are estimated to be $100 per cruise day.
• The revenue per passenger is expected to be $280 per cruise day.
• The fixed expenses for running the ship, other than depreciation, are estimated to be $90,000,000 per year.
• The ship has a service life of 10 years, with a residual value of $60,000,000 at the end of 10 years.

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	1.833	1.736	1.690	1.626	1.528
3	2.673	2.487	2.402	2.283	2.106
4	3.465	3.170	3.037	2.855	2.589
5	4.212	3.791	3.605	3.353	2.991
6	4.917	4.355	4.111	3.785	3.326
7	5.582	4.868	4.564	4.160	3.605
8	6.210	5.335	4.968	4.487	3.837
9	6.802	5.759	5.328	4.772	4.031
10	7.360	6.145	5.650	5.019	4.192

a. Determine the annual net cash flow from operating the cruise ship.

Revenues	$fill in the blank 1
Variable expenses	fill in the blank 2
Fixed expenses (other than depreciation)	fill in the blank 3
Annual net cash flow	$fill in the blank 4

b. Determine the net present value of this investment, assuming a 12% minimum rate of return. Use the present value tables provided above.

Present value of annual net cash flows	$fill in the blank 5
Present value of residual value	fill in the blank 6
Total present value	$fill in the blank 7
Amount to be invested	fill in the blank 8
Net present value	$fill in the blank 9

Question 6

Net Present ValueUnequal Lives

Daisy's Creamery Inc. is considering one of two investment options. Option 1 is a $75,000 investment in new blending equipment that is expected to produce equal annual cash flows of $19,000 for each of seven years. Option 2 is a $90,000 investment in a new computer system that is expected to produce equal annual cash flows of $27,000 for each of five years. The residual value of the blending equipment at the end of the fifth year is estimated to be $15,000. The computer system has no expected residual value at the end of the fifth year.

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	1.833	1.736	1.690	1.626	1.528
3	2.673	2.487	2.402	2.283	2.106
4	3.465	3.170	3.037	2.855	2.589
5	4.212	3.791	3.605	3.353	2.991
6	4.917	4.355	4.111	3.785	3.326
7	5.582	4.868	4.564	4.160	3.605
8	6.210	5.335	4.968	4.487	3.837
9	6.802	5.759	5.328	4.772	4.031
10	7.360	6.145	5.650	5.019	4.192

Assume there is sufficient capital to fund only one of the projects. Determine which project should be selected, computing the (a) net present values and (b) present value indexes of the two projects. Assume a minimum rate of return of 10%. Use the present value tables appearing above.

a. Determine the net present values of the two projects.

	Blending Equipment	Computer System
Total present value of cash flows	$fill in the blank 1	$fill in the blank 2
Less amount to be invested	fill in the blank 3	fill in the blank 4
Net present value	$fill in the blank 5	$fill in the blank 6

b. Determine the present value indexes of the two projects. If required, round the present value index to two decimal places.

	Present Value Index
Blending Equipment	fill in the blank 7
Computer System	fill in the blank 8

Which project should be selected?

Blending EquipmentComputer System

Question 7

Capital Rationing Decision for a Service Company Involving Four Proposals

Clearcast Communications Inc. is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated Operating income, and net cash flow for each proposal are as follows:

	Investment	Year		Operating Income		Net Cash Flow
Proposal A:	$450,000	1		$30,000		$120,000
2	30,000	120,000
3	20,000	110,000
4	10,000	100,000
5	(30,000)	60,000
	$60,000	$510,000
Proposal B:	$200,000	1	$60,000	$100,000
2	40,000	80,000
3	20,000	60,000
4	(10,000)	30,000
5	(20,000)	20,000
	$90,000	$290,000
Proposal C:	$320,000	1	$36,000	$100,000
2	26,000	90,000
3	26,000	90,000
4	16,000	80,000
5	16,000	80,000
	$120,000	$440,000
Proposal D:	$540,000	1	$92,000	$200,000
2	72,000	180,000
3	52,000	160,000
4	12,000	120,000
5	(8,000)	100,000
	$220,000	$760,000

The company's capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average rate of return of 12% is required on all projects. If the preceding standards are met, the net present value method and present value indexes are used to rank the remaining proposals.

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Required:

1. Compute the cash payback period for each of the four proposals.

	Cash Payback Period
Proposal A:	4 years3 years3 years, 4 months2 years3 years, 9 months
Proposal B:	2 years2 years, 4 months3 years3 years, 3 months4 years
Proposal C:	3 years3 years, 3 months2 years, 9 months3 years, 6 months4 years
Proposal D:	3 years3 years, 6 months2 years, 6 months2 years, 8 months3 years, 10 months

2. Giving effect to straight-line depreciation on the investments and assuming no estimated residual value, compute the average rate of return for each of the four proposals. If required, round answers to one decimal place.

	Average Rate of Return
Proposal A:	fill in the blank 5 %
Proposal B:	fill in the blank 6 %
Proposal C:	fill in the blank 7 %
Proposal D:	fill in the blank 8 %

3. Using the following format, summarize the results of your computations in parts (1) and (2). By placing the calculated amounts in the first two columns on the left and indicate which proposals should be accepted for further analysis and which should be rejected. If required, round answers to one decimal place.

Proposal	Cash Payback Period	Average Rate of Return	Accept or Reject
A	3 years, 6 months3 years, 3 months2 years4 years2 years, 9 months	fill in the blank 10	%	AcceptReject
B	2 years, 4 months3 years, 3 months3 years, 6 months3 years4 years	fill in the blank 13	%	AcceptReject
C	3 years, 6 months3 years, 3 months3 years4 years2 years, 9 months	fill in the blank 16	%	AcceptReject
D	3 years, 6 months3 years, 3 months2 years3 years4 years2 years, 9 months	fill in the blank 19	%	AcceptReject

4. For the proposals accepted for further analysis in part (3), compute the net present value. Use rate of 12% and the present value of $1 table above. Round to the nearest dollar.

Select the proposal accepted for further analysis.	Proposal AProposal BProposal CProposal D	Proposal AProposal BProposal CProposal D
Present value of net cash flow total	$fill in the blank 23	$fill in the blank 24
Amount to be invested	fill in the blank 25	fill in the blank 26
Net present value	$fill in the blank 27	$fill in the blank 28

5. Compute the present value index for each of the proposals in part (4). If required, round answers to two decimal places.

Select proposal to compute Present value index.	Proposal AProposal BProposal CProposal D	Proposal AProposal BProposal CProposal D
Present value index (rounded)	fill in the blank 31	fill in the blank 32

6. Rank the proposals from most attractive to least attractive, based on the present values of net cash flows computed in part (4).

Rank 1st	Proposal AProposal BProposal CProposal D
Rank 2nd	Proposal AProposal BProposal CProposal D

7. Rank the proposals from most attractive to least attractive, based on the present value indexes computed in part (5).

Rank 1st	Proposal AProposal BProposal CProposal D
Rank 2nd	Proposal AProposal BProposal CProposal D

8. The analysis indicates that although Proposal

ABCD

has the larger net present value, it is not as attractive as Proposal

ABCD

in terms of the amount of present value per dollar invested. Proposal

ABCD

requires the larger investment. Thus, management should use investment resources for Proposal

ABCD

before investing in Proposal

ABCD

, absent any other qualitative considerations that may impact the decision.

Question 8

Cash Payback Period, Net Present Value Analysis, and Qualitative Considerations

The plant manager of Shenzhen Electronics Company is considering the purchase of new automated assembly equipment. The new equipment will cost $272,000. The manager believes that the new investment will result in direct labor savings of $68,000 per year for 10 years.

Present Value of an Annuity of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	1.833	1.736	1.690	1.626	1.528
3	2.673	2.487	2.402	2.283	2.106
4	3.465	3.170	3.037	2.855	2.589
5	4.212	3.791	3.605	3.353	2.991
6	4.917	4.355	4.111	3.785	3.326
7	5.582	4.868	4.564	4.160	3.605
8	6.210	5.335	4.968	4.487	3.837
9	6.802	5.759	5.328	4.772	4.031
10	7.360	6.145	5.650	5.019	4.192

a. What is the payback period on this project? fill in the blank 1 years

b. What is the net present value, assuming a 10% rate of return? Use the table provided above. Round to the nearest whole dollar.

Net present value

$fill in the blank 2

c. What else should the manager consider in the analysis?

DepreciationTaxes and Maintenance costsDepreciation and TaxesMaintenance costsTaxes