Question 3

Net present value method

The following data are accumulated by Geddes Company in evaluating the purchase of $130,000 of equipment, having a four-year useful life:

	Net Income	Net Cash Flow
Year 1	$40,000		$72,500
Year 2	30,000		62,500
Year 3	14,000		46,500
Year 4	5,500		38,000

This information has been collected in the Microsoft Excel Online file. Open the spreadsheet, perform the required analysis, and input answers in the questions below.

Open spreadsheet

1. Assuming that the desired rate of return is 10%, determine the net present value for the proposal. If required, round to the nearest dollar.

Net present value

$fill in the blank 2

1. Would management be likely to look with favor on the proposal?

YesNo

1. , the net present value indicates that the return on the proposal isthan the minimum desired rate of return of 10%.

greaterless

Question 4

Determine Cash Flows

Natural Foods Inc. is planning to invest in new manufacturing equipment to make a new garden tool. The new garden tool is expected to generate additional annual sales of 8,100 units at $52 each. The new manufacturing equipment will cost $175,400 and is expected to have a 10-year life and a $13,400 residual value. Selling expenses related to the new product are expected to be 5% of sales revenue. The cost to manufacture the product includes the following on a per-unit basis:

Direct labor	$8.80
Direct materials	28.90
Fixed factory overhead-depreciation	2.00
Variable factory overhead	4.50
	Total	$44.20

Determine the net cash flows for the first year of the project, Years 2-9, and for the last year of the project. Use the minus sign to indicate cash outflows. Do not round intermediate calculations but, if required, round final answers to the nearest dollar.

	Year 1	Years 2-9	Last Year
Initial investment	$fill in the blank 1
Operating cash flows:
Annual revenues	$fill in the blank 2	$fill in the blank 3	$fill in the blank 4
Selling expenses	fill in the blank 5	fill in the blank 6	fill in the blank 7
Cost to manufacture	fill in the blank 8	fill in the blank 9	fill in the blank 10
Net operating cash flows	$fill in the blank 11	$fill in the blank 12	$fill in the blank 13
Total for Year 1	$fill in the blank 14
Total for Years 2-9 (operating cash flow)		$fill in the blank 15
Residual value			fill in the blank 16
Total for last year			$fill in the blank 17

Question 5

Net present valueunequal lives

Bunker Hill Mining Company has two competing proposals: a processing mill and an electric shovel. Both pieces of equipment have an initial investment of $780,000. The net cash flows estimated for the two proposals are as follows:

	Net Cash Flow
Year	Processing Mill	Electric Shovel
1	$320,000		$336,000
2	244,000		323,000
3	244,000		321,000
4	256,000		310,000
5	185,000
6	149,000
7	132,000
8	132,000

The estimated residual value of the processing mill at the end of Year 4 is $280,000.

This information has been collected in the Microsoft Excel Online file. Open the spreadsheet, perform the required analysis, and input answers in the questions below.

Open spreadsheet

Determine which equipment should be favored, comparing the net present values of the two proposals and assuming a minimum rate of return of 20%. If required, round to the nearest dollar.

	Processing Mill	Electric Shovel
Net present value	$fill in the blank 2	$fill in the blank 3

Which project should be favored?

Electric ShovelProcessing MillNeither because they are equal

Question 6

Average Rate of Return Method, Net Present Value Method, and Analysis for a service company

The capital investment committee of Arches Landscaping Company is considering two capital investments. The estimated operating income and net cash flows from each investment are as follows:

	Front-End Loader		Greenhouse
Year	Operating Income	Net Cash Flow		Operating Income	Net Cash Flow
1	$36,100		$110,000			$76,000		$176,000
2	36,100		110,000			58,000		149,000
3	36,100		110,000			29,000		105,000
4	36,100		110,000			13,000		72,000
5	36,100		110,000			4,500		48,000
Total	$180,500		$550,000			$180,500		$550,000

Each project requires an investment of $380,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 10% 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 answer to one decimal place.

	Average Rate of Return
Front-End Loader	fill in the blank 1%
Greenhouse	fill in the blank 2%

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

	Front-End Loader	Greenhouse
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. A brief report for the capital investment committee, advising it on the relative merits of the two investments.

The front-end loader has a

smallerlarger

net present value because cash flows occur

earlierlater

in time compared to the greenhouse. Thus, if only one of the two projects can be accepted, the

front-end loadergreenhouse

would be the more attractive.

Question 7

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 $111,000. The manager believes that the new investment will result in direct labor savings of $37,000 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

Question 8

Average Rate of Return, Cash Payback Period, Net Present Value Method for a Service Company

Spanish Peaks Railroad Inc. is considering acquiring equipment at a cost of $260,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $65,000. The company's minimum desired rate of return for net present value analysis is 10%.

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

Compute the following:

a. The average rate of return, giving effect to straight-line depreciation on the investment. If required, round answer to one decimal place. fill in the blank 1%

b. The cash payback period.

2 years3 years4 years5 years6 years7 years8 years

c. The net present value. Use the above table of the present value of an annuity of $1. Round to the nearest dollar. If required, use a minus sign to indicate negative net present value for current grading purpose.

Present value of annual net cash flows	$fill in the blank 3
Amount to be invested	$fill in the blank 4
Net present value	$fill in the blank 5

Question 9

Internal Rate of Return Method for a Service Company

The Riverton Company, announced a $340,760 million expansion of lodging properties, ski lifts, and terrain in Park City, Utah. Assume that this investment is estimated to produce $70,000 million in equal annual cash flows for each of the first seven years of the project life.

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 expected internal rate of return of this project for seven years, using the present value of an annuity of $1 table above. fill in the blank 1 %

b. Identify the uncertainties that could reduce the internal rate of return of this project?

Warm weather conditions, or no snowRecessionary economic conditions that reduce the demand for ski holidaysCompetitor property improvements that siphon demand from the projectIncreased fuel costs that increase the cost of travel to ski resorts, thus reducing demand from nonlocal patronsIndustry overbuilding that causes a price war to maintain volumeAll of these

Question 10

Average Rate of Return

The following data are accumulated by Watershed Inc. in evaluating two competing capital investment proposals:

	Project A	Project Z
Amount of investment	$48,000			$84,000
Useful life	4 years			9 years
Estimated residual value	0			0
Estimated total income over the useful life	$7,680			$43,470

Determine the expected average rate of return for each project. Round answers to one decimal place.

Project A	fill in the blank 1%
Project Z	fill in the blank 2%