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Exam 25: Capital Investment Analysis

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Question 91

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Methods that ignore present value in capital investment analysis include the average rate of return method.

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Question 92

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Sunrise Inc. is considering a capital investment proposal that costs $227,500 and has an estimated life of 4 years and no residual value. The estimated net cash flows are as follows: $\begin{array} { l l } \text { Year } & \text { Net Cash Flow } \\1 & \$ 97,500 \\2 & 80,000 \\3 & 60,000 \\4 & 40,000\end{array}$ The minimum desired rate of return for net present value analysis is 10%. The present value of $1 at compound interest rates of 10% for 1, 2, 3, and 4 years is 0.909, 0.826, 0.751, and 0.683, respectively. Determine the net present value. Round interim answers to the nearest dollar.

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Question 93

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Below is a table for the present value of $1 at compound interest. $\begin{array} { l l l l } \text { Year } & 6 \% & 10 \% & 12 \% \\\hline 1 & 0.943 & 0.909 & 0.893 \\2 & 0.890 & 0.826 & 0.797 \\3 & 0.840 & 0.751 & 0.712 \\4 & 0.792 & 0.683 & 0.636 \\5 & 0.747 & 0.621 & 0.567\end{array}$ Below is a table for the present value of an annuity of $1 at compound interest. $\begin{array} { l l l l } \text { Year } & 6 \% & { 10 \% }&12\% \\\hline 1 & 0.943 & 0.909 & 0.893 \\2 & 1.833 & 1.736 & 1.690 \\3 & 2.673 & 2.487 & 2.402 \\4 & 3.465 & 3.170 & 3.037 \\5 & 4.212 & 3.791 & 3.605\end{array}$ -Tennessee Corporation is analyzing a capital expenditure that will involve a cash outlay of $109,332. Estimated cash flows are expected to be $36,000 annually for 4 years. The present value factors for an annuity of $1 for 4 years at interest of 10%, 12%, 14%, and 15% are 3.170, 3.037, 2.914, and 2.855, respectively. The internal rate of return for this investment is

Proposals A and B each cost $600,000 and have 5-year lives. Proposal A is expected to provide equal annual net cash flows of $159,000, while the net cash flows for Proposal B are as follows: $\begin{array} { l l } \text { Year 1 } & \$ 150,000 \\\text { Year 2 } & 140,000 \\\text { Year 3 } & 110,000 \\\text { Year 4 } & 150,000 \\\text { Year 5 } &{ 50,000 }\\& { \$ 600,000 }\end{array}$ Determine the cash payback period for each proposal. Round answers to two decimal places.

Tipper Co. is considering a 10-year project that is estimated to cost $700,000 and has no residual value. Tipper seeks to earn an average rate of return of 15% on all capital projects. Determine the necessary average annual income using straight-line depreciation) that must be achieved on this project for it to be acceptable to Tipper Company.

The excess of the cash flowing in from revenues over the cash flowing out for expenses is termed net cash flow.

Match each definition that follows with the term a-e) it defines. -Average income as a percentage of average investment

The rate of earnings is 12% and the cash to be received in 2 years is $10,000. Determine the present value amount, using the following partial table of present value of $1 at compound interest: $\begin{array} { l l l l } \text { Year } & 6 \% & 10 \% & 12 \% \\\hline 1 & 0.943 & 0.909 & 0.893 \\2 & 0.890 & 0.826 & 0.797 \\3 & 0.840 & 0.751 & 0.712 \\4 & 0.792 & 0.683 & 0.636\end{array}$

A project has estimated annual cash flows of $90,000 for 3 years and is estimated to cost $250,000. Assume a minimum acceptable rate of return of 10%. Using the following tables, determine the a) net present value of the project and b) the present value index, rounded to two decimal places. Below is a table for the present value of $1 at compound interest. $\begin{array} { l l l l } \text { Year } & 6 \% & 10 \% & 12 \% \\\hline 1 & 0.943 & 0.909 & 0.893 \\2 & 0.890 & 0.826 & 0.797 \\3 & 0.840 & 0.751 & 0.712 \\4 & 0.792 & 0.683 & 0.636 \\5 & 0.747 & 0.621 & 0.567\end{array}$ Below is a table for the present value of an annuity of $1 at compound interest. $\begin{array} { l l l l } \text { Year } & 6 \% & 10 \% & 12 \% \\\hline 1 & 0.943 & 0.909 & 0.893 \\2 & 1.833 & 1.736 & 1.690 \\3 & 2.673 & 2.487 & 2.402 \\4 & 3.465 & 3.170 & 3.037 \\5 & 4.212 & 3.791 & 3.605\end{array}$

Match each definition that follows with the term a-f) it defines. -The process by which management allocates funds among various capital investment proposals

The process by which management allocates available investment funds among competing investment proposals is called

The average rate of return method of analyzing capital budgeting decisions measures the average rate of return from using the asset over its entire life.

The management of California Corporation is considering the purchase of a new machine costing $400,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability of this investment: $\begin{array} { l l l } & \text { Income from } & \text { Net Cash } \\\text { Year } & \text { Operations } & \text { Flow } \\1 & \$ 100,000 & \$ 180,000 \\2 & 40,000 & 120,000 \\3 & 20,000 & 100,000 \\4 & 10,000 & 90,000 \\5 & 10,000 & 90,000\end{array}$ The present value index for this investment is

Which of the following are two methods of analyzing capital investment proposals that both ignore present value?

A company is considering purchasing a machine for $21,000. The machine will generate income from operations of $2,000; annual net cash flows from the machine will be $3,500. The payback period for the new machine is 10.5 years.

When several alternative investment proposals of the same amount are being considered, the one with the largest net present value is the most desirable. If the alternative proposals involve different amounts of investment, it is useful to prepare a relative ranking of the proposals by using an)

The expected average rate of return for a proposed investment of $800,000 in a fixed asset with a useful life of 4 years, straight-line depreciation, no residual value, and an expected total net income of $360,000 for the 4 years, is

What is capital investment analysis? Why are capital investment analysis decisions often difficult and risky?

A company is contemplating investing in a new piece of manufacturing machinery. The amount to be invested is $100,000. The present value of the future cash flows at the company's desired rate of return is $100,000. The IRR on the project is 12%. Which of the following statements is true?

What is the present value of $8,000 to be received at the end of 6-years if the required rate of return is 15%? Below is a table for the present value of $1 at compound interest. $\begin{array} { l l l l } \text { Year } & 15 \% & \text { Year } & 15 \% \\\hline 1 & 0.870 & 6 & 0.432 \\2 & 0.756 & 7 & 0.376 \\3 & 0.658 & 8 & 0.327 \\4 & 0.572 & 9 & 0.284 \\5 & 0.497 & 10 & 0.247\end{array}$ Below is a table for the present value of an annuity of $1 at compound interest. $\begin{array}{llll}\text { Year } & 15 \% & \text { Year } &15 \%\\\hline1 & 0.870 & 6 & 3.785 \\2 & 1.626 & 7 & 4.160 \\3 & 2.283 & 8 & 4.487 \\4 & 2.855 & 9 & 4.772 \\5 & 3.353 & 10 & 5.019\end{array}$