164. Nelson Inc. is considering the purchase of a $600,000 machine to manufacture a specialty
tap for electrical equipment. The tap is in high demand and Nelson can sell all that it can
manufacture each year for the next 10 years, the government exempts taxes on profits from new
investments. This legislation will most likely remain in effect in the foreseeable future. The
equipment is expected to have 10 years of useful life with no salvage value. The firm uses the
double-declining-balance depreciation method and switches to the straight-line depreciation
method in the last four years of the asset’s 10-year life. Nelson uses a rate of 10% (weighted–
average cost of capital) in evaluating its capital investments. The net cash inflows are expected
to be as follows:
Year Cash
Inflow
1 $40,000
2 70,000
3 100,000
4 170,000
5 200,000
6 250,000
7 230,000
8 200,000
9 100,000
10 40,000
Required:
1. Under the assumption that cash inflows occur evenly throughout the year, what is the
estimated payback period for this investment (round your answer to two decimal points)?
2. What is the estimated accounting (book) rate of return (ARR) based on initial investment
(rounded to two decimal places, e.g., 12.348% = 12.35%)?
3. What is the estimated accounting (book) rate of return (ARR) based on average investment,
where “average investment” is defined as a simple average of the beginning–of-project book
value and the end–of-project book value of the asset? Round your answer to two decimal places.
165. Nelson Inc. is considering the purchase of a $600,000 machine to manufacture a specialty
tap for electrical equipment. The tap is in high demand and Nelson can sell all that it could
manufacture each year for the next 10 years; the government exempts taxes on profits from new
investments (including the investment being considered here). This legislation will most likely
remain in effect in the foreseeable future. The equipment is expected to have a 10-year useful
life with no salvage value. The firm uses the double-declining-balance depreciation method and
switches to the straight-line depreciation method in the last four years of the asset’s 10-year life.
Nelson uses a 10% weighted-average cost of capital (WACC) in evaluating its capital investment
proposals. The net cash inflows are expected to be as follows:
Year Cash
Inflow
1 $40,000
2 70,000
3 100,000
4 170,000
5 200,000
6 250,000
7 230,000
8 200,000
9 100,000
10 40,000
Note: PV $1 factors, at 10%: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683; year
5 = 0.621; year 6 = 0.564; year 7 = 0.513; year 8 = 0.467; year 9 = 0.424; year 10 = 0.386. The PV
annuity factor for 10 years, 10% = 6.145.
Required:
1. What is the estimated net present value (NPV) of this proposed investment, rounded to the
nearest thousand?
2. What is the estimated internal rate of return (IRR) on this project, rounded to the nearest
whole % (e.g., 20.34% = 20%, 20.52% = 21%, etc.)? (Note: Students would have to have access to
Excel in order to answer this question.)
3. What is the present value payback period for this proposed investment, in years (rounded to
two decimal places)?
In the solutions below, the PV factors from the tables in the chapter are used for PV calculations
(as given above, in the problem). If Excel is used, there will likely be minor rounding differences.
166. Fritz Company is planning to acquire a $250,000 machine to improve manufacturing
efficiencies, thereby reducing annual cash operating costs (before taxes) by $80,000 for each of
the next five years. The company has a minimum rate of return of 8% on all capital investments.
The machine will be depreciated using straight-line method over a five-year life with no salvage
value at the end of five years. Fritz is subject to a combined 40% income tax rate.
Required:
1. What is the machine’s payback period, in years (rounded to two decimal places, e.g., 4.25
years), under the assumption that cash flows occur evenly throughout the year?
2. What is the accounting (book) rate of return (ARR), based on the initial investment amount
(rounded to one decimal place, that is, nearest one-tenth of a percent, e.g., 12.3%)?
167. Kravitz Company is planning to acquire a $250,000 machine to improve manufacturing
efficiencies, thereby reducing annual cash operating costs (before taxes) by $80,000 for each of
the next five years. The company’s estimated weighted-average cost of capital (WACC) is 8%.
The machine will be depreciated using straight-line method over a five-year life with no salvage
value. Fritz is subject to a combined 40% income tax rate.
Note: at 8%, the PV annuity factor for five years is 3.993; at 8%, PV $1 factors are as follows: for
year 1 = 0.926; for year 2 = 0.857; for year 3 = 0.794; for year 4 = 0.735; and, for year 5 = 0.681.
Required:
1. What is the estimated net present value (NPV) of the proposed investment?
2. What is the present value payback period, in years (rounded to one decimal place, that is, to
tenth of a year, e.g., 4.1 years)?
3. What is the estimated internal rate of return (IRR) on the proposed investment? Round your
answer to one decimal place (i.e., tenth of a percent, e.g., 13.4%). (Note: to answer this question,
you will need access to the tables presented in Chapter 12, Appendix C or to Excel.)
168. Slumber Company is considering two mutually exclusive investment alternatives. Its
estimated weighted-average cost of capital (WACC), used as the discount rate for capital
budgeting purposes, is 10%. Following is information regarding each of the two projects:
Alternative 1 Alternative 2
Required investment outlay $170,000 $100,000
After-tax cash inflows/year $50,000 $30,000
Estimated project life (in years) 5 5
Estimated salvage value (end of life) $0 $0
Required:
1. Compute the estimated net present value (NPV) of each project and determine which
alternative, based on NPV, is more desirable. (The PV annuity factor for 10%, 5 years, is 3.7908.)
2. Compute the profitability index (PI) for each alternative and state which alternative, based on
PI, is more desirable.
3. Why do the project rankings differ under the two methods of analysis? Which alternative
would you recommend, and why?
