Chapter 12: The Capital Budgeting Decision
c. Net Present Value Profile
12-23. (Continued)
d. Since the projects are not mutually exclusive, they both can
e. With mutually exclusive projects, only one can be accepted.
Net present value
$8,000
6,000
4,000
2,000
0
5% 10% 15% 20%
IRRC = 13.25%
Project E
Project H
IRRH = 16.30%
Discount rate (%)
Chapter 12: The Capital Budgeting Decision
12-32
24. Net present value profile (LO4) Davis Chili Company is considering an investment of
$15,000, which produces the following inflows:
Year
Cash Flow
1…………….
$8,000
2…………….
7,000
3…………….
4,000
You are going to use the net present value profile to approximate the value for the internal
rate of return. Please follow these steps:
a. Determine the net present value of the project based on a zero discount rate.
b. Determine the net present value of the project based on a 10 percent discount rate.
c. Determine the net present value of the project based on a 20 percent discount rate
(it will be negative).
d. Draw a net present value profile for the investment and observe the discount rate at
which the net present value is zero. This is an approximation of the internal rate of
return based on the interpolation procedure presented in this chapter. Compare your
answer in parts d and e.
e. Actually compute the internal rate of return based on the interpolation procedure
presented in this chapter. Compare your answers in parts d and e.
12–24. Solution:
Davis Chili Company
a. NPV @ 0% discount rate
Inflows Outflow
b.
Year Cash Flow PVIF at10% Present Value
1 $8,000 .909 $ 7,272
2 7,000 .826 5,782
Chapter 12: The Capital Budgeting Decision
12-24. (Continued)
c.
Year Cash Flow PVIF at 20% Present Value
1 $8,000 .833 $ 6,664
2 7,000 .694 4,858
d. Net Present Value Profile
6,000
4,000
2,000
0
5% 10% 15% 20%
Net present value
Discount rate (%)
Chapter 12: The Capital Budgeting Decision
12-34
12-24. (Continued)
e. The answer appears to be slightly above 14%. We will use
14% as the first approximation.
Year Cash Flow PVIF at 14% Present Value
1 $8,000 .877 $ 7,016
Year Cash Flow PVIF at 15% Present Value
1 $8,000 .870 $ 6,960
We interpolate between 14% and 15%.
$15,099 PV @ 14% $15,099 PV @ 14%
Chapter 12: The Capital Budgeting Decision
12-35
25. MACRS depreciation and cash flow (LO2) Telstar Commumications is going to
purchase an asset for $300,000 that will produce $140,000 per year for the next four years
in earnings before depreciation and taxes. The asset will be depreciated using the three-year
MACRS depreciation schedule in Table 12–9 on page ___. (This represents four years of
depreciation based on the half-year convention.) The firm is in a 35 percent tax bracket.
Fill in the schedule below for the next four years.
Earnings before depreciation and taxes
_____
Depreciation
_____
Earnings before taxes
_____
Taxes
_____
Earnings after taxes
_____
+ Depreciation
_____
Cash flow
_____
12–25. Solution:
Telstar Communications Corporation
First determine annual depreciation.
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
1 $300,000 .333 $ 99,900
Then determine the annual cash flow. Earnings before
Chapter 12: The Capital Budgeting Decision
12-36
1
2
3
4
EBDT
$140,000
$140,000
$140,000
$140,000
–D
99,900
133,500
44,400
22,200
EBT
40,100
6,500
95,600
117,800
T (35%)
14,035
2,275
33,460
41,230
EAT
26,065
4,225
62,140
76,570
+ D
99,900
133,500
44,400
22,200
Cash Flow
$125,965
$137,725
$106,540
$98,770
26. MACRS depreciation categories (LO4) Assume $60,000 is going to be invested in each
of the following assets. Using Tables 12–8 and 12–9, indicate the dollar amount of the first
year’s depreciation.
a. Office furniture.
b. Automobile.
c. Electric and gas utility property.
d. Sewage treatment plant.
12–26. Solution:
a. Office furniture – Based on Table 12-8, this falls under
7-year MACRS depreciation. Then examining Table 12-9,
the first year depreciation rate is .143. Thus:
$60,000 .143 $8,580=
b. Automobile – This falls under 5-year MACRS depreciation.
This first year depreciation rate is .200.
$60,000 .200 $12,000=
c. Electric and gas utility property – This falls under 20-year
MACRS depreciation. The first year depreciation rate is .038.
$60,000 .038 $2,280=
Chapter 12: The Capital Budgeting Decision
12-37
d. Sewage treatment plant – This falls under 15-year MACRS
depreciation. This first year depreciation rate is .050.
$60,000 .050 $3,000=
27. MACRS depreciation and net present value (LO4) The Summitt Petroleum Corporation
will purchase an asset that qualifies for three-year MACRS depreciation. The cost is
$80,000 and the asset will provide the following stream of earnings before depreciation and
taxes for the next four years:
Year 1……………… $36,000
Year 2……………… 40,000
Year 3……………… 31,000
Year 4……………… 19,000
The firm is in a 35 percent tax bracket and has an 11 percent cost of capital. Should it
purchase the asset? Use the net present value method.
12–27. Solution:
Summit Petroleum Corporation
First determine annual depreciation.
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
1 $80,000 .333 $26,640
2 80,000 .445 35,600
Then determine the annual cash flow.
Chapter 12: The Capital Budgeting Decision
12-38
1 2 3 4
EBDT $36,000 $40,000 $31,000 $19,000
– D 26,640 35,600 11,840 5,920
12-27. (Continued)
Then determine the net present value.
Cash Flow Present
Year (inflows) PVIF at 11% Value
1 $32,724 .901 $29,484
2 38,460 .812 31,230
28. MACRS depreciation and net present value (LO4) Propulsion Labs will acquire new
equipment that falls under the five-year MACRS category. The cost is $200,000. If the
equipment is purchased, the following earnings before depreciation and taxes will be
generated for the next six years.
Chapter 12: The Capital Budgeting Decision
12-39
Year 1………………… $75,000
Year 2………………… 70,000
Year 3………………… 55,000
Year 4………………… 35,000
Year 5………………… 25,000
Year 6………………… 21,000
The firm is in a 30 percent tax bracket and has a 14 percent cost of capital. Should
Propulsion Labs purchase the equipment? Use the net present value method.
12–28. Solution:
Propulsion Labs
First determine annual depreciation.
Percentage
Depreciation Depreciation Annual
Year Base (Table 12-9) Depreciation
1 $200,000 .200 $ 40,000
2 200,000 .320 64,000
Chapter 12: The Capital Budgeting Decision
12-40
12-28. (Continued)
Then determine the annual cash flow.
1 2 3 4 5 6
EBDT $75,000 $70,000 $55,000 $35,000 $25,000 $21,000
– D 40,000 64,000 38,400 23,000 23,000 11,600
EBT 35,000 6,000 16,600 12,000 2,000 9,400
Then determine the net present value.
Cash Flow Present
Year (inflows) PVIF at 14% Value
1 $64,500 .877 $ 56,567
2 68,200 .769 52,446
3 50,020 .675 33,764