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Taking It to the Net — BTN 24-5
Period Cash flow Cumulative cash flow
0.............................................................................$(15,000) $(15,000)
1.............................................................................1,000 (14,000)
$3,000/$7,000 = 0.43
The project has a payback period of 4.43 years, about 1.77 years more
than the original cash flows provided on the website.
Present
Present Value of
Net Cash
Flows
Value of
1 at 10%
Net Cash
Flows
Year 1............................................................... $ 1,000 0.9091 $ 909
Year 2............................................................... 2,000 0.8264 1,653
Year 3............................................................... 3,000 0.7513 2,254
Amount invested............................................ (15,000)
Net present value........................................... $ (1,740)
The investment now has a negative net present value, as opposed to the
positive net present value of $563 using the original cash flows provided
on the website.
Teamwork in Action — BTN 24-6
Instructor note: Answers will vary across students. Yet the examples, while
different, should capture similar qualitative factors.
SAMPLE SOLUTION
Project: Investment in an improved baggage handling system.
The new, improved baggage handling system is expected to increase both
customer satisfaction and likelihood of repeat business.
Qualitative Factors
Competition has a new, more efficient and effective system.
Need to replace old system.
Increased customer demand for a new system because of special
baggage handling needs, for example, golf clubs to vacation destination.
Financial and Managerial Accounting, 6th Edition
Entrepreneurial Decision — BTN 24-7
1. Limor could use payback period, accounting rate of return, net present
2. For these tools, Limor needs estimates of how much the manufacturing
facility and warehouse will cost, both upfront and for recurring (e.g.
3.
Payback Period Accounting Rate
of Return
Net Present
Value
Internal Rate
of Return
Advantages Easy to
understand
Allows
comparison of
projects
Easy to
understand
Allows
comparison of
projects
Reflects
time value
of money
Reflects
different
risk levels
over
project’s life
Reflects
time value
of money
Allows
compari-
sons of
dissimilar
projects
Hitting the Road — BTN 24-8
1. Answers will vary among students.
Sample Example
For illustrative purposes, one sample solution would appear as follows:
Lease terms—$400 per month for 35 months; plus $10,000 final
payment at the end of 35 months; 12% annual interest rate.
To compute the present value of the lease payments
PV of 35 payments of $400 per month discounted
Total PV of lease................................................................................$18,822
* $400 x 29.4086 (from Table B.3)
** $10,000 x 0.7059 (from Table B.1)
2. In most cases the students will find it more costly to lease an
automobile than to purchase it outright. Also, getting the salesperson
Using the sample numbers from part 1, the PV of the lease is $18,822,
which is $2,322 more than the outright purchase price of $16,500.
Global Decision — BTN 24-9
Samsung would probably use the 4.1% interest rate as one factor in
determining the discount rate to use in evaluating the cash flows from any
capital investments. There are many other factors besides this, however.
For instance, Samsung would have to consider what it could earn on
Financial and Managerial Accounting, 6th Edition
