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Chapter 25 - Capital Budgeting and Managerial Decisions
EXERCISES
Exercise 25-1 (20 minutes)
Annual Net Cumulative
Cash Flows Cash Flows
Year 1..................................................................... $ 60,000 $ 60,000
Year 2..................................................................... 40,000 100,000
Cost of investment.............................................................................$180,000
Paid back in years 1-3........................................................................ 170,000
Paid back in year 4.............................................................................$ 10,000
Net Cash
Flows
Present
Value of
1 at 10%
Present
Value of Net
Cash Flows
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Chapter 25 - Capital Budgeting and Managerial Decisions
Totals.....................................................................$330,000 247,300
ANNUAL CASH FLOWS
Net
Income Depreciation*
Net Cash
Flow
Cumulative
Cash Flow
Year 1 $ 10,000 $30,000 $ 40,000 $ 40,000
Year 2 25,000 30,000 55,000 95,000
Year 3 50,000 30,000 80,000 175,000
Paid back in year 3...........................................................................$ 15,000
= = 0.188
Payback period = 2 + 0.188 = 2.188 years
Exercise 25-4 (30 minutes)
COMPUTATION OF ANNUAL DEPRECIATION EXPENSE
Double-declining balance rate = (100% / 5) x 2 = 40%
Annual Depr.
Beginning (40% of Accum. Depr. Ending
Year Book Value Book Value) at Year-End Book Value
1 $150,000 $60,000 $ 60,000 $90,000
2 90,000 36,000 96,000 54,000
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$15,000
$80,000
Amount paid back in year 3
Net cash flows in year 3
3 54,000 21,600 117,600 32,400
4 32,400 12,960 130,560 19,440
5 19,440 19,440 150,000 0
ANNUAL CASH FLOWS
Net
Income Depreciation
Net Cash
Flow
Cumulative
Cash Flow
Year 1 $ 10,000 $60,000 $ 70,000 $ 70,000
Year 2 25,000 36,000 61,000 131,000
= = 0.265
a.
Payback period = = = 2.21 years
where
Annual after-tax income...................................................................$150,000
b.
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$19,000
$71,600
Amount paid back in year 3
Net cash flows in year 3
Cost of investment
Annual net cash flow
$520,000
$235,000
6
Chapter 25 - Capital Budgeting and Managerial Decisions
Exercise 25-6 (20 minutes)
a.
Net present value of investment*
Present value of six $235,000** cash inflows ($235,000 x 4.3553)..........
$1,023,496
Present value of $10,000 at end of six years ($10,000 x 0.5645)............. 5,645
Present value of cash inflows..................................................................... 1,029,411
Less immediate cash outflow..................................................................... 520,000
Net present value.........................................................................................$ 509,141
**Cash inflow = net income + straight-line depreciation, $150,000 + $85,000
Exercise 25-6 (continued)
b.
Net present value of investment*
Present value of eight $105,000** cash inflows ($105,000 x 5.3349)........$560,165
Present value of $20,000 at end of eight years ($20,000 x 0.4665).......... 9,330
25-1484
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill
Education.
$380,000
Cost of investment
8
Chapter 25 - Capital Budgeting and Managerial Decisions
**Cash inflow = net income + straight-line depreciation, $60,000 + $45,000
Exercise 25-7 (15 minutes)
Accounting rate of return = $52,000 / $400,000 = 13.0%
Exercise 25-8 (20 minutes)
COMPUTING NET CASH FLOWS FROM NET INCOME
Net income Cash flows
Sales................................................................................$225,000 $225,000
Materials, labor & overhead..........................................120,000 120,000
Depreciation................................................................... 30,000
Selling and administrative............................................. 22,500 22,500
1. Payback period = = 5.39 years
2. Accounting rate of return = = 20.42%
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$360,000
$180,000*
Chapter 25 - Capital Budgeting and Managerial Decisions
Exercise 25-9 (15 minutes)
Annual
Net Cash
Flows
Present
Value of
Annuity
at 8%
Present
Value of
Net Cash
Flows
Years 1 through 6.................................................$ 66,750 4.6229 $ 308,579
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Chapter 25 - Capital Budgeting and Managerial Decisions
Exercise 25-10 (20 minutes)
PROJECT A
Net Cash
Flows
Present
Value of
1 at 10%
Present
Value of Net
Cash Flows
Year 1.....................................................................$ 40,000 0.9091 $ 36,364
Year 2.....................................................................56,000 0.8264 46,278
Year 3.....................................................................80,295 0.7513 60,326
Year 4.....................................................................90,400 0.6830 61,743
PROJECT B
Net Cash
Flows
Present
Value of
1 at 10%
Present
Value of Net
Cash Flows
Year 1..................................................................... $ 32,000 0.9091 $ 29,091
Year 2.....................................................................50,000 0.8264 41,320
Year 3.....................................................................66,000 0.7513 49,586
Both projects have positive net present values. However, if the company
can choose only one project, it should select project B, since it has a
higher profitability index.
Exercise 25-11 (25 minutes)
a.
Present
Present
Value of Net
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Chapter 25 - Capital Budgeting and Managerial Decisions
Project X1 Net Cash
Flows
Value of
1 at 4%
Cash Flows
Year 1.....................................................................$ 25,000 0.9615 $ 24,038
Year 2.....................................................................35,500 0.9246 32,823
Project X2 Net Cash
Flows
Present
Value of
1 at 4%
Present
Value of Net
Cash Flows
Year 1.....................................................................$ 60,000 0.9615 $ 57,690
Year 2.....................................................................50,000 0.9246 46,230
b.
Profitability index, Project X1 = $110,646 / $80,000 = 1.38
a.
Project X1 Net Cash
Flows
Present
Value of
1 at 12%
Present
Value of
Net Cash
Flows
Year 1.....................................................................$ 25,000 0.8929 $ 22,323
Year 2.....................................................................35,500 0.7972 28,301
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Chapter 25 - Capital Budgeting and Managerial Decisions
Project X2 Net Cash
Flows
Present
Value of
1 at 4%
Present
Value of Net
Cash Flows
Year 1.....................................................................$ 60,000 0.8929 $ 53,574
Year 2.....................................................................50,000 0.7972 39,860
Year 3..................................................................... 40,000 0.7118 28,472
b.
Profitability index, Project X1 = $93,688 / $80,000 = 1.17
Exercise 25-13 (20 minutes)
Using Excel, Project X1 (X2) has an internal rate of return of 20.34% (12.99%).
Project X1 Project X2
A B C D
1 Initial investment -80000 -120000
8 Formula for IRR =IRR(C1:C5) =IRR(D1:D5)
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Chapter 25 - Capital Budgeting and Managerial Decisions
Exercise 25-14 (35 minutes)
1.
PROJECT C1
Net Cash
Flows
Present
Value of
1 at 12%
Present
Value of Net
Cash Flows
Year 1.....................................................................$ 12,000 0.8929 $ 10,715
Year 2.....................................................................108,000 0.7972 86,098
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