Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Chapter 16 Planning for Capital Investments
16-1
a (1)
Cash Inflow
Table Value*
Present Value
Year 1
$ 360,000
0.892857
$ 321,429
Year 2
502,500
0.797194
400,590
Year 3
865,000
0.711780
615,690
Year 3
5,175,000
0.711780
3,683,462
Present value of inflows
5,021,171
Present value of outflows
(4,500,000)
Net present value
$ 521,171
*Table 1, n = 1– 3, r = 12%
Present value index $5,021,171 ÷ $4,500,000 = 1.12
Summit Apartments
a (2)
Cash Inflow
Table Value
Present Value
Year 1
$ 290,000
0.892857
$ 258,929
Year 2
435,000
0.797194
346,779
Year 3
600,000
0.711780
427,068
Year 3
4,050,000
0.711780
2,882,709
Present value of inflows
3,915,485
Present value of outflows
(3,450,000)
Net present value
$ 465,485
Present value index $3,915,485 ÷ $3,450,000 = 1.13
of return.
ATC 16-2 (continued)
c. It would certainly affect the decision. If EREIC decides to invest in Summit
Apartments, roughly 23 percent ($1,050,000 ÷ $4,500,000) of the invested funds
would be earning a low 5 percent return. The remainder of the investment would
earn a return of more than 12 percent. The weighted average return would be
approximately:
0.05
x
0.23
=
0.0115
0.13
x
0.77
=
0.1001
Weighted average
0.1116 = 11.2%
(rounded)
Chapter 16 Planning for Capital Investments
16-2
d. There is no definitive answer to this question. However, it should be noted that
all of the future cash flows represent estimates that are uncertain. The possibility
ATC 16-3
a. Ten, (note, there are 2 stores opening in Denver). There were 108 stores as of the
b. 2010 = $22,434 (thousands), 2011 = $76,580, 2012 = $172,616. No, there would also
be the costs of working capital items, such as inventory and receivables. Note from
c. The cash to fund new investments in capital expenditures came from financing
ATC 16-4
The student’s response should recognize the fact that planning techniques for capital
investment are only as good as the estimated data that are used in the analysis. With respect
to discounted cash flow techniques, the discount rate or desired rate of return is usually
raised when the data involve a great deal of uncertainty. Even so, investing remains a matter
variable that goes into the decision making process.
In the case of Webb Publishing, the opportunity to purchase a printing company would be
more suitable to analysis with the planning techniques of capital investments. This is so
because the cash flows are more predictable. However, this does not mean that the printing
Chapter 16 Planning for Capital Investments
16-3
ATC 16-5
a.
Present Value Table Factor (a) 3.790787 (Table 2, 10%, 5 Years)
Actual
Projected
Projected
Cash inflows (b)
$91,000
$90,000
$70,000
Present value (a x b)
$344,961.62
$341,170.83
$265,355.09
Cost of investment
(250,000.00)
(250,000.00)
(250,000.00)
Net present value
$ 94,961.62
$ 91,170.83
$ 15,355.09
ATC 16-5 (continued)
Bonus if $90,000 is used as the projected annual cash inflow:
$94,961.62 − $91,170.83 = $3,790.79 x 0.10 = $379.08
b. Mr. Holt may not be a member of the Institute of Management Accountants and
therefore may not be bound by the organization’s ethical standards though he is clearly
unethical. Regardless, his behavior is in violation of many of the standards including:
c. The bonus plan encourages managers to consistently underestimate cash inflows and to
reject investment opportunities for which real cash flows approach the company’s
d. The bonus plan should seek to motivate accuracy in reporting. A motive to
underestimate cash flows is just as detrimental as a motive to overestimate. The
