Problem 24-6B (Concluded)
Part 5
While the total cash flows are identical to those in Problem 24-5B, the cash
flows are reversed, with the largest cash flows coming in the early years of
the project. This will shorten the payback period and the break-even time.
In addition, it will increase the net present value of the investment.
1. Payback period = = 2.7 years
2. Accounting rate of return = = 40.8%
$300,000
$111,250
$61,250
$150,000*
©2016 by McGraw–Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Solutions Manual, Chapter 24
1427
Reporting in Action — BTN 24-1
1. The internal rate of return (given here as 10%) is the rate which yields a
$2.12 billion = Annual cash flows x 6.1446
Annual cash flows = $2.12 billion / 6.1446
2. Answer depends on the information obtained.
©2016 by McGraw–Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Financial and Managerial Accounting, 6th Edition
1428
Comparative Analysis — BTN 24-2
1. We know that the present value equals the annual cash flows times the
$2.42 billion = Annual cash flows x 4.1604
Therefore,
2. Relatively speaking, Google’s assumed hurdle rate is higher than
1. Present value of $100 to be received in 10 years assuming a 12%
2. We need to be concerned about any project with expected long-term
cash inflows. This is especially the case if the larger cash inflows are
expected later rather than sooner in the asset’s life. This concern is tied
to the riskiness of long-term predictions and the likely biases of
individuals proposing the project.
Taking It to the Net — BTN 24-5
Period
Cash flow
Cumulative cash flow
0 …………………………..………………………………………
$(15,000)
$(15,000)
1 …………………………..………………………………………
1,000
(14,000)
2 …………………………..………………………………………
2,000
(12,000)
3 …………………………..………………………………………
3,000
(9,000)
4 …………………………..………………………………………
6,000
(3,000)
5 …………………………..………………………………………
7,000
4,000
$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
Year 4 ……………………………………………………..
6,000
0.6830
4,098
Year 5 ……………………………………………………..
7,000
0.6209
4,346
Totals ……………………………………………………..
$19,000
$ 13,260
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.
This analysis shows that receiving cash flows from an investment sooner
is more desirable rather than receiving them later.
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.
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
Disadvantages
Ignores time
value of money
Ignores cash
flows after
payback period
Ignores time
value of
money
Ignores annual
rates over life
of project
Difficult to
compare
dissimilar
projects
Ignores
varying
risk levels
over life of
project
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
at 1% (12%/12 months) …………………………………………………..…..
$11,763*
PV of $10,000 final payment at end of 35 months
discounted at 1% …………………………………………………………..……..
7,059**
Total PV of lease …………………………..………………………………….……..
$18,822
* $400 x 29.4086 (from Table B.3)
** $10,000 x 0.7059 (from Table B.1)
Purchase terms—$16,500
2. In most cases the students will find it more costly to lease an
automobile than to purchase it outright. Also, getting the salesperson
to negotiate the outright purchase of the automobile is sometimes
challenging once you’ve shown interest in leasing. This is because of