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Problem 11-25A (continued)
2. Considering all three investments together, Linda did not earn a 16%
rate of return. The computation is:
Net
Present
Value
Common stock .........................
$ 7,560
Preferred stock .........................
(8,650)
Bonds ......................................
(2,743)
Overall net present value ..........
$(3,833)
The defect in the broker’s computation is that it does not consider the
time value of money and therefore has overstated the rate of return
earned.
3.
Investment required
Factor of the internal =
rate of return Annual net cash inflow
Ethics Challenge (45 minutes)
1. Rachel Arnett’s revision of her first proposal can be considered a
violation of the IMA’s Statement of Ethical Professional Practice. She
discarded her reasonable projections and estimates after she was
questioned by William Earle. She used figures that had a remote chance
2. Earle was clearly in violation of the Standards of Ethical Conduct for
Management Accountants because he tried to persuade a subordinate to
prepare a proposal with data that was false and misleading. Earle has
Ethics Challenge (continued)
3. The internal controls Fore Corporation could implement to prevent
unethical behavior include:
approval of all formal capital expenditure proposals by the Controller
and/or the Board of Directors.
Case (45 minutes)
1. The net cash inflow from sales of the device for each year would be:
Year
1
2
3
4-6
Sales in units ........................
9,000
15,000
18,000
22,000
Sales in dollars
(@ $35 each) ....................
$315,000
$525,000
$630,000
$770,000
Variable expenses
(@ $15 each) ....................
135,000
225,000
270,000
330,000
Contribution margin ..............
180,000
300,000
360,000
440,000
Fixed expenses:
Salaries and other* ............
85,000
85,000
85,000
85,000
Advertising ........................
180,000
180,000
150,000
120,000
Total fixed expenses .............
265,000
265,000
235,000
205,000
Net cash inflow (outflow) ......
$(85,000)
$ 35,000
$125,000
$235,000
*
Depreciation is not a cash expense and therefore must be eliminated
from this computation. The analysis is:
($315,000 – $15,000 = $300,000) ÷ 6 years = $50,000 depreciation;
$135,000 total expense – $50,000 depreciation = $85,000.
Case (continued)
2. The net present value of the proposed investment would be:
Now
1
2
3
4
5
6
Cost of equipment ...
$(315,000)
Working capital ........
(60,000)
Yearly net cash
flows .......................
$(85,000)
$35,000
$125,000
$235,000
$235,000
$235,000
Release of working
capital .....................
60,000
Salvage value of
equipment ...............
_______
______
______
______
______
______
15,000
Total cash flows (a) .
$(375,000)
$(85,000)
$35,000
$125,000
$235,000
$235,000
$310,000
Discount factor
(14%) (b) ...............
1.000
0.877
0.769
0.675
0.592
0.519
0.456
Present value
(a)×(b) ...................
$(375,000)
$(74,545)
$26,915
$84,375
$139,120
$121,965
$141,360
Net present value ....
$64,190
Chapter 11
Take Two Solutions
Exercise 11-1 (10 minutes)
1. The payback period is determined as follows:
Year
Investment
Cash Inflow
Unrecovered
Investment
1
$17,500
$1,000
$16,500
2
$8,000
$2,000
$22,500
3
$2,500
$20,000
4
$4,000
$16,000
5
$5,000
$11,000
6
$6,000
$5,000
7
$5,000
$0
8
$4,000
$0
9
$3,000
$0
10
$2,000
$0
The investment in the project is fully recovered in the 7th year. The
payback period is 7.0 years.
2. Because the investment is recovered prior to the last year, the amount
Exercise 11-2 (10 minutes)
1.
Now
1
2
3
4
5
Purchase of machine ......................
$(27,000)
Reduced operating costs ................
________
$7,000
$7,000
$7,000
$7,000
$7,000
Total cash flows (a) .......................
$(27,000)
$7,000
$7,000
$7,000
$7,000
$7,000
Discount factor (10%) (b) ..............
1.000
0.909
0.826
0.751
0.683
0.621
Present value (a)×(b) ....................
$(27,000)
$6,363
$5,782
$5,257
$4,781
$4,347
Net present value ..........................
$(470)
Note: The annual reduction in operating costs can also be converted to its present value using the
discount factor of 3.791 as shown in Exhibit 11B-2 in Appendix 11B.
2.
Item
Cash
Flow
Years
Total
Cash
Flows
Annual cost savings ..
$7,000
5
$ 35,000
Initial investment .....
$(27,000)
1
(27,000)
Net cash flow ...........
$ 8,000
Exercise 11-4 (10 minutes)
This is a cost reduction project, so the simple rate of return would be
computed as follows:
Operating cost of old machine ....................
$ 30,000
Less operating cost of new machine ...........
12,000
Less annual depreciation on the new
machine ($120,000 ÷ 8 years) .................
15,000
Annual incremental net operating income ...
$ 3,000
Cost of the new machine ...........................
$120,000
Scrap value of old machine ........................
40,000
Initial investment .......................................
$ 80,000
Annual incremental net operating income
Simple rate =
of return Initial investment
$3,000
= = 3.75%
$80,000
Exercise 11-6 (15 minutes)
1. Computation of the annual cash inflow associated with the new
electronic games:
Net operating income ..........................................
$50,000
Add noncash deduction for depreciation ................
35,000
Annual net cash inflow .........................................
$85,000
The payback computation would be:
Investment required
Payback period = Annual net cash inflow
$300,000
= = 3.53 years
$85,000 per year
Yes, the games would be purchased. The payback period is less than
the maximum 5 years required by the company.
2. The simple rate of return would be:
Annual incremental net income
Simple rate =
of return Initial investment
Exercise 11-8 (10 minutes)
Now
1
2
3
Purchase of stock..............................
$(13,000)
Annual cash dividend ........................
$500
$500
$ 500
Sale of stock .....................................
_______
____
____
16,000
Total cash flows (a) ..........................
$(13,000)
$500
$500
$16,500
Discount factor (14%) (b) .................
1.000
0.877
0.769
0.675
Present value (a)×(b) .......................
$(13,000)
$439
$385
$11,138
Net present value .............................
$(1,038)
No, Kathy did not earn a 14% return on the Malti Company stock. The negative net present value
indicates that the rate of return on the investment is less than the minimum required rate of return of
14%.
Exercise 11-11 (10 minutes)
Project X:
Now
1
2
3
4
5
6
Initial investment ..............
$(35,000)
Annual cash inflows ..........
________
$12,000
$12,000
$12,000
$12,000
$12,000
$12,000
Total cash flows (a) ..........
$(35,000)
$12,000
$12,000
$12,000
$12,000
$12,000
$12,000
Discount factor (15%) (b) .
1.000
0.870
0.756
0.658
0.572
0.497
0.432
Present value (a)×(b) .......
$(35,000)
$10,440
$9,072
$7,896
$6,864
$5,964
$5,184
Net present value .............
$10,420
Appendix 11A
The Concept of Present Value
Exercise 11A-1 (10 minutes)
Amount of Cash Flows
18%
Present Value of Cash
Flows
Year
Investment
A
Investment
B
Factor
Investment
A
Investment
B
1
$3,000
$12,000
0.847
$ 2,541
$10,164
2
$6,000
$9,000
0.718
4,308
6,462
3
$9,000
$6,000
0.609
5,481
3,654
4
$12,000
$3,000
0.516
6,192
1,548
$18,522
$21,828
Investment project B is best.
Exercise 11A-2 (10 minutes)
The present value of the first option is $150,000, since the entire amount would be received
immediately.
Exercise 11A-3 (10 minutes)
1. From Exhibit 11B-1, the factor for 10% for 3 periods is 0.751. Therefore, the present value of the
2. From Exhibit 11B-1, the factor for 14% for 3 periods is 0.675. Therefore, the present value of the
Exercise 11A-4 (10 minutes)
1. From Exhibit 11B-1, the factor for 10% for 5 periods is 0.621. Therefore, the company must invest:
2. From Exhibit 11B-1, the factor for 14% for 5 periods is 0.519. Therefore, the company must invest:
Exercise 11A-5 (10 minutes)
1. From Exhibit 11B-2, the factor for 16% for 8 periods is 4.344. The computer system should be
2. From Exhibit 11B-2, the factor for 20% for 8 periods is 3.837. Therefore, the maximum purchase
Exercise 11A-6 (10 minutes)
1. From Exhibit 11B-2, the factor for 12% for 20 periods is 7.469. Thus, the present value of Mr.
2. Whether or not it is correct to say that Mr. Ormsby is the state’s newest millionaire depends on your
