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Chapter 13: Capital Budgeting Techniques
130
© Pearson Education Limited 2008
9. a.
Amount of cash outflow:
Time
of cash
outflow
8%
discount
factor Rockbuilt Bulldog
Incremental
savings of
Rockbuilt over
Bulldog truck
0 1.000 $(74,000) $ (59,000) $(15,000)
1 .926 (2,000) (3,000) 1,000
* $4,000 maintenance cost plus salvage value of $9,000.
** $13,500 maintenance cost plus salvage value of $5,000.
The Rockbuilt bid should be accepted as the lower maintenance and rebuilding expenses
more than offset its higher cost.
b.
Amount of cash outflow:
Time
of cash
outflow
15%
discount
factor Rockbuilt Bulldog
Incremental
savings of
Rockbuilt over
Bulldog truck
0 1.000 $(74,000) $ (59,000) $(15,000)
1 .870 (2,000) (3,000) 1,000
Present value of
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition, Instructor’s Manual
131
© Pearson Education Limited 2008
No. With a higher discount rate, more distant cash outflows become less important relative
SOLUTIONS TO SELF-CORRECTION PROBLEMS
1. a.
Year Cash flow Present value discount
factor (15%)
Present
value
0 $ (700,000) 1.000 $(700,000)
As the net present value is negative, the project is unacceptable.
b. The internal rate of return is 13.21 percent. If the trial-and-error method were used, we
would have the following:
Year Cash flow
14% discount
factor
14% discount
factor
13% discount
factor
13% discount
factor
0 $ (700,000) 1.000 $(700,000) 1.000 $(700,000)
* PVIFA for 10 years minus PVIFA for 4 years.
** Total for years 5–10.
Chapter 13: Capital Budgeting Techniques
132
© Pearson Education Limited 2008
To approximate the actual rate, we interpolate between 13 and 14 percent as follows:
X $14,000
=
X = = .0021
and IRR = 0.13 + X = 0.13 + 0.0021 = 0.1321, or 13.21 percent. As the internal rate of
return is less than the required rate of return, the project would not be acceptable.
c. The project would be acceptable.
d. Payback period = 6 years. (–$700,000 – $1,000,000 + $250,000 + $300,000 + $350,000
2.
Year
Cash flow
Present value discount
factor (14%)
Present
value
0 $(404,424) 1.000 $(404,424)
1 86,890 .877 76,203
As the net present value is positive, the project is acceptable.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition, Instructor’s Manual
133
© Pearson Education Limited 2008
3.
Project
Investment required
Present value of future
cash flows
Net
present value
1 $200,000 $290,000 $ 90,000
2 115,000 185,000 70,000
Projects 1 and 3 should be chosen as they provide the highest net present value.
