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P16.31.
a.
0 1 2 3 4 5 6 7 8 9 10
6.1446 (Table 6-5 0.3855 (Table 6-4
$(280,000) 10 periods, 10 periods,
258,073 10%) 10%)
11,565
$ (10,362) net present value
b.
Present Value Ratio = ($269,638 present value of inflows / $280,000 investment) = 0.96
P16.32.
a.
Year
Volume
Contribution Margin
@ $ 4.20 per dozen
Present Value Factor
(Table 6-4, 8%)
Present
Value
2016
3,000 dozen
$12,600
0.9259
$ 11,666
2017
4,700 dozen
19,740
0.8573
16,923
c.
Because the net present value is positive and the profitability index is rather high, the
IRR is significantly greater than the 8% discount rate used to calculate the NPV.
d.
Year
Cash Flow
Cumulative Cash Flow
1.
2016
$12,600
$ 12,600
3.
2018
29,820
62,160
5.
2020
42,000
143,640
Chapter 16 Costs for Decision Making
P16.32.
(continued)
d.
The investment of $94,000 will be recovered in the 4th year, after $31,840 of that year's
P16.33.
a.
Proposal
Investment
Net PV
PV of Inflows
(Investment +
Net PV)
Profitability Index
(PV of Inflows / Outflows)
1
$50,000
$30,000
$80,000
$80,000 / $50,000 = 1.6
P16.34.
a.
Project B:
Initial investment…………………………………………………………
$(100,000)
Present value of net cash return, by year(s):
Years 3-5 = $32,000 * (0.7513 + 0.6830 + 0.6209) ……………………
65,766
Year 6-10 = $20,000 * (6.1446 - 3.7908) …………………………..…
47,076
Net present value…………………………………………………………
$ 12,842
b.
Project
B
C
D
E
Initial investment ……………..……
$100,000
$200,000
$200,000
$400,000
+ Net present value…………………
12,842
19,866
(8,259)
11,501
P16.34.
(continued)
c.
1. Based on quantitative analysis only, Project C should be invested in because the
$19,866 net present value of this project is expected to exceed the total net present
2. Projects A, B, and C should be invested in—even though this would mean that
3. Projects A, B, C, and E should be invested in—even though this would mean that
only $800,000 has been invested. Project D has a negative net present value.
d.
The analysis above represents only quantitative factors. Management of Scott, Inc.,
should also take a number of qualitative factors into account, such as: 1) the possibility
of estimation errors with respect to net cash return projections, 2) an assessment of
P16.35.
a.
Accounting rate of return =
Investment Average
IncomeNet
=
2 / )## $90,000 ($100,000
# $10,000 - $29,000
= 20%
b.
Investment:
Year 1
Year 2
Year 3
Year 4
Machine
$(80,000)
Working Capital
(20,000)
Cash returns:
Operations
$14,000
$24,000
$29,000
$20,000
Salvage
50,000
c.
The net present value analytical approach is the best technique to use because it recognizes
the time value of money.
P16.36.
a.
Accounting rate of return =
Investment Average
IncomeNet
=
2 / )## $82,000 ($100,000
18$- $28,000
= 10.99%
The investment would probably not be made because the indicated ARR of 10.99% is less
b.
($100,000 investment / $28,000 cash flows per year) = 3.57 years
c.
Investment:
Year 1
Year 2
Year 3
Year 4
Year 5
Machine
$(100,000)
Cash returns:
Operations
$28,000
$28,000
$28,000
$28,000
$28,000
d.
The net present value analytical approach is the best technique to use because it
recognizes the time value of money.
C16.37.
a.
Notes: All amounts are rounded to the nearest US$1.00 psf = per square foot,
sf = square feet, 1.25 = conversion factor, PV = present value factor (10 years, 12% =
0.3220), PVa = present value of an annuity factor (10 years, 12% = 5.6502).
Initial investment:
US$
US$
Real estate (CI$150 psf * 1,000 sf * 1.25) ………………………
(187,500)
Equipment for health spa ……………………………………
(35,000)
Inventory of cosmetics and skin care products ………………
(8,000)
(230,500)
b.
Initial investment:
US$
US$
Real estate (CI$150 psf * 2,500 sf * 1.25) ………………………
(468,750)
Equipment for fitness center …………………………………
(50,000)
Equipment for health spa ……………………………………
(35,000)
Inventory of cosmetics and skin care products ………………
(8,000)
(561,750)
Annual operating costs:
C16.37.
(continued)
c.
Note: Changes from the solution to part b are shown in bold.
Initial investment:
US$
US$
Real estate (CI$150 psf * 2,500 sf * 1.25) ………………………
(468,750)
Equipment for fitness center …………………………………
(50,000)
Annual cash inflows:
Fitness center (CI$300 * 300 members * 1.25 * 5.6502 PVa) ……
635,648
Health spa (CI$6,000 * 12 months * 1.25 * 5.6502 PVa) …………
508,518
1,144,166
Future sale of real estate (CI$200 psf * 2,500 sf * 1.25 * 0.3220 PV)..
201,250
Net present value………………………………………………
$ 56,202
d.
If Jinny initially decides to open the health spa only, she should consider leasing (rather
than purchasing) the 1,000 square foot unit for the following reasons:
By leasing, her initial investment cost would be reduced to only US$43,000 because
Although the nominal value of real estate in Grand Cayman is likely to double over
the next 10 years (from CI$150 to CI$300 per square foot), the present value of the
future selling price of Jinny’s unit (US$120,750) is less than the cost of purchasing it
Chapter 16 Costs for Decision Making
C16.37.
(continued)
e.
Analysis:
1. Without considering the cost of Jinny’s salary, the net present value calculations in
parts a and b adequately support either alternative. The profitability index for each of
these alternatives would be extremely high, calculated as follows:
1,000 sf unit
(see part a)
2,500 sf unit
(see part b)
PV of annual cash inflows …………………………
$678,024
$1,737,437
+ PV of future sale of real estate………………………
120,750
301,875
2. One additional line should now be added to the solutions presented for parts a and b.
Without adjusting Jinny’s “reasonably comfortable salary” of CI$4,000 for inflation
over the next 10 years, the following results would occur (changes in bold):
1,000 sf unit
(see part a)
2,500 sf unit
(see part b)
PV of annual cash inflows …………………………
$678,024
$1,737,437
+ PV of future sale of real estate………………………
120,750
301,875
3. It now becomes clear that the real money to be made is in the full-scale operation.
The combined fitness center / health spa allows Jinny to pay herself a reasonably
4. The analysis above represents only quantitative factors. Jinny should also take a
number of qualitative factors into account, such as: 1) the possibility of estimation errors
with respect to her projections, 2) an assessment of non-financial risks involved with
C16.37.
(continued)
e.
Recommendation:
After consulting with Jinny in terms of how she perceives the various risks involved, I
would recommend that she either: 1) consider purchasing the 2,500 square foot unit
C16.38.
a.
Investment...………………………………………………………………
$(150,000)
Investment in working capital……………………………………………
(50,000)
Annual cash inflows, by year:
2016 = $40,000 * 0.8929………………………………………………
35,716
b.
Profitability index = ($198,027 present value of inflows / $200,000 outflows) = 0.99
c.
Because the net present value is negative, the IRR will be lower than the cost of
capital.
d.
Payback period = 4.00 years
Initial investment
$(200,000)
Return in year 1 ……………………………………………
$ 40,000
e.
No. The ROI is expected to be lower than the cost of capital.
f.
What are the probabilities of exceeding the annual cash flow estimates? Is the 12%
cost of capital used by Sunset Beach, Inc., a conservative estimate of the firm’s long-
run cost of acquiring funds? If not, what is the firm’s incremental cost of borrowing?
