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491
CHAPTER 15
CAPITAL INVESTMENT ANALYSIS
CLASS DISCUSSION QUESTIONS
1. The principal objection to the use of the av-
erage rate of return method is its failure to
4. The cash payback period ignores the cash
flows that occur after the cash payback pe-
riod; the net present value method includes
all cash flows in the analysis. The cash pay-
back period also ignores the time value of
money, which is included by the net present
9. The net present values indicate both projects
are desirable but not necessarily equal in
the method assumes the cash received from
the proposal during its useful life will be
reinvested at the rate of return used to com-
pute the present value of the proposal. This
assumption may not always be reasonable.
11. The computations for the internal rate of
return method are more complex than those
492
16. Monsanto indicated that it recognized the
market was demanding higher product quality
that could be achieved only with a large
Monsanto indicated the following six consid-
erations in making its investment:
a. After-tax cash flows
493
EXERCISES
E15–1
Testing Diagnostic
Equipment Software
Estimated average annual income:
E15–2
Return o
f
Rate
Average = Average Annual Income
Average Investment
494
E15–3
Return
on
Investment
= Investment Average
Income AnnualAverageEstimated
E15–4
a. Year 1 Years 2–9 Last Year
Operating cash flows:
Annual revenues (120,000 units × $9) ...... $1,080,000 $1,080,000 $1,080,000
b. The cash payback will occur on December 2 of Year 1. Net operating cash
495
E15–5
Net Cash Cumulative
Flow
Net Cash Flows
E15–6
a. The Shampoo/Conditioner product line is recommended, based on its shorter
cash payback period. The cash payback period for both products can be
determined using the following schedule:
Shampoo/Conditioner Body Wash
Net Cash Cumulative Net Net Cash Cumulative Net
Flow Cash Flows Flow Cash Flows
Year 1 $700,000 $ 700,000 $400,000 $ 400,000
b. The cash payback periods are different between the two product lines
496
E15–6, Concluded
c. The cash payback would be 4 years, 9 months, determined as follows:
At the end of Year 4 the cumulative net cash flows for Shampoo/Conditioner
E15–7
a.
Present Value Net Cash Present Value of
Year of $1 at 10% Flow Net Cash Flow
1 0.909 $100,000 $ 90,900
497
E15–8
a.
20Y4 20Y5 20Y6 20Y7 20Y8
Revenues ............. $ 70,000 $ 70,000 $ 70,000 $ 70,000 $ 70,000
b.
Net Cash Flow Present Value of Present Value of
Year [from part (a)] $1 at 12% Net Cash Flow
20Y4 $36,000 0.893 $ 32,148
498
E15–9
a.
(in millions)
Annual revenues .................................................................................. $15
b.
(in millions,
except present
value factor)
Annual net cash flow ........................................................................... $ 13
499
E15–10
a. Annual cash inflows:
Hours of operation ...................................... 1,850
Annual cash outflows:
Hours of operation ...................................... 1,850
b. Annual net cash flow (at the end of each of five years) ................... $ 92,000
500
E15–11
a. Revenues (3,600 × 300 days × $450) ............................................ $ 486,000,000
b. Present value of annual net cash flows ($288,800,000 × 5.650) $ 1,631,720,000
E15–12
a. Present Value Index = Total Present Value of Net Cash Flow
Amount to Be Invested
