1. Independent projects are such that the acceptance of one does not preclude the acceptance of
another. With mutually exclusive projects, acceptance of one precludes the acceptance of others.
5. (a)
A
measure of risk. Roughly, projects with shorter paybacks are less risky.
(b) Obsolescence. If the risk of obsolescence is high, firms will want to recover funds quickly.
(c) Self-interest. Managers want quick paybacks so that short-run performance measures are
affected positively, enhancing chances for bonuses and promotion.
6. The accounting rate of return is the average income divided by original investment.
ARR = $100,000/$300,000 = 33.33%
A
11. If NPV > 0, then the investment is acceptable. If NPV < 0, then the investment should be rejected.
12. Disagree. Only if the funds received each period from the investment are reinvested to earn the
14 CAPITAL INVESTMENT DECISIONS
DISCUSSION QUESTIONS
CHAPTER 14 Capital Investment Decisions
14. NPV signals which investment maximizes firm value. IRR may provide misleading signals. IRR
14-1. c
14-2. e
14-9. d
14-10. e
14-11. a
14-12. b
MULTIPLE-CHOICE QUESTIONS
14-2
CHAPTER 14 Capital Investment Decisions
CE 14-21
a. Payback Period = = 4.0 years
b. Payback period:
1.0 year
CE 14-22
Average Net Income =
CE 14-23
1.
Y
ea
r
Cash Flow
0 Equipment……………………………………………
$(1,440,000)
Working capital………………………………………
(180,000)
Total…………………………………………………
$(1,620,000)
Item
$300,000 + $300,000 + $500,000 + $900,000
CORNERSTONE EXERCISES
$3,000,000
$750,000
+ $1,000,000 + $2,100,000 + $1,200,000
7
$ 375,000
CHAPTER 14 Capital Investment Decisions
CE 14-23 (Continued)
2. Calculation of NPV:
Y
ea
r
Cash Flow* Discount Factor** Present Value
0$(1,620,000) 1.00000 $(1,620,000)
3. Calculation of NPV:
Y
ea
r
Cash Flow* Discount Factor** Present Value
0$(1,620,000) 1.00000 $(1,620,000)
CE 14-24
df = I/CF = $3,455,400/$600,000 = 5.75900
14-4
CE 14-25
1. CAM X Model:
Y
ea
r
0 $(2,400,000)
1–10 3,686,742
NPV………………………………………………………
…
$ 1,286,742
CAM Y Model:
Y
r
…
r
2. df (CAM X) = I==
CF
Present ValueCash Flow Discount Facto
r
1.00000$(2,400,000)
$2,400,000
$600,000
4.00000
6.14457
600,000
14-5
CHAPTER 14 Capital Investment Decisions
E 14-26
1. Payback Period = = 3.33 years
2. Payback Period:
1.0 year
= $520,000 per year
E 14-27
1. Initial investment (Average Depreciation = $720,000):
2. Accounting rate of return (ARR):
Project A: ARR = = 46%
$49,500 – $15,000
$75,000
$400,000
$120,000
350,000$
EXERCISES
14-6
CHAPTER 14 Capital Investment Decisions
E 14-27 (Continued)
3. ARR =
E 14-28
1. NPV = P – I
= (5.65022 × $400,000) – $2,250,000 = $10,088
Yes, the company should make the investment.
Average Net Income
Initial Investment
14-7
CHAPTER 14 Capital Investment Decisions
E 14-29
1. P = CF(df) =I for the IRR, thus,
2. P = CF(df) =I for the IRR, thus,
d
f
= $1,248,000
$240,000
= 5.2
14-8
CHAPTER 14 Capital Investment Decisions
E 14-30
1. Puro equipment:
Present Value
0 $(560,000)
Briggs equipment:
Present Value
0 $(560,000)
2. CF(df) –I= NPV
Cash Flow
$(560,000)
Cash Flow
1.00000
1.00000
Discount Facto
r
$(560,000)
Y
ea
r
Y
ea
r
Discount Facto
r
CHAPTER 14 Capital Investment Decisions
E 14-31
1. Payback Period =
2. Initial investment (Average Depreciation = $192,000):
3.
Y
ea
r
Present Value
0$(960,000)
1340,909
4. = I for the IRR, thus,
$(960,000)
375,000
1.00000
0.90909
Original Investment
Annual Cash Inflow
Cash Flow Discount Facto
r
P = CF(df)
14-10
CHAPTER 14 Capital Investment Decisions
E 14-32
1. Payback period:
Project A:
1.00 year
1.00 year
2. Accounting rate of return (ARR):
Project A: ARR = = 24%
3. P = 11.46992 × $30,000 = $344,098
Wilma should take the lump sum.
$ 6,000
8,000
$8,800 – $4,000
$20,000
CHAPTER 14 Capital Investment Decisions
E 14-33
1. a. Return of the original investment………………… $600,000
b. Cost of capital ($600,000 × 0.10)…………………
…
60,000
2. Cash Flow Discount Facto
r
$(600,000) 1.00000
E 14-34
1. P = I =d
f
× CF
2.91371* × CF =
CF = $41,185
f
$120,000
Present Value
$(600,000)
0
Y
ea
r
CHAPTER 14 Capital Investment Decisions
E 14-34 (Continued)
Substituting Equation 1 into Equation 2:
3. For IRR:
4. X = Cash Flow in Year 4
Investment = 2X
Y
ea
r
0
(2X)
Present Value
(2X)
Cash Flow
Discount Facto
r
1.00000
CHAPTER 14 Capital Investment Decisions
E 14-35
1. NPV:
Project I
Y
ea
r
Cash Flow Discount Facto
r
Present Value
Project II
Y
ea
r
Cash Flow Discount Facto
r
Present Value
0 $(100,000) 1.00000 $(100,000)
IRR:
Project I
I=df × CF
Project II
2. NPV is an absolute profitability measure and reveals how much the value
of the firm will change for each project. IRR gives a measure of relative
profitability. Thus, since NPV reveals the total wealth change attributable
to each project, it is preferred to the IRR measure.
14-14
CHAPTER 14 Capital Investment Decisions
P 14-36
1. Schedule of cash flows:
Y
ea
r
Cash Flow Cash Flow
0 Equipment……………………………
…
$(1,200,000)
2. NPV:
Y
ea
r
Cash Flow Discount Facto
r
Present Value
0 $(1,320,000) 1.00000 $(1,320,000)
P 14-37
1. Schedule of cash flows:
Y
ea
r
Cash Flow
0 Equipment……………………………
…
$(1,750,000)
Working capital………………………
…
(90,000)
Total………………………………… $(1,840,000)
PROBLEMS
Item
Item
…