CHAPTER 14 Capital Investment Decisions
P 14-37 (Continued)
Revenues……………………………………………………………
…
$ 1,650,000
2. Discount Facto
r
Present Value
1.00000 $(1,840,000)
3.60478 1,189,577
0.50663 91,193
P 14-38
2. Since I = P for the IRR:
3. For a life of 8 years:
6 180,000
10
$(1,840,000)
330,000
Cash Flow
0
1–5
Y
ea
r
14-16
CHAPTER 14 Capital Investment Decisions
P 14-38 (Continued)
The IRR is between 8% and 9%—greater than the 8% cost of capital. The company
4. Requirement 2 reveals that the estimates for cash savings can be off by as much as
$9,479 (over 15%) without affecting the viability of the new system. Requirement 3
P 14-39
1. First, calculate the expected cash flows:
Days of operation each year: 365 – 15 = 350
Revenue per day: $235 × 2 × 150 = $70,500
2. Revised Cash Flow = (0.80 × $24,675,000) – $3,250,000
=
$16,490,000
14-17
CHAPTER 14 Capital Investment Decisions
P 14-39 (Continued)
3. NPV = (7.46944)CF – $120,000,000 = 0
CF =
=
Annual Revenue = $16,065,461 + $3,250,000
4. Round-Trip Average Price = (2 × $235) × 1.1 = $517
Seats to Be Sold = = 107 (rounded up)
7.46944
$120,000,000
$55,187
$16,065,461
$517
CHAPTER 14 Capital Investment Decisions
P 14-40
1. 1.00 year $16,800
2. Accounting rate of return:
Average Cash Revenue = = $27,900
3.
Y
ea
r
0
IRR (by trial and error): Using 14% as the first guess:
Y
ea
r
0
Discount Facto
r
Present Value
$(74,000) 1.00000 $(74,000)
Cash Flow
1.00000
($19,800 + $27,000 + $32,400 + $32,400)
4
Cash Flow
$(74,000)
Discount Facto
r
Present Value
$(74,000)
CHAPTER 14 Capital Investment Decisions
P 14-40 (Continued)
4. Year Cash Flow
0 $(74,000) 1.00000 $(74,000)
1 11,200 0.89286 10,000
P 14-41
1. Annual CF (rebuild alternative) = ($295.00 – $274.65)10,000 = $203,500
NPV = (CF × df) – I = ($203,500 × 3.79079) – $600,000 = $171,425
2. For the rebuild alternative, df = $600,000 = 2.94840. The IRR ≈ 20%.
$203,500
For the scrap alternative, df × CF = 0 implies that the IRR is infinite (CF is
Discount Factor Present Value
14-20
CHAPTER 14 Capital Investment Decisions
P 14-42
1.
A
llocation
(1) Substance abuse wing……
…
$1,500,000
2. With unlimited capital, the substance abuse wing and the laboratory would be chosen.
With limited capital, the laboratory and outpatient surgery wing would be chosen.
3. Answers may vary, but three qualitative considerations that should generally be
considered in capital budgeting evaluations include:
P 14-43
2.
Y
ea
r
Present Value
0 $(3,500,000)
Cash Flow
Project
Investment
$1,500,000
Discount Facto
r
1.00000
$(3,500,000)
14-21
CHAPTER 14 Capital Investment Decisions
P 14-43 (Continued)
P = CF(df) = I for the IRR, thus,
For 5 years and a discount factor of 3.88889, the IRR is about 9%.
3.
Y
ea
r
Discount Facto
r
Present Value
It is very important to adjust cash flows for inflationary effects. Since the required rate
of return for capital budgeting analysis reflects an inflationary component at the time
decision.
P 14-44
1. Bond Cost = $3,000/$60,000 = 0.05
Cost of Capital = 0.05(0.60) + 0.175(0.40)
= 0.03 + 0.07
= 0.10
2.
Y
ea
r
Discount Facto
r
Present Value
Cash Flow
Cash Flow*
14-22
P 14-45
1. Original savings and investment:
Y
f
NPV………………………………………………
…
$(18,143,680)
(20% rate):
Y
ear CF d
f
Present Value
0 $(45,000,000) 1.00000 $(45,000,000)
1–20 4,000,000 4.86958 19,478,320
20 5,000,000 0.02608 130,400
NPV………………………………………………
…
$(25,391,280)
2. Total benefits: ($4,000,000 + $1,000,000 + $2,400,000)
(14% rate):
Y
f
…
Y
f
…
3. Analysis with increased investment:
(14% rate):
Y
ear CF d
f
Present Value
0 $(48,000,000) 1.00000 $(48,000,000)
1–20 7,400,000 6.62313 49,011,162
20 5,000,000 0.07276 363,800
NPV………………………………………………
…
$ 1,374,962
Y
f
…
14-23
CHAPTER 14 Capital Investment Decisions
P 14-45 (Continued)
4. The automated plant is an attractive investment when the additional
benefits are considered—it promises to return at least the cost of capital
P 14-46
1.
Y
ea
r
CF df Present Value
0 $(860,000) 1.00000 $(860,000)
1–8 225,000 4.34359 977,308
NPV……………………………………………… $ 117,308
Y
r
4. A postaudit can help ensure that a firm’s resources are being used wisely.
It may reveal that additional resources ought to be invested or that
CHAPTER 14 Capital Investment Decisions
P 14-47
1. Standard (Rate = 18%):
Year CF df Present Value
0 $(500,000) 1.00000 $(500,000)
1 300,000 0.84746 254,238
2 200,000 0.71818 143,636
3–10 100,000 2.92845 * 292,845
NPV……………………………………………
…
$ 190,719
*d
f
for Years 1
–
10 minus df for Years 1
–
2 (from Exhibit 14B.2)
2. Standard (Rate = 10%):
Year CF df Present Value
0 $(500,000) 1.00000 $(500,000)
1 300,000 0.90909 272,727
2 200,000 0.82645 165,290
3–10 100,000 4.40903 440,903
NPV……………………………………………
…
$ 378,920
…
–
14-25
…
CHAPTER 14 Capital Investment Decisions
P 14-47 (Continued)
3. Notice how the cash flows using a 10% rate in Years 8–10 are weighted compared
to the 18% rate. The difference in present value is significant. Using an excessive
P 14-48
1. Standard (Rate = 14%):
Year CF df Present Value
0 $(500,000) 1.00000 $(500,000)
1 300,000 0.87719 263,157
2 200,000 0.76947 153,894
3–10 100,000 3.56946 356,946
NPV…………………………………………………………… $ 273,997
2. Standard (Rate = 14%):
Year CF df Present Value
0 $(500,000) 1.00000 $(500,000)
14-26
CHAPTER 14 Capital Investment Decisions
Case 14-49
The statement that Manny would normally have taken the first bid without
hesitation implies that the bid met all of the formal requirements outlined
by the company. If Manny’s friend had met the bid as requested, then
presumably Manny would have offered the business to his friend. The
The fact that Manny was tempted by Todd’s enticements and appeared to
be leaning toward accepting Todd’s original offer compounds the
difficulty of the issue. If Manny actually accepts Todd’s offer and grants
the business at the original price and accepts the gifts, then his behavior
is unquestionably unethical. Some parts of the Statement of Ethical
Professional Practice that would be violated are listed below.
II. Confidentiality
1. Keep information confidential except when disclosure is authorized or
III. Integrity
2. Refrain from engaging in any conduct that would prejudice carrying
out duties ethically.
CASES
CHAPTER 14 Capital Investment Decisions
Case 14-50
1.
Sales (35,000 × $45)…………………………………………
…
$1,575,000
Less: Variable expenses ($35.08 × 35,000).……………
…
1,227,800
2. Payback Period =
** Net income of $51,000 + depreciation of $56,200
Karl is wrong. The book value of the equipment and the furniture should not be
3. NPV:
Y
ea
r
Shaftel Ready Mix
Income Statement
For the Proposed Plant
Present Value
Cash Flow
Original Investment
Annual Cash Flow
Discount Facto
r
14-28
CHAPTER 14 Capital Investment Decisions
Case 14-50 (Continued)
If the furniture and equipment can be sold for book value:
NPV:
Y
ea
r
Discount Facto
r
Present Value
0 $(582,000) 1.00000 $(582,000)
4. Breakeven:
= $35.08X + $296,200
= $296,200
= 29,859 cubic yards
NPV (using break-even amount):
Y
ea
r
Discount Facto
r
Present Value
0 $(352,000) 1.00000 $(352,000)
X
Cash Flow
$9.92X
$45X
Cash Flow
Case 14-50 (Continued)
5. Cost of Capital = 10% for 10 years, so df = 6.14457
df =I
CF
Net Income = Sales – Variable Expenses – Fixed Expenses
= $45X – $35.08X – $296,200
$1,086