Accounting Chapter 15 Homework The Short Network has the largest present value index. Although EZ Expansion has the largest net present value, it returns less present value per dollar invested

500

P15–3

1.

EZ Expansion

Present Value Net Cash Present Value of

Year of $1 at 20% Flow Net Cash Flow

1 0.833 $2,100,000 $ 1,749,300

2 0.694 1,800,000 1,249,200

Notorious Facilities

Present Value Net Cash Present Value of

Year of $1 at 20% Flow Net Cash Flow

1 0.833 $ 500,000 $ 416,500

Short Network

Present Value Net Cash Present Value of

Year of $1 at 20% Flow Net Cash Flow

1 0.833 $300,000 $ 249,900

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P15–3, Concluded

2. Present Value Index = Total Present Value of Net Cash Flow

Amount to Be Invested

3. The Short Network has the largest present value index. Although EZ Expan-

sion has the largest net present value, it returns less present value per dollar

invested (1.93 present value index) than does the Short Network (2.47 present

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P15–4

1. a. Radio Station

Annual net cash flows (at the end of each of 4 years) …………… $ 560,000

Present value of an annuity of $1 at 10% for 4 years (Exhibit 5) × 3.170

TV Station

Annual net cash flows (at the end of each of 4 years) …………… $ 1,120,000

Present value of an annuity of $1 at 10% for 4 years (Exhibit 5) × 3.170

b. Present Value Index = Invested Be to Amount

Flows Cash Net of ValuePresent Total

2. Present Value Factor for an Annuity of $1 = Flows Cash Net Annual

Invested Be to Amount

Radio Station: 000,560$

800,598,1$ = 2.855

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P15–4, Concluded

3. By using the internal rate of return method, all proposals are placed on a

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P15–5

1. Net present value analysis:

Site A

Annual net cash flows (at the end of each of 6 years) ………………… $ 400,000

Site B

Annual net cash flows (at the end of each of 4 years) ………………… $ 500,000

Present value of an annuity of $1 at 20% for 4 years (Exhibit 5) …. × 2.589

2. Net present value analysis:

Present Value of

Present Value of Net Cash Flows Net Cash Flows

Year $1 at 20% Site A Site B Site A Site B

1 0.833 $ 400,000 $ 500,000 $ 333,200 $ 416,500

3. To: Investment Committee

Both Sites A and B have a positive net present value. This means both pro-

jects meet our minimum expected return of 20% and would be acceptable

investments. However, if funds are limited and only one of the two projects

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P15–6

1. Proposal Bravo: 3 years and 6 months cash payback period, as follows:

Net Cash Cumulative

Year Flows Net Cash Flows

1 $125,000 $125,000

2 125,000 250,000

Net Cash Cumulative

Year Flows Net Cash Flows

1 $280,000 $280,000

2 270,000 550,000

3 months* 50,000 600,000

*The net cash flows required is $50,000 out of $200,000 in Year 3 or 1/4.

Thus, 1/4 of 12 months is 3 months.

Net Cash Cumulative

Year Flows Net Cash Flows

1 $60,000 $ 60,000

2 60,000 120,000

3 60,000 180,000

3 months* 10,000 190,000

*The net cash flows required is $10,000 out of $40,000 in Year 4 or 1/4.

Thus, 1/4 of 12 months is 3 months.

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P15–6, Continued

2. Proposal Bravo: 9.4% average rate of return, determined as follows:



$100,000 ÷ 5

$425,000 + $0 ÷ 2 = $20,000

$212,500 = 9.4% (Rounded)

Proposal Uniform: 31.3% average rate of return, determined as follows:



$215,000 ÷ 5

$275,000 + $0 ÷ 2 = $43,000

$137,500 = 31.3% (Rounded)

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P15–6, Continued

3. Of the four proposed investments, only Proposals Tango and Uniform meet

the company’s requirements as the following table indicates:

Cash Payback Average Rate Accept for

Proposal Period of Return Further Analysis Reject

Bravo 3 yrs., 6 mos. 9.4% X

4.

Proposal Tango

Present Value Net Cash Present Value of

Year of $1 at 12% Flows Net Cash Flows

1 0.893 $ 280,000 $ 250,040

Proposal Uniform

Present Value Net Cash Present Value of

Year of $1 at 12% Flows Net Cash Flows

1 0.893 $100,000 $ 89,300

2 0.797 100,000 79,700

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P15–6, Concluded

5. Present Value Index = Invested Be toAmount

Flow CashNet of luePresent Va Total

Present value index of Proposal Tango: $765,400

$600,000 = 1.28 (Rounded)

7. Based on the present value index, the proposals should be ranked as follows:

Proposal Uniform: 1.29

Proposal Tango: 1.28

8. The present value indexes indicate that although Proposal Tango has the

larger net present value, it is not as attractive as Proposal Uniform in terms of

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METRIC-BASED ANALYSIS

MBA 15–1

1. Return on Total Assets = $35,058

$254,580 = 13.8%

Return on Stockholders’ Equity = $35,058 $110,360 $254,580

××

$110,360 $254,580 $85,215

Return on Stockholders’ Equity = 31.77% × 0.43 × 2.99 = 40.8%*

Profit Asset Financial

Margin Turnover Leverage

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MBA 15–2

1. Return on Total Assets =

$4,116

$24,198

= 17.0%

2. Return on Stockholders’ Equity =

$4,116

$9,436

= 43.6%

MBA 15–3

1. Return on Total Assets =

$6,114

$52,277

= 11.7%

2. Return on Stockholders’ Equity =

$6,114

$13,099

= 46.7%

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MBA 15–4

The comparative metrics for Southwest Airlines and Delta Air Lines are summa-

rized as follows:

Southwest Delta

Return on total assets …………………….. 17.0% 11.7%

Southwest’s profit margin of 19.44% is significantly higher than Delta’s profit

margin of 14.82%. This is surprising given the competitive nature of the passen-

ger airline services. Southwest’s asset turnover of 0.87 is higher than Delta’s as-

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MBA 15–5

1. Return on Total Assets:

Costco ($4,111 ÷ $34,755) ……………………. 11.8%

Walmart ($20,437 ÷ $201,674) ………………. 10.1%

Asset Turnover:

Costco ($129,025 ÷ $34,755) ………………… 3.71

Walmart ($500,343 ÷ $201,674) …………….. 2.48

* 35.1% = 3.19% × 3.71 × 2.97

** 25.3% = 4.08% × 2.48 × 2.50

4. The return on total assets is higher for Costco (11.8%) than Walmart (10.1%).

Costco’s return on stockholders’ equity of 35.1% is higher than Walmart’s

25.3%. The profit margin, asset turnover, and financial leverage metrics reveal

operating differences between Costco and Walmart. Specifically, Costco’s

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CASES

Case 15–1

The plant manager wants a project to become accepted and places pressure

on the analyst to come up with the “right numbers.” Zuhair is right when he

states the net present value analysis has many assumptions and room for

interpretation. Many use this room for interpretation to work the numbers until

they satisfy the minimum return (hurdle) rate. Some analysts state they start with

the hurdle rate and work back into the numbers. Clearly, this is not what should

be expected of Erin.

on his systems so he doesn’t need the warehouse space.

This difficult issue revolves around the nature of ethical dilemmas. Erin has had a

brief tenure with the organization. Erin has little organizational clout and could

easily find her career short-circuited by crossing Zuhair. Erin might want to slide

on this one; after all, who would know? If the project is eventually a failure, it’s

unlikely that the decision would come back to haunt Erin. Much time will have

passed, and Erin will likely be in another job in the company. The decision to con-

front Zuhair has immediate repercussions. This is the heart of real-world ethical

dilemmas. The dilemma occurs when the ethical decision has grave short-term

consequences (Zuhair short-circuits the career) and few seemingly long-term

rewards (no one sees the ethical decision), while the unethical decision looks

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Case 15–2

1. Annual salary …………………………………………………………………… $ 50,000

Present value of $1 annuity for 10 years at 10% ………………… × 6.145

2. Annual tuition at the beginning of the graduate year …………. $ (15,000)

Annual salary …………………………………………………………………… $ 65,000

Note: The present values of parts (1) and (2) must be determined as of the

beginning of the graduate year in order to be compared. Thus, the present

value of the salary at the end of graduate school must be brought back one

period to the beginning of the graduate year since this salary stream is

delayed by one year of schooling. The following timeline shows the calculation.

0 1 2 3 4 5 6 7 8 9 10

($ 15,000) $65,000 $65,000 $65,000 $65,000 $65,000 $65,000 $65,000 $65,000 $65,000

$340,271 ($65,000  5.759)  0.909

$325,271

3. Present value of graduate option ………………………………………. $325,271

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Case 15–3

1. Since all the net cash flows are incurred in the local economy under this

assumption, the internal rate of return of the new plant will likely decline. This

is because the cash profits earned on the plant will be less in U.S. dollars as a

2. If the plant produced for export only, then the expenses would be incurred in

local currency, and the revenues would be earned in U.S. dollars. This could

work in favor of the project because the expenses in U.S. dollar terms would

Case 15–4

In all three companies, the executives indicate that financial investment analysis

plays a minor role in the selection of projects because all three companies deal

with products that have highly uncertain future cash flows. Thus, any attempt at a

financial investment analysis could be highly suspect. Instead, these managers

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Case 15–5

1. (All amounts are in millions.)

20Y5 cash flows:

Gross ticket sales ……………………………………………………… $ 240

Production cost …………………………………………………………. (200)

Net present value:

Present Value Net Cash Present Value of

Year of $1 at 20% Flows Net Cash Flows

20Y5 0.833 $(40) $ (33)

20Y6 0.694 50 35

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Case 15–6

This activity could be assigned individually or in groups. This activity has the stu-

dent(s) perform a capital investment analysis for a printer/copier/scanner/fax

machine, using information available to them on the Internet and from local busi-

Assumed average charge per document ……………………………….. $ 0.20

Semester cost (1,000 documents × $0.20) ……………………………… $ 200

Present value of $200 for 6 semiannual periods at 5%

($200 × 5.08) ……………………………………………………………….. $1,016

Less assumed price of a mid-range printer/copier/scanner/fax