3. The average rate of return is not based on cash flows but on operating income. Thus, for
4. A one-year payback will not equal a 100% average rate of return because the payback period
6. The majority of the cash flows of a new motion picture are earned within two years of
p
p
8. The net present values indicate that both projects are desirable, but they are not necessarily
equal in desirability. The present value index can be used to compare the two projects. For
9. The computations for the net present value method are more complex than those for the
p
p
10. The computations for the internal rate of return method are more complex than those for the
p
11. The major advantages of leasing are that it avoids the need to use funds to purchase assets
CHAPTER 25 (FIN MAN); CHAPTER 10 (MAN)
CAPITAL INVESTMENT ANALYSIS
DISCUSSION QUESTIONS
25-1
CHAPTER 25 Capital Investment Analysis
PE 25–1A (FIN MAN); PE 10–1A (MAN)
PE 25–1B (FIN MAN); PE 10–1B (MAN)
PE 25–2A (FIN MAN); PE 10–2A (MAN)
PE 25–2B (FIN MAN); PE 10–2B (MAN)
PE 25–3A (FIN MAN); PE 10–3A (MAN)
PE 25–3B (FIN MAN); PE 10–3B (MAN)
PE 25–4A (FIN MAN); PE 10–4A (MAN)
PE 25–4B (FIN MAN); PE 10–4B (MAN)
PRACTICE EXERCISES
25-2
CHAPTER 25 Capital Investment Analysis
PE 25–5A (FIN MAN); PE 10–5A (MAN)
a. Present value of $5,000 per year at 12% for 6 years*…………………………
$20,555
PE 25–5B (FIN MAN); PE 10–5B (MAN)
a. Present value of $15,000 per year at 20% for 4 years*………………………… $38,835
25-3
CHAPTER 25 Capital Investment Analysis
Ex. 25–1 (FIN MAN); Ex. 10–1 (MAN)
Testing
Equipment Vehicle
Estimated average annual income:
$18,720 ÷ 6……………………………………………………………
…
$3,120
Ex. 25–2 (FIN MAN); Ex. 10–2 (MAN)
Average Annual Income
Average Investment
EXERCISES
Average Rate
of Return =
25-4
…
CHAPTER 25 Capital Investment Analysis
Ex. 25–3 (FIN MAN); Ex. 10–3 (MAN)
Ex. 25–4 (FIN MAN); Ex. 10–4 (MAN)
Year 1 Years 2–9 Last Year
Initial investment………………………………………
…
$(107,000)
Operating cash flows:
Annual revenues (4,000 units × 68)……………
…
$ 272,000 $ 272,000 $ 272,000
Average Annual Income
Average Investment
Average Rate
of Return =
=Average Revenues – Annual Product Costs*
(Beginning Cost + Residual Value) ÷ 2
25-5
CHAPTER 25 Capital Investment Analysis
Ex. 25–5 (FIN MAN); Ex. 10–5 (MAN)
Location 1: $380,000 ÷ $76,000 = 5-year cash payback period.
Location 2: 4-year cash payback period, as indicated below.
Cumulative
Net Cash Net Cash
Flow Flows
Year 1………………………………………………………………………
…
$120,000 $120,000
Ex. 25–6 (FIN MAN); Ex. 10–6 (MAN)
a. The Liquid Soap 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:
Initial investment: $540,000
Cumulative Cumulative
Net Cash Net Cash Net Cash Net Cash
Flow Flows Flow Flows
Year 1……………………………… $170,000 $170,000 $90,000 $ 90,000
Year 2……………………………… 150,000 320,000 90,000 180,000
b. The cash payback periods are different between the two product lines because
Liquid Soap earns cash faster than does Body Lotion. Even though both
Body LotionLiquid Soap
25-6
…
…
…
CHAPTER 25 Capital Investment Analysis
Ex. 25–7 (FIN MAN); Ex. 10–7 (MAN)
a. Year
1
2
Ex. 25–8 (FIN MAN); Ex. 10–8 (MAN)
a. 2014 2015 2016 2017 2018
Revenues………………… $ 58,000 $ 58,000 $ 58,000 $ 58,000 $ 58,000
b. Year
2014
$13,000 0.893 $11,609
[from part (a)] of $1 at 12% Net Cash Flow
Net Cash Flow Present Value Present Value of
23,000
17,388
Present Value of
Net Cash Flow
0.870
0.756
Present Value
of $1 at 15%
Net Cash
Flow
$19,000 $16,530
25-7
CHAPTER 25 Capital Investment Analysis
Ex. 25–9 (FIN MAN); Ex. 10–9 (MAN)
a.
Annual revenues………………………………………………………………
…
$47
b.
Annual cash flows………………………………………………………………
$19
in millions
value factor)
(in millions
except present
25-8
CHAPTER 25 Capital Investment Analysis
Ex. 25–10 (FIN MAN); Ex. 10–10 (MAN)
a. Cash inflows:
Hours of operation……………………………………
…
1,500
Cash outflows:
Hours of operation……………………………………
…
1,500
Fuel cost per hour…………………………………
…
$46
b. Annual net cash flow (at the end of each of five years)………
…
$ 46,000
c. Yes. Briggs should accept the investment because the bulldozer cost is less
d. 3.791 [(Hrs. × $110) – (Hrs. × $74) – $8,000] = $132,000
25-9
CHAPTER 25 Capital Investment Analysis
Ex. 25–11 (FIN MAN); Ex. 10–11 (MAN)
a. Revenues (3,600 × 330 days × $340)………………………………………
…
$403,920,000
b. Present value of annual net cash flows ($157,600,000 × 5.650)………
…
$890,440,000
Ex. 25–12 (FIN MAN); Ex. 10–12 (MAN)
a. Total Present Value of Net Cash Flow
Amount to Be Invested
Present Value Index =
25-10
CHAPTER 25 Capital Investment Analysis
Ex. 25–13 (FIN MAN); Ex. 10–13 (MAN)
a. Annual net cash flow—Sewing Machine:
Annual net cash flow—Packing Machine:
Sewing Machine:
Annual net cash flow (at the end of each of 8 years)………………………
…
$ 80,640
…
…
Packing Machine:
Annual net cash flow (at the end of each of 8 years)………………………
…
$ 29,400
…
c. The present value index indicates that the packing machine would be the
b. =
Total Present Value of Net Cash Flow
Amount to Be Invested
Present Value Index
25-11
CHAPTER 25 Capital Investment Analysis
Ex. 25–14 (FIN MAN); Ex. 10–14 (MAN)
$30,000
($450,000 + $0) ÷ 2
*The annual earnings are equal to the cash flow less the annual depreciation expense,
shown as follows:
Ex. 25–15 (FIN MAN); Ex. 10–15 (MAN)
b. Net present value:
c. Some critical elements that are missing from this analysis are:
●The manager is viewing the acquisition of automated assembly equipment as
●The cost of the automated assembly equipment does not stop with the initial
●There will likely be a start-up or learning curve with this new technology that
Average rate of return on investment:
b. = 6 years
a. = 13.3%
$450,000
Cash payback period: $75,000
*
25-12
CHAPTER 25 Capital Investment Analysis
Ex. 25–16 (FIN MAN); Ex. 10–16 (MAN)
Ex. 25–17 (FIN MAN); Ex. 10–17 (MAN)
b. There are many uncertainties that could adversely impact a project of this
scale and scope. There are uncertainties affecting the initial investment and
the annual cash flow assumptions. Regarding the initial investment, the
construction cost could be higher than $415 million, due to delays, labor
issues, and other construction site problems. The annual cash flow
assumptions could be adversely impacted by uncertainties such as:
1. warm weather conditions, or no snow.
a. Present Value Factor for an
Annuity of $1 for 10 Periods =
Present Value Factor for an
Annuity of $1 for 6 Periods =
a.
Amount to Be Invested
Annual Net Cash Flow
Amount to Be Invested
Annual Net Cash Flow
25-13
CHAPTER 25 Capital Investment Analysis
Ex. 25–18 (FIN MAN); Ex. 10–18 (MAN)
a. Delivery Truck
Cash received from additional delivery (95,000 bags × $0.45)……………… $42,750
Bagging Machine
Direct labor savings (3 hrs./day × $18/hr. × 250 days/yr.)……………………
…
$13,500
b. To: Management
Re: Investment Recommendation
An internal rate of return analysis was performed for the delivery truck and
Present Value Factor for an Annuity
of $1 for 7 Periods =
Amount to Be Invested
Annual Net Cash Flow
Present Value Factor for an Annuity
of $1 for 7 Periods =Amount to Be Invested
Annual Net Cash Flow
25-14
CHAPTER 25 Capital Investment Analysis
Ex. 25–19 (FIN MAN); Ex. 10–19 (MAN)
b. The rate of return is less than 12% because there is a negative net present
value.
Ex. 25–20 (FIN MAN); Ex. 10–20 (MAN)
With an expected useful life of five years, the cash payback period cannot be
greater than five years. This would indicate that the cost of the initial investment
c.
Amount to Be Invested
Annual Net Cash Flow
Present Value Factor
for an Annuity of $1 =
25-15
CHAPTER 25 Capital Investment Analysis
Ex. 25–21 (FIN MAN); Ex. 10–21 (MAN)
Processing Mill
Present Value
Year of $1 at 15%
1 0.870
Electric Shovel
Year
1
2
Present Value of
Net Cash Flow
Net Cash
Flow
$ 310,000 $269,700
325,000 245,700
Present Value Net Cash Present Value of
of $1 at 15% Flow Net Cash Flow
0.756
0.870 $ 330,000 $287,100
25-16
CHAPTER 25 Capital Investment Analysis
Ex. 25–22 (FIN MAN); Ex. 10–22 (MAN)
a. Blending Equipment
Equal annual cash flows for Years 1–5…………………………………
…
$19,000
Computer System
…
…
$27,000
$81,344
$75,000
Present value index of blending equipment: b. = 1.08
25-17
…
CHAPTER 25 Capital Investment Analysis
Prob. 25–1A (FIN MAN); Prob. 10–1A (MAN)
1. a. Average annual rate of return for both projects:
b. Net present value analysis:
Year Greenhouse Greenhouse
1 $ 38,000 $33,934 $20,539
2 28,000 22,316 18,331
2. The report to the capital investment committee can take many forms. The
report should, as a minimum, present the following points:
0.797
23,000
0.893 $ 23,000
Front End
Net Cash FlowNet Cash Flow
Loader$1 at 12%
Value of
Front End
Loader
PROBLEMS
Present Value of
Present
25-18
CHAPTER 25 Capital Investment Analysis
Prob. 25–2A (FIN MAN); Prob. 10–2A (MAN)
1. a. Cash payback period for both projects: 2 years (the year in which
accumulated net cash flows equal $750,000), shown as follows:
Net Cash Cumulative Net Cash Cumulative
Year Flow Net Cash Flow Year Flow Net Cash Flow
b. Net present value analysis:
Present
Value of Plant Retail Store Plant Retail Store
Year $1 at 15% Expansion Expansion Expansion Expansion
1 0.870 $ 390,000 $ 375,000 $339,300 $326,250
2. The report can take many forms and should include, as a minimum, the
following points:
a. Both projects offer the same total net cash flow.
Plant Expansion
Net Cash FlowNet Cash Flow
Present Value of
Retail Store Expansion
25-19
CHAPTER 25 Capital Investment Analysis
Prob. 25–3A (FIN MAN); Prob. 10–3A (MAN)
1.
Present Value Net Cash Present Value of
Year of $1 at 20% Flow Net Cash Flow
1 0.833 $ 5,000,000 $4,165,000
Present Value Net Cash Present Value of
Year of $1 at 20% Flow Net Cash Flow
1 0.833 $10,000,000 $ 8,330,000
Present Value Net Cash Present Value of
Year of $1 at 20% Flow Net Cash Flow
1 0.833 $ 5,000,000 $ 4,165,000
Route Expansion
Acquire Railcars
New Maintenance Yard
25-20