Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 24
Chapter 24
Capital Budgeting and Investment
Analysis
QUESTIONS
1. Capital budgeting decisions require careful analysis because they are generally
the most difficult and risky decisions that management faces.
2. Capital budgeting is the process of planning the acquisition or sale of plant
assets.
3. Capital budgeting decisions are risky because: (1) the outcomes are uncertain,
4. The payback period ignores both the present value of cash flows and all cash
flows after the payback period.
5. A shorter payback period is desirable because management prefers to reduce
the risk that the investment might not be profitable over the long run. As a result
6. If net income is earned evenly throughout each year and straight-line
7. When the present value of expected net cash flows, discounted at 10%, exceeds
the amount invested it indicates that the expected rate of return on the
Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 24
8. Receiving $100 one year from today is worth less than $100 today because a
9. The internal rate of return is the rate that produces a net present value of zero. If
the internal rate of return is higher than the company’s hurdle rate, it means that
the net present value of the project is positive, and the company should make
the investment.
10. Accelerated depreciation produces larger tax deductions and lower tax
payments in the early years of an asset’s life compared with straight-line
11. An investment of this nature in technology is risky for many reasons: (1) Samsung
cannot be 100% certain of the costs and benefits of such a system; (2) there is a
12. Some of the costs and benefits are: cost of the new equipment; cost savings from
13. Apple management could use one of the following common methods to evaluate the
potential investment in the expansion: payback period, accounting rate of return, net
present value, or internal rate of return.
14. A postaudit is an evaluation of the actual results of a capital budgeting decision with
the projected results. Potential benefits of a postaudit include:
15. The advantage of break-even time is that it considers the time value of money. This
means break-even time should provide a superior estimate of the recovery time
Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 24
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QUICK STUDIES
Quick Study 24-1 (5 minutes)
Net present value of investment
Present value of four $9,000 cash inflows ($9,000 x 3.1699*) ………………
$28,529
Quick Study 24-3 (5 minutes)
Present value factor = Amount invested = $27,000 = 3.00
Net cash flows $9,000
than the hurdle rate of 10%, the company should make the investment.
Quick Study 24-4 (10 minutes)
1. Investment A would be preferred over Investment B because of A’s
shorter payback period.
Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 24
Quick Study 24-5 (10 minutes)
*($280,000 – $30,000)/5
Quick Study 24-6 (10 minutes)
Quick Study 24-7 (5 minutes)
Quick Study 24-8 (15 minutes)
Net present value of investment*
Present value of three $14,950 cash inflows ($14,950 x 2.2832)…………..
$34,134
Present value of $6,000 at end of three years ($6,000 x 0.6575) …………..
3,945
Present value of cash inflows ……………………………………………………….
Less immediate cash outflow ……………………………………………………….
45,000
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Quick Study 24-9 (15 minutes)
Net present value of investment*
Present value of seven $10,000 cash inflows ($10,000 x 4.8684) …………
$48,684
Present value of $6,000 at end of seven years ($6,000 x 0.5132) …………
3,079
Less immediate cash outflow ……………………………………………………….
Quick Study 24–10 (10 minutes)
Project A: Profitability index = $1,100,000 / $400,000 = 2.75
Quick Study 24–11 (15 minutes)
Net Cash
Flows
Present
Value of
1 at 12%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$100,000
0.8929
$ 89,290
Year 2 ……………………………………………………….
0.7972
Year 3 ……………………………………………………….
0.7118
Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 24
Quick Study 24-12 (15 minutes)
Net Cash
Flows
Present
Value of
1 at 12%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$100,000
0.8929
$ 89,290
Year 2 ……………………………………………………….
0.7972
Year 3 ……………………………………………………….
0.7118
Quick Study 24-13 (10 minutes)
Quick Study 24-14 (10 minutes)
Net present value of investment
Present value of three $21,000 cash inflows ($21,000 x 2.5771*) …………
$54,119
Less immediate cash outflow ……………………………………………………….
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Quick Study 24-15 (10 minutes)
Net present value of investment*
Present value of 35, $13,000 cash inflows ($13,000 x 11.6546*) ……………
$151,509.80
Quick Study 24-16 (10 minutes)
Present value factor = Amount invested = $125,374.60 = 9.6442
Net cash flows $13,000
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Quick Study 24–17 (15 minutes)
Year
Cash flows
Present value
of 1 at 10%
Present value of
cash flows
Cumulative
present value of
cash flows
0
$(90,000)
1.0000
$(90,000)
$(90,000)
1
35,000
0.9091
31,819
(58,181)
2
35,000
0.8264
28,924
(29,257)
3
35,000
0.7513
26,296
4
35,000
0.6830
23,905
5
35,000
0.6209
21,732
Quick Study 24–18 (15 minutes)
1. Payback period of investment = €80,000,000 / €16,000,000 = 5 years
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EXERCISES
Exercise 24-1 (20 minutes)
Annual Net
Cumulative
Cash Flows
Cash Flows
Year 0 …………………………………………………………..
Year 1 …………………………………………………………..
$(180,000)
60,000
$(180,000)
(120,000)
Year 3 …………………………………………………………..
Cost of investment …………………………………………………………………..
$180,000
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Exercise 24-2 (20 minutes)
Net Cash
Flows
Present
Value of
1 at 10%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$ 60,000
0.9091
$ 54,546
Year 2 ……………………………………………………….
40,000
0.8264
33,056
Year 3 ……………………………………………………….
70,000
0.7513
52,591
Year 4 ……………………………………………………….
0.6830
85,375
Year 5 ……………………………………………………….
0.6209
Exercise 24-3 (15 minutes)
ANNUAL CASH FLOWS
Net
Income
Depreciation*
Net Cash
Flow
Cumulative
Cash Flow
Year 0
Year 1
$ 10,000
$30,000
$(150,000)
$ 40,000
$(150,000)
(110,000
130,000
Cost of machine ……………………………………………………………………
$150,000
Paid back in years 1 and 2 ……………………………………………………..
95,000
Paid back in year 3 ………………………………………………………………..
$ 55,000
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Exercise 24-4 (30 minutes)
COMPUTATION OF ANNUAL DEPRECIATION EXPENSE
Double-declining balance rate = (100% / 5) x 2 = 40%
Annual Depr.
Beginning
(40% of
Accum. Depr.
Ending
Year
Book Value
Book Value)
at Year-End
Book Value
1
$150,000
$60,000
$ 60,000
$90,000
2
54,000
3
32,400
4
19,440
5
ANNUAL CASH FLOWS
Net
Income
Depreciation
Net Cash
Flow
Cumulative
Cash Flow
(19,000)
119,440
Year 0
$(150,000)
$(150,000)
Cost of machine ……………………………………………………………………
$150,000
Paid back in years 1 and 2 ……………………………………………………..
131,000
Paid back in year 3 ………………………………………………………………..
$ 19,000
1436
Exercise 24-5 (20 minutes)
a.
Payback period = = = 2.21 years
b.
Payback period = = = 3.62 years
Exercise 24-6 (20 minutes)
a.
Net present value of investment*
Present value of six $235,000** cash inflows ($235,000 x 4.3553) ……….
$1,023,496
Present value of cash inflows ……………………………………………………….
Cost of investment
Annual net cash flow
$520,000
$235,000
Cost of investment
Annual net cash flow
$380,000
$105,000
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Exercise 24–6 (continued)
b.
Net present value of investment*
Present value of eight $105,000** cash inflows ($105,000 x 5.3349) ……..
$560,165
Present value of $20,000 at end of eight years ($20,000 x 0.4665) ……….
9,330
Present value of cash inflows ……………………………………………………….
Less immediate cash outflow ……………………………………………………….
380,000
Exercise 24-7 (15 minutes)
Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 24
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Exercise 24-8 (20 minutes)
COMPUTING NET CASH FLOWS FROM NET INCOME
Net income
Cash flows
Sales ……………………………………………………………………..
$225,000
$225,000
Materials, labor & overhead ……………………………………
120,000
120,000
Depreciation ……………………………………………………….
$ 36,750
1. Payback period = = 5.39 years
2. Accounting rate of return = = 20.42%
Exercise 24-9 (15 minutes)
Annual
Net Cash
Flows
Present
Value of
Annuity
at 8%
Present
Value of
Net Cash
Flows
Years 1 through 12………………………………………..
$ 66,750
7.5361
$ 503,035
$360,000
$66,750
$36,750
$180,000*
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Exercise 24–10 (20 minutes)
PROJECT A
Net Cash
Flows
Present
Value of
1 at 10%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$ 40,000
0.9091
$ 36,364
Year 2 ……………………………………………………….
56,000
0.8264
46,278
Year 3 ……………………………………………………….
80,295
0.7513
60,326
Year 4 ……………………………………………………….
90,400
0.6830
61,743
Year 5 ……………………………………………………….
0.6209
$331,695
(160,000)
PROJECT B
Net Cash
Flows
Present
Value of
1 at 10%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$ 32,000
0.9091
$ 29,091
Year 2 ……………………………………………………….
50,000
0.8264
41,320
Year 3 ……………………………………………………….
66,000
0.7513
49,586
Year 4 ……………………………………………………….
72,000
0.6830
49,176
Year 5 ……………………………………………………….
0.6209
$244,000
Project A’s profitability index = $245,070 / $160,000 = 1.53
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Exercise 24-11 (25 minutes)
a.
Project X1
Net Cash
Flows
Present
Value of
1 at 4%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$ 25,000
0.9615
$ 24,038
Year 2 ……………………………………………………….
0.9246
Year 3 ……………………………………………………….
$121,000
Project X2
Net Cash
Flows
Present
Value of
1 at 4%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$ 60,000
0.9615
$ 57,690
Year 2 ……………………………………………………….
0.9246
Year 3 ……………………………………………………….
b.
Profitability index, Project X1 = $110,646 / $80,000 = 1.38
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Exercise 24–12 (25 minutes)
a.
Project X1
Net Cash
Flows
Present
Value of
1 at 12%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$ 25,000
0.8929
$ 22,323
Year 2 ……………………………………………………….
0.7972
Year 3 ……………………………………………………….
0.7118
Project X2
Net Cash
Flows
Present
Value of
1 at 4%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$ 60,000
0.8929
$ 53,574
Year 2 ……………………………………………………….
0.7972
Year 3 ……………………………………………………….
0.7118
b.
Profitability index, Project X1 = $93,688 / $80,000 = 1.17
1442
Exercise 24–13 (20 minutes)
Using Excel, Project X1 (X2) has an internal rate of return of 20.34% (12.99%).
Project X1 Project X2
A
B
C
D
1
Initial investment
-80000
–120000
2
Annual cash flows,
end of period
4
2
5
3
6
Formula for IRR
Exercise 24–14 (35 minutes)
1.
PROJECT C1
Net Cash
Flows
Present
Value of
1 at 12%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$ 12,000
0.8929
$ 10,715
Year 2 ……………………………………………………….
0.7972
Year 3 ……………………………………………………….
0.7118
Exercise 24–14 (continued)
PROJECT C2
Net Cash
Flows
Present
Value of
1 at 12%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$ 96,000
0.8929
$ 85,718
Year 2 ……………………………………………………….
0.7972
Year 3 ……………………………………………………….
0.7118
$288,000
PROJECT C3
Net Cash
Flows
Present
Value of
1 at 12%
Present
Value of
Net Cash
Flows
Year 1 ……………………………………………………….
$180,000
0.8929
$160,722
Year 2 ……………………………………………………….
0.7972
Year 3 ……………………………………………………….
0.7118
$288,000
$242,720
Analysis and Interpretation: Both Project C2 and C3 yield a positive net
present value. Accordingly, both C2 and C3 are acceptable investments.
Project C1 has a negative net present value, so it should be rejected.
2. INTERNAL RATE OF RETURN VS. NET PRESENT VALUE FOR C2
Project C2 will have an internal rate of return higher than 12%.
1444
Exercise 24-15 (15 minutes)
1.
Annual
Net Cash
Flows
P.V. of an
Annuity of
1 at 10%
P.V. of Net
Cash
Flows
Years 1-20 direct labor savings ……………………..
$ 500,000
8.5136
$ 4,256,800
2. The project has a positive net present value, thus the internal rate of
return is greater than the required return of 10%.
Exercise 24–16A (20 minutes)
A
B
C
1
Initial
investment
-4000000
Formula for
IRR