25 Minutes, Medium PROBLEM 26.5B
I.C. CREAM
a.
(1)
(2)
(3) Net present value, discounted at 12%:
(1)
(2)
$3,000,000 ÷ $700,000 = 4.3 years
Return on average investment:
($700,000 – $350,000) ÷ [($3,000,000 + $200,000) ÷ 2]
$350,000 ÷ $1,600,000 = 21.9%
(3) Net present value, discounted at 12%:
Total present value of eight annual net cash flows ($700,000 × 4.968) 3,477,600$
b.
Proposal B
Payback period:
Proposal A
Payback period:
$4,000,000 ÷ $800,000 = 5 years
Return on average investment:
($800,000 – $500,000) ÷ ($4,000,000 ÷ 2)
$300,000 ÷ $2,000,000 = 15%
Based on the above analysis, Proposal B is the only acceptable investment of the two
proposals under consideration. Although Proposal A has an acceptable payback period and
30 Minutes, Strong
PROBLEM 26.6B
CAFIELD APPLIANCE COMPANY
a.
Estimated sales (15,000 units @ $40) 600,000$
Less estimated incremental costs:
Variable manufacturing costs (15,000 units @ $18) 270,000$
b. Computation of annual net cash flow:
Cash receipts 600,000$
Less cash outlays:
Variable manufacturing costs 270,000$
c. (1)
(2)
(3) Net present value of project, discounted at 12%:
Total present value of annual cash flows ($154,500 × 3.605) 556,973$
Less: Amount to be invested 300,000
Net present value of project 256,973$
CAFIELD APPLIANCE COMPANY
Schedule of Estimated Net Income
40 Minutes, Strong PROBLEM 26.7B
DOCTORS
a.
The supporting calculations for the above payback figure are:
Incremental annual revenue of investment 900,000$
Less: Incremental annual expenses of investment 800,000
b.
Return on average investment:
Payback period:
PROBLEM 26.7B
DOCTORS (concluded)
c. Net present value:
The discounted present value of the incremental annual cash flow of
the investment (see part a) discounted at 15% for 9 years is
$244,444 × 4.772 (from Exhibit 26.4) 1,166,487$
d.
Some of the nonfinancial factors that the doctors should consider include (1) the pace at which MRI
technology is changing, (2) changes in legislation pertaining to government funding of medical
Discounted present value of all cash flows 1,223,287$
Less: Cost of investment 1,500,000
Net present value (276,713)$
As shown above, the net present value of the MRI investment is negative. Thus,
50 Minutes, Strong PROBLEM 26.8B
JACKSON MOUNTAIN
a.
The supporting calculations are:
Incremental annual revenue of investment 72,500$
Less: Incremental annual expenses of investment 20,000
Incremental annual income of investment 52,500$
Add: Depreciation expense 22,500*
Incremental annual cash flow of investment 75,000$
The supporting calculations for the payback period figure are:
Incremental annual revenue of investment 70,000$
Less: Incremental annual expenses of investment 22,000
Payback period:
Snow-Making Equipment
PROBLEM 26.8B
JACKSON MOUNTAIN (continued)
b.
c. Net present value:
Snow-Making Equipment
The discounted present value of the incremental annual cash flow of
the investment (see part a) discounted at 20% for 10 years is
Less: Cost of investment 225,000
Net present value 89,400$
The discounted present value of the incremental annual cash flow
Less: Cost of investment 250,000
Net present value 44,635$
Chairlift
Return on average investment:
Snow-Making Equipment
PROBLEM 26.8B
JACKSON MOUNTAIN (concluded)
d.
e.
The management of Jackson Mountain must decide which investment opportunity will best
serve its customers. Thus, it must try to determine if adequate snow coverage with long lift
and alternative investment opportunities.
It is likely that management will elect to invest in snow-making equipment. This investment
45 Minutes, Strong PROBLEM 26.9B
BOOM, INC.
a.
The supporting calculations for the above payback figure are:
Incremental annual revenue of investment 400,000$
Less: Incremental annual expenses of investment 260,000
Add: Depreciation expense 100,000*
Incremental annual cash flow of investment 240,000$
The supporting calculations for the payback figure are:
Incremental annual revenue of investment 260,000$
Less: Incremental annual expenses of investment 140,000
Add: Depreciation expense 70,000*
Incremental annual cash flow of investment 190,000$
Program Bank Installation
*Depreciation expense: $500,000 ÷ 5 years = $100,000
Payback period:
Memory Stick Equipment
PROBLEM 26.9B
BOOM, INC. (continued)
b.
Thus, the return on average investment is:
c. Net present value:
Memory Stick Equipment
The discounted present value of the incremental annual cash flow of
Less: Cost of investment 500,000
Net present value 365,200$
Program Bank Installation
The discounted present value of the incremental annual cash flow of
Less: Cost of investment 350,000
Net present value 334,950$
Return on average investment:
Memory Stick Equipment
Program Bank Installation
Thus, the return on average investment is:
PROBLEM 26.9B
BOOM, INC. (concluded)
d.
e.
There are several nonfinancial considerations worth mentioning. First, the company must
try to determine which medium the customers are most likely to use. Second, it must try to
determine future industry trends regarding software distribution. Third, it must evaluate
If Boom invests in the program bank, there will no longer be a need for employees to load
SOLUTIONS TO CRITICAL THINKING CASES
a.
b.
25 Minutes, Strong
Present value of estimated incremental annual cash flows for 10 years:
CASE 26.1
Net present value of proposal, discounted at an annual rate of 15%:
METRO PRINTERS
The cost of the laser printer is $1,300,000, not $2,500,000 as Adams suggests. Adams is
Present value of proceeds from sale of existing equipment
Present value of tax savings from loss on disposal of existing equipment,
60 Minutes, Strong CASE 26.2
GRIZZLY COMMUNITY HOSPITAL
a.
The supporting calculations are:
Incremental annual revenue of investment 1,150,000$
Less: Incremental annual expenses of investment 850,000
Incremental annual income of investment 300,000$
Add: Depreciation expense 225,000*
Incremental annual cash flow of investment 525,000$
Net Present Value
The discounted present value of the incremental annual cash flow of
the investment (see above) discounted at 12% for 20 years is
Less: Cost of investment 4,500,000
Net present value (578,775)$
The negative net present value computed above indicates that
expected return of the center is less than the 12% return required
by the hospital.
Thus, the return on average investment is:
*Depreciation expense: 4,500,000 ÷ 20 years = $225,000
Return on average investment:
Relevant financial measures introduced in the chapter include:
Payback period
CASE 26.2
b.
c.
There are many nonfinancial issues related to this decision. Questions that should be
The estimates of the revenues and costs associated with the dialysis center were provided
by the physicians, who are strongly in favor of building the center. Due to their position on
GRIZZLY COMMUNITY HOSPITAL (concluded)
20 Minutes, Medium
CASE 26.3
INTERNATIONAL INVESTMENTS IN OUTSCOURCING
a.
b.
Lower cost does not always mean gains in efficiency. This implies that the cash flow
savings obtained from lower cost inputs overseas (labor for example) may be offset by
higher costs and related cash flows due to reduced productivity. Often, lower labor costs
go hand-in-hand with less skilled labor. A lower skilled labor force will result in lower
ivi effici
Although companies have been known to undertake transfer of knowledge between
current and future employees, there are significant ethical concerns about asking current
employees to train their offshore replacements. There is the potential for the employees to
Choosing to run your own offshore operation versus outsourcing the management of that
operation can have significant cash flow implications. It is likely to be more costly to
manage your own offshore operation. However, gains in efficiency, productivity, and
quality can offset those initial costs.
CASE 26.4
a.
b.
The ethical violations identified in the Red Robin case are two particular instances. First,
the CEO employed corporate assets for his own personal use. When the airplane was
purchased, a capital investment analysis was performed to assess its net present value.
Conversion of assets for personal use were not part of those computations. If they had been
30 Minutes, Medium
RED ROBIN GOURMET BURGERS
Student answers will vary considerably. However, given recent evidence of earnings
ETHICS, FRAUD & CORPORATE GOVERNANCE