2. The principal limitations of the cash payback method are its failure to consider cash flows
occurring after the payback period and its failure to use present value concepts.
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
7. The $7,900 net present value indicates that the proposal is desirable because the proposal is
expected to recover the investment and provide more than the minimum rate of return.
8. The net present values indicate that both projects are desirable, but not necessarily equal in
desirability. The present value index can be used to compare the two projects. For example,
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 26
CAPITAL INVESTMENT ANALYSIS
DISCUSSION QUESTIONS
26-1
CHAPTER 26 Capital Investment Analysis
PE 26–1A
PE 26–1B
PE 26–2A
PE 26–2B
PE 26–3A
PE 26–3B
PE 26–4A
PE 26–4B
PRACTICE EXERCISES
26-2
CHAPTER 26 Capital Investment Analysis
PE 26–5A
a. Present value of $5,000 per year at 12% for 6 years*…………………………
$20,555
PE 26–5B
a. Present value of $15,000 per year at 20% for 4 years*………………………… $38,835
26-3
CHAPTER 26 Capital Investment Analysis
Ex. 26–1
Testing
Equipment Vehicle
Estimated average annual income:
$1,920 ÷ $16,000………………………………………………………
…
12%
Ex. 26–2
EXERCISES
Average Rate
of Return =
=Average Savings* – Annual Depreciation – Additional Operating Costs
(Beginning Cost + Residual Value) ÷ 2
Average Annual Income
Average Investment
26-4
…
…
CHAPTER 26 Capital Investment Analysis
Ex. 26–3
Ex. 26–4
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 Rate
of Return =
Average Annual Income
Average Investment
26-5
CHAPTER 26 Capital Investment Analysis
Ex. 26–5
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
Ex. 26–6
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
b. The cash payback periods are different between the two product lines because
Body LotionLiquid Soap
26-6
CHAPTER 26 Capital Investment Analysis
Ex. 26–7
a. Year
1
2
Ex. 26–8
a. 2014 2015 2016 2017 2018
Revenues………………… $ 58,000 $ 58,000 $ 58,000 $ 58,000 $ 58,000
b. Year
2014
Present Value of
Net Cash Flow
0.870
0.756
Present Value
of $1 at 15%
Net Cash
Flow
$19,000 $16,530
23,000
17,388
[from part (a)] of $1 at 12% Net Cash Flow
Net Cash Flow Present Value Present Value of
$13,000 0.893 $11,609
26-7
CHAPTER 26 Capital Investment Analysis
Ex. 26–9
a.
Annual revenues………………………………………………………………
…
$47
b.
in millions
value factor)
(in millions
except present
26-8
CHAPTER 26 Capital Investment Analysis
Ex. 26–10
a. Cash inflows:
Hours of operation……………………………………
…
1,500
b. Annual net cash flow (at the end of each of five years)………
…
$ 46,000
of 10%.
d. 3.791 [(Hrs. × $110) – (Hrs. × $74) – $8,000] = $132,000
(Hrs. × $417) – (Hrs. × $281) – $30,328 = $132,000
26-9
…
CHAPTER 26 Capital Investment Analysis
Ex. 26–11
a. Revenues
(
3,600 × 330 da
y
s × $340
)
……………………………………………
…
$403,920,000
Less: Variable expenses
(
3,600 × 330 da
y
s × $140
)
…………………………
…
(166,320,000)
Ex. 26–12
a. Total Present Value of Net Cash Flow
Amount to Be Invested
Present Value Index =
26-10
CHAPTER 26 Capital Investment Analysis
Ex. 26–13
a. Annual net cash flow—Sewing 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
26-11
CHAPTER 26 Capital Investment Analysis
Ex. 26–14
$30,000
($450,000 + $0) ÷ 2
*The annual earnings are equal to the cash flow less the annual depreciation expense,
shown as follows:
Ex. 26–15
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
purchase price and installation costs. The equipment will require the company
b. = 6 years
a. = 13.3%
$450,000
Cash payback period: $75,000
a. Payback period: $1,400,000
$350,000 4 years=
Average rate of return on investment: *
26-12
CHAPTER 26 Capital Investment Analysis
Ex. 26–16
b. Row 6 in Exhibit 2. The column associated with the factor 4.111 is 12%.
Ex. 26–17
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.
3. competitor property improvements that siphon demand from the project.
5. industry overbuilding that causes a price war to maintain volume.
Amount to Be Invested
Annual Net Cash Flow
Amount to Be Invested
Annual Net Cash Flow
Present Value Factor for an
Annuity of $1 for 6 Periods =
a.
12%
a. Present Value Factor for an
Annuity of $1 for 10 Periods =
26-13
CHAPTER 26 Capital Investment Analysis
Ex. 26–18
a. Delivery Truck
Bagging Machine
Direct labor savings (3 hrs./day × $18/hr. × 250 days/yr.)……………………
…
$13,500
b. To: Management
Re: Investment Recommendation
26-14
CHAPTER 26 Capital Investment Analysis
Ex. 26–19
a. Present value of annual net cash flows ($35,000 × 4.968*)…………………
…
$173,880
Ex. 26–20
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
26-15
CHAPTER 26 Capital Investment Analysis
Ex. 26–21
Processing Mill
Present Value
Year of $1 at 15%
2 0.756
4 0.572
Electric Shovel
Year
2
4
260,000 148,720
0.572 320,000 183,040
325,000 245,700
Present Value Net Cash Present Value of
of $1 at 15% Flow Net Cash Flow
0.756
Present Value of
Net Cash Flow
Net Cash
Flow
260,000
196,560
26-16
CHAPTER 26 Capital Investment Analysis
Ex. 26–22
a. Blending Equipment
Equal annual cash flows for Years 1–5…………………………………
…
$19,000
Computer System
Equal annual cash flows for Years 1–5…………………………………
…
$27,000
…
$81,344
$75,000
Present value index of blending equipment: b. = 1.08
26-17
…
CHAPTER 26 Capital Investment Analysis
Prob. 26–1A
1. a. Average annual rate of return for both projects:
b. Net present value analysis:
Year Greenhouse Greenhouse
2. The report to the capital investment committee can take many forms. The
report should, as a minimum, present the following points:
PROBLEMS
Present Value of
Present
Front End Loader
Net Cash FlowNet Cash Flow
Front End Loader$1 at 12%
Value of
26-18
CHAPTER 26 Capital Investment Analysis
Prob. 26–2A
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
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
26-19
CHAPTER 26 Capital Investment Analysis
Prob. 26–3A
1.
Present Value Net Cash Present Value of
Year of $1 at 20% Flow Net Cash Flow
2 0.694 4,000,000 2,776,000
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
26-20