Appendix
Capital Investment Decisions: An Overview
Solutions to Review Questions
A-1.
The timing is important because cash received earlier has a greater economic
A-2.
The time value of money merely states that cash received earlier has a greater
A-3.
Revenues represent the accounting measure of inflows to the firm. Revenues
A-4.
Expenses represent the accounting measure of outflows from the firm. Expenses
after cash is spent.
A-5.
Depreciation is an accounting measure of the use of a capital asset and is not a
Solutions to Critical Analysis and Discussion Questions
A-6.
To determine which, if either, project should be approved, the net present value
A-7.
The four types of cash flows are:
A-8.
A-9.
The total amount depreciated over the life of the machine (and, therefore, often
A-10.
Although the working capital might be assumed to be returned to the firm at the
A-11.
The net present value analysis for a new plant considered in this appendix
Solutions to Exercises
A-12. (20 min.) Present Value of Cash Flows: Star City.
a. At 20%
Time
Year
0
1
2
3
4
5
A-13. (25 min.) Present Value of Cash Flows: Rush Corporation.
a.
Year
Depreciation
Tax Shield
at 40%
PV Factor
(8%)
Present
Value
1
$120,000
$ 48,000
.926
$ 44,448
4
.735
$600,000
$240,000
$195,996
b.
Year
Depreciation
Tax Shield
at 40%
PV Factor
(8%)
Present
Value
.857
.681
A-14. (30 min.) Present Value Analysis in Nonprofit Organizations: Johnson Research Organization.
Year
0
1
2
3
4
5
6
7
Investment flows ……………..
$(6,000,000
)
Periodic operating flows:
Annual cash savings …….
$1,400,000
$1,400,000
$1,400,000
$1,400,000
$1,400,000
$1,400,000
$1,400,000
Disinvestment flows ……..
$(6,000,000
)
PV factor 10% …………….
Present value ……………..
)
$1,090,800
$ 991,200
$ 901,200
$ 819,600
$ 745,200
$ 676,800
$ 820,800
Solutions to Problems
A-15. (35 min.) Compute Net Present Value; Compare to Accounting Income:
Lucas Company.
a. Accounting income each year will be $500. The total over four years is $2,000.
b.
A-16. (35 min.) Sensitivity Analysis in Capital Investment Decisions: Square
Manufacturing.
The schedule of cash flows is ($000 omitted):
Year
Best Case
Expected
Worst
Case
0
($9,000
)
($9,000
)
($9,000
)
1
0
0
0
2
0
0
0
3
5
6
7
Net Present Value @ 14%
Note: In the following calculations, the present value factors are from Exhibit A.8. If you
use Excel or a financial calculator, the net present values might differ slightly.
a$2,802 = $(9,000) + ($6,000 x (0.592 + 0.519 + 0.456 + 0.400))
A-17. (40 min.) Compute Net Present Value: Dungan Corporation.
b. Depreciation schedule:
Year
Depreciation
Tax Shield
at 40%
Present Value
Factor (16%)
Present
Value
1
$ 40,000
$16,000
.862
$13,792
3
.641
4
.552
$200,000
$80,000
$54,624
A-17. (continued)
g.
Year
0
1
2
3
4
5
6
7
8
9
10
Investment flows:
Equipment cost ……………………………………………………
$(200,000
)
Removal ……………………………………………………………..
(3,000
)
New equipment:
Year 1 ……………………………………………………………..
Year 2 ……………………………………………………………..
Years 3–5 ………………………………………………………..
)
)
)
)
)
)
)
)
)
)
Disinvestment:
Tax on gain …………………………………………………………
)
Total cash flows …………………………………………………….
$(139,000
)
Present values ………………………………………………………
$(139,000
)
Net present value …………………………………………………..