ANSWERS TO CHAPTER QUESTIONS
Chapter 8 Household Investments
1) The three approaches to decision-making for capital expenditures includes:
a) Stand alone – Capital expenditure decisions are made based solely on the
2) Total Portfolio Management is a method of taking into account all assets and
liabilities in making financial planning decisions. It uses inputs that come from
3) Capital expenditures are used in the household today and depreciate in value.
4) Unlike normal expenses capital expenditures have benefits that extend beyond the
current year. To group them together with expenses can lead to distortions in
5) The strengths and weaknesses of the NPV and IRR methods are as follows:
a) NPV Strengths – Theoretically pure, not subject to more than one answer, can
enter required rate of return and accept or reject easily
6) The profitability index, by relating the NPV value to the cost, provides a benchmark
to rank the relative attractiveness of alternative investments.
7) Because they benefit the household over an extended period of time. The durable
8) Education is a capital expenditure because the outlay of time and dollars results in
higher job related cash flow.
9) Skilled workers may actually have their human asset valuations rise before declining
10) Capital expenditure decisions here are performed on an as should be done basis.
11) Try to use more detailed and numerical approaches. When not possible or desired to
do so at least rank items mentally with some thought given to the advantages and
disadvantages of each.
12) State of present car, existing finances, current car promotions, and attractiveness of
new car.
13) Factors to consider when buying a new car include:
a) How long you intend to keep car – the longer the more attractive buying becomes.
14) Some advantages of leasing over purchasing include:
15) More people are leasing autos and other assets because of the case in contracting for
16) Leasing is generally more costly than purchase. However, leasing for lesser periods of
17) Some advantages and disadvantages of leasing a car include:
a) Advantages
i) Convenient. No need to sell.
b) Disadvantages
i) Greater cost
ANSWERS TO CHAPTER PROBLEMS
Chapter 8 Household Investments
1) Laurence was presented with a capital expenditure for a boiler that would cost
$12,000 today and would generate the following savings.
Year Amount
1 $2,000
2 $3,000
If the appropriate discount rate is 8 percent, what is the NPV and the IRR for this outlay?
Excel Solution
3
4
5
8
A B C D E F G H I J
Inputs
Discount Rate 8%
Calculator Solution
General Calculator Approach
HP12C
Clear the register
Enter cash inflow Year 1
2,000
Enter cash inflow Year 2
3,000
Enter cash inflow Year 3
2,000
CFj
g
ENTER
↓
↓
CFj
g
ENTER
↓
↓
CFj
g
ENTER
↓
↓
Enter cash outflow Year 0
12,000
Enter cash inflow Year 4
4,000
Enter cash inflow Year 5
5,000
Enter cash inflow Year 7
5,000
Enter cash inflow Year 8
Calculate the net present value
9,349
CFj
g
ENTER
↓
↓
i
ENTER
↓
g
ENTER
↓
↓
Enter cash inflow Year 6
7,500
CF0
ENTER
↓
f
FIN
CF
2nd
CLR Work
g
CHS
+/–
CFj
g
ENTER
↓
↓
CFj
g
ENTER
↓
↓
CFj
g
ENTER
↓
↓
NPV = $9,349
General Calculator Approach
HP12C
Clear the register
Enter cash outflow Year 0
12,000
Enter cash inflow Year 2
3,000
Enter cash inflow Year 3
2,000
CFj
g
ENTER
↓
↓
CFj
g
ENTER
↓
↓
g
ENTER
↓
↓
Enter cash inflow Year 4
4,000
Enter cash inflow Year 5
5,000
Enter cash inflow Year 6
7,500
Enter cash inflow Year 7
5,000
Enter cash inflow Year 8
2,500
Calculate the internal rate of
return
23%
CFj
g
ENTER
↓
↓
g
ENTER
↓
↓
f
IRR
IRR
IRR = 23%
CF0
ENTER
↓
f
FIN
CF
2nd
CLR Work
g
CHS
+/–
CFj
g
ENTER
↓
↓
CFj
g
ENTER
↓
↓
CFj
g
ENTER
↓
↓
2) Helen, a sociologist, is considering buying a new power lawn mower. It would save
her 30 minutes of work a week, which she would use to see another client. Her fee
Initial Payment = $1,400
Weekly Inflows = Existing Hrly Fee × Hrs Per Week
Calculator Solution
General Calculator Approach
HP12C
TI BA II Plus
Clear the register
↓
CHS
f
FIN
CF
2nd
CLR Work
Excel Solution
2
3
4
5
6
21
A B C D E F G H I J
Inputs
Cost of Lawn Mower $1,400
Hourly Fee $16
Weekly Time Savings (in hours) 0.5
The IRR of 23 percent exceeds the required 9 percent. Therefore, Helen should buy the
new power lawn mower.
3) Marcia had a choice of two washing machines of equal performance. One cost
$400 and had a PV of $230 in savings over having clothes done through an outside
service. The second cost $600 and had a PV of $450. Which one should she
select?
Washing Machine 1
Washing Machine 2
Excel Solution
1
2
3
4
5
7
9
Present Value of Future Savings $230
Washing Machine 2
Present Value of Future Savings $450
Solution
Washing Machine 1
Washing Machine 2
A B C D
Problem 2
Inputs
Washing Machine 1
4) Billy is considering enrolling in an MBA program. It would cost him $22,000 a
year for 2 years. He believes it would raise his salary, which is now $50,000 a year,
by the following amounts:
Year Amount
After-Tax Gain Year 11-15 = Pretax Gain × (1 – t)
= $25,000 × (1 – 0.3)
= $17,500 per year
Number of Years of Gain = 5 years
The cost of attending school is:
Combined Yearly Cost = Schooling Cost + Opportunity Cost
= $22,000 + $36,000
= $58,000 a year for 2 years
a) NPV method
Calculator Solution for Return
General Calculator Approach
HP12C
Clear the register
Enter cash outflow Year 1
58,000
Enter cash outflow Year 2
58,000
Enter cash inflows Year 3-7*
10,500
Enter number of years
5
CF0
ENTER
↓
CHS
Nj
g
ENTER
↓
CFj
ENTER
↓
CHS
↓
g
ENTER
↓
Enter cash inflows Year 8-12*
14,000
Enter number of years
5
Enter cash inflows Year 13-17*
17,500
Enter number of years
5
Nj
g
ENTER
↓
CFj
g
ENTER
↓
f
FIN
CF
2nd
CLR Work
CFj
g
ENTER
↓
Nj
g
ENTER
↓
Calculate the net present value
-7,693
*This numbering takes into account the next two years of MBA study
b) IRR method
Calculator Solution
HP12C
58,000
10,500
CF0
ENTER
↓
CHS
CFj
ENTER
↓
CHS
↓
CFj
g
ENTER
↓
5
5
17,500
g
↓
CFj
g
ENTER
↓
↓
14,000
f
FIN
CF
2nd
CLR Work
Nj
g
ENTER
↓
CFj
g
ENTER
↓
7%
Since that rate of 7 percent is less than Billy’s rate of return on marketable investments of
8 percent, he should not pursue the MBA.
Excel Solution