Accounting Poblem 4

Topics: Net present value, Investment, Rate of return Pages: 11 (2125 words) Published: June 6, 2013
Chapter 13:
1) E13-14 (5 points);
2) E13-16 (5 points);
3) E13-18 (5 points);
4) E13-19 (1 point);
5) P13-23A (8 points);
6) P13-25A (8 points);
7) P13-33A parts a, b and c only (8 points);
8) P13-39B (8 points);
9) P13-42B (7 points)

Solutions:

E13-14 (5 points):

(a)The cash payback period is: $48,000 ÷ $8,000 = 6 years

The net present value is:| | Time Period| | CashFlows| ×| 9% DiscountFactor| =| PresentValue| Present value of net annual cash flows| | 1–8| | $8,000| | 5.53482| | $44,279| Present value of salvage value| | 8| | 20,000| | 0.50187| | 10,037| | | | | | | | | 54,316|

Capital investment| | | | | | | | 48,000|
Net present value| | | | | | | | $6,316|

Using financial calculator:
CF0=-48,000; C01=8,000; F01=7; C02 = 28,000; F02 = 1; I = 9; CPT NPV = 6,315.88

(b)In order to meet the cash payback criteria, the project would have to have a cash payback period of less than 5.6 years (8 × 70%). It does not meet the criteria. However, the net present value is positive, suggesting the project should be accepted. The reason for the difference is that the project’s high estimated salvage value increases the present value of the project. The net present value is a better indicator of the project’s worth.

E13-16 (5 points):
Project A:| | Time Period| | CashFlows| ×| 10% DiscountFactor| =| PresentValue| Present value of net annual cash flows| | 1–8| | $20,000| | 5.33493| | $106,699| Present value of salvage value| | 8| | —| | —| | —| | | | | | | | | $106,699|

Capital investment| | | | | | | | 98,000|
Net present value| | | | | | | | $8,699|

Using financial calculator:
CF0=-98,000; C01=20,000; F01=8; I = 10; CPT NPV = 8,698.52
Total PV of net cash flows = NPV + Initial Investment = 8,698.52 + 98,000 = 106,698.52

Profitability index = $106,699 ÷ $98,000 = 1.089

Project B:| | Time Period| | CashFlows| ×| 10% DiscountFactor| =| PresentValue| Present value of net annual cash flows| | 1–8| | $28,000| | 5.33493| | $149,378| Present value of salvage value| | 8| | —| | —| | —| | | | | | | | | $149,378|

Capital investment| | | | | | | | 170,000|
Net present value| | | | | | | | $(20,622)|

Using financial calculator:
CF0=-170,000; C01=28,000; F01=8; I = 10; CPT NPV = -20,622.07 Total PV of net cash flows = NPV + Initial Investment = -20,622.07 + 170,000 = 149,377.93

Profitability index = $149,378 ÷ $170,000 = 0.879

Machine B has a negative net present value, which means its profitability index is less than one. Machine B should be rejected. Machine A should be purchased, as it has a positive net present value.

E13-18 (5 points):

(a)| |
| Project| | CapitalInvestment| ÷| Net Annual CashFlows*| =| IRRFactor| | ClosestDiscountFactor| | Approx.IRR| | 22A23A24A| | $231,000$270,000$288,000| ÷÷÷| $49,9001$50,7502$52,0003| ===| 4.629 5.320 5.538| | 4.622885.334935.53705| | 8%10%11%|

*(Annual income + Depreciation expense)
1 $11,400 + ($231,000 ÷ 6)
2 $17,000 + ($270,000 ÷ 8)
3 $20,000 + ($288,000 ÷ 9)

Using financial calculator:
22A IRR: CF0 = -231,000; C01 = 49,900; F01 = 6; CPT IRR = 7.95% 23A IRR: CF0 = -270,000; C01 = 50,750; F01 = 8; CPT IRR = 10.08% 24A IRR: CF0 = -288,000; C01 = 52,000; F01 = 9; CPT IRR = 10.99%

(b)The acceptable projects are 23A and 24A because their rates of return are equal to or greater than the 9% required rate of return.

E13-19 (1 point):

The annual rate of return is calculated by dividing expected annual income by the average investment. The company’s expected annual income is:

$87,500 – $40,000 = $47,500

Its average investment is:
| $400,000 + $100,000| =| $250,000|
| 2| | |
Therefore, its annual rate of return is: $47,500 ÷ $250,000 = 19%

P13-23A (8 points):...
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