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Chapter 26: 1RQ (page 1463)
Explain the difference between capital assets, capital investments, and capital budgeting.
Capital assets, capital investments, and capital budgeting are associated with maintaining and utilizing the funds and other resources for the most profitable outcomes.
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Calculate the present value of the following future cash flows, rounding all calculations to the nearest dollar.
11. \(5,000 received in three years with interest of 10%
12. \)5,000 received in each of the following three years with interest of 10%
13. Payments of \(2,000, \)3,000, and $4,000 received in years 1, 2, and 3, respectively, with interest of 7%
Hicks Company is considering an investment opportunity with the following expected net cash inflows: Year 1, \(235,000; Year 2, \)195,000; Year 3, \(125,000. The company uses a discount rate of 6%, and the initial investment is \)365,000. Calculate the NPV of the investment. Should the company invest in the project? Why or why not?
S26-2 Using payback to make capital investment decisions
Carter Company is considering three investment opportunities with the following payback periods:
Project A | Project B | Project C | |
Payback period | 2.7 years | 6.4 years | 3.8 years |
Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being equal.
Henderson Manufacturing, Inc. has a manufacturing machine that needs attention. The company is considering two options. Option 1 is to refurbish the current machineat a cost of \(1,200,000. If refurbished, Henderson expects the machine to last anothereight years and then have no residual value. Option 2 is to replace the machine at acost of \)4,600,000. A new machine would last 10 years and have no residual value.Henderson expects the following net cash inflows from the two options:
YearRefurbish CurrentPurchase New
MachineMachine
1 \( 350,000 \) 3,780,000
2 340,000 510,000
3 270,000 440,000
4 200,000 370,000
5 130,000 300,000
6 130,000 300,000
7 130,000 300,000
8 130,000 300,000
9 300,000
10 300,000
Total \( 1,680,000 \) 6,900,000
Henderson uses straight-line depreciation and requires an annual return of 10%.
Requirements
1. Compute the payback, the ARR, the NPV, and the profitability index of these twooptions.
2. Which option should Henderson choose? Why?
How is the present value of a lump sum determined?
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