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Chapter 26: Q10RQ (page 1463)
What is the decision rule for payback?
Answer
The general rule is that investments with shorter payback periods are observed as more appropriate and preferable.
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Outlining the capital budgeting process Review the following activities of the capital budgeting process: a. Budget capital investments. b. Project investments鈥� cash flows. c. Perform post-audits. d. Make investments. e. Use feedback to reassess investments already made. f. Identify potential capital investments. g. Screen/analyze investments using one or more of the methods discussed. Place the activities in sequential order as they occur in the capital budgeting process.
Splash Nation is considering purchasing a water park in Atlanta, Georgia, for \(1,910,000. The new facility will generate annual net cash inflows of \)483,000 foreight years. Engineers estimate that the facility will remain useful for eight years andhave no residual value. The company uses straight-line depreciation, and its stockholdersdemand an annual return of 10% on investments of this nature.
Requirements
1. Compute the payback, the ARR, the NPV, the IRR, and the profitability index ofthis investment.
2. Recommend whether the company should invest in this project.
Using accounting rate of return to make capital investment decisions
Carter Company is considering three investment opportunities with the following accounting rates of return:
Project X | Project Y | Project Z | |
ARR | 13.25% | 6.58% | 10.47% |
Use the decision rule for ARR to rank the projects from most desirable to least desirable. Carter Company鈥檚 required rate of return is 8%.
Why are net present value and internal rate of return considered discounted cash flow methods?
Lockwood Company is considering a capital investment in machinery:
Initial investment $ 600,000
Residual value 50,000
Expected annual net cash inflows 100,000
Expected useful life 8 years
Required rate of return 12%
8. Calculate the payback.
9. Calculate the ARR. Round the percentage to two decimal places.
10. Based on your answers to the above questions, should Lockwood invest in the machinery?
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