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Chapter 26: Q13SE (page 1467)
Refer to Short Exercise S26-4. Assume the expansion has no residual value. What is the project鈥檚 NPV (round to nearest dollar)? Is the investment attractive? Why or why not?
The investment is attractive and the net present value is$2,215,432.21.
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Spencer Wilkes is the marketing manager at Darby Company. Last year, Spencer recommended the company approve a capital investment project for the addition of a new product line. Spencer鈥檚 recommendation included predicted cash inflows for five years from the sales of the new product line. Darby Company has been selling the new products for almost one year. The company has a policy of conducting annual post audits on capital investments, and Spencer is concerned about the one-year post-audit because sales in the first year have been lower than he estimated. However, sales have been increasing for the last couple of months, and Spencer expects that by the end of the second year, actual sales will exceed his estimates for the first two years combined.
Spencer wants to shift some sales from the second year of the project into the first year. Doing so will make it appear that his cash flow predictions were accurate. With accurate estimates, he will be able to avoid a poor performance evaluation. Spencer has discussed his plan with a couple of key sales representatives, urging them to report sales in the current month that will not be shipped until a later month. Spencer has justified this course of action by explaining that there will be no effect on the annual financial statements because the project year does not coincide with the fiscal year鈥撯�揵y the time the accounting year ends, the sales will have actually occurred.
Requirements
1. What is the fundamental ethical issue? Who are the affected parties?
2. If you were a sales representative at Darby Company, how would you respond to Spencer鈥檚 request? Why?
3. If you were Spencer鈥檚 manager and you discovered his plan, how would you respond?
4. Are there other courses of action Spencer could take?
List some common cash outflows from capital investments.
Henry Co. is considering acquiring a manufacturing plant. The purchase price is \(1,200,000. The owners believe the plant will generate net cash inflows of \)325,000 annually. It will have to be replaced in six years. Use the payback method to determine whether Henry should purchase this plant. Round to one decimal place.
P26-40 Using payback, ARR, NPV, and IRR to make capital investment decisions
This problem continues the Piedmont Computer Company situation from Chapter 25. Piedmont Computer Company is considering purchasing two different types of servers. Server A will generate net cash inflows of \(25,000 per year and have a zero residual value. Server A鈥檚 estimated useful life is three years, and it costs \)45,000. Server B will generate net cash inflows of \(25,000 in year 1, \)15,000 in year 2, and \(5,000 in year 3. Server B has a \)5,000 residual value and an estimated useful life of three years. Server B also costs $45,000. Piedmont Computer Company鈥檚 required rate of return is 14%.
Requirements
1. Calculate payback, accounting rate of return, net present value, and internal rate of return for both server investments. Use Microsoft Excel to calculate NPV and IRR.
2. Assuming capital rationing applies, which server should Piedmont Computer Company invest in?
What is net present value?
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