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Chapter 26: Q14RQ (page 1464)
What is the decision rule for ARR?
Answer
If the ARR achieves or exceeds the statutory accounting rate of return, the project is only acknowledged.
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You are planning for a very early retirement. You would like to retire at age 40 and have enough money saved to be able to withdraw \(215,000 per year for the next 40 years (based on family history, you think you will live to age 80). You plan to save by making 10 equal annual installments (from age 30 to age 40) into a fairly risky investment fund that you expect will earn 10% per year. You will leave the money in this fund until it is completely depleted when you are 80 years old.
Requirements
1. How much money must you accumulate by retirement to make your plan work? (Hint:Find the present value of the \)215,000 withdrawals.)
2. How does this amount compare to the total amount you will withdraw from the investment during retirement? How can these numbers be so different?
John Johnson is the majority stockholder in Johnson鈥檚 Landscape Company, owning 52% of the company鈥檚 stock. John asked his accountant to prepare a capital investment analysis to purchase new mowers. John used the analysis to persuade a loan officer at the local bank to loan the company $100,000. Once the loan was secured, John used the cash to remodel his home, updating the kitchen and bathrooms, installing new flooring, and adding a pool.
Requirements
1. Are John鈥檚 actions fraudulent? Why or why not? Does John鈥檚 percentage of ownership affect your answer?
2. What steps could the bank take to prevent this type of activity?
Why should both quantitative and qualitative factors be considered in capital investment decisions?
Use the NPV method to determine whether Hawkins Products should invest in the
following projects:
鈥� Project A: Costs \(285,000 and offers seven annual net cash inflows of \)55,000. Hawkins Products requires an annual return of 14% on investments of this nature.
鈥� Project B: Costs \(395,000 and offers 10 annual net cash inflows of \)77,000. Hawkins Products demands an annual return of 12% on investments of this nature.
Requirements
1. What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
2. What is the maximum acceptable price to pay for each project?
3. What is the profitability index of each project? Round to two decimal places.
Use the Present Value of \(1 table (Appendix A, Table A-1) to determine the present value of \)1 received one year from now. Assume a 8% interest rate. Use the same table to find the present value of \(1 received two years from now. Continue this process for a total of five years. Round to three decimal places.
Requirements
1. What is the total present value of the cash flows received over the five-year period?
2. Could you characterize this stream of cash flows as an annuity? Why or why not?
3. Use the Present Value of Ordinary Annuity of \)1 table (Appendix A, Table A-2) to determine the present value of the same stream of cash flows. Compare your results to your answer to Requirement 1.
4. Explain your findings.
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