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Chapter 26: Q16RQ (page 1464)
Question: What is an annuity? How does it differ from a lump sum payment?
Answer
An annuity is an equal monetary payment, while a lump sum payment is a one-time payment.
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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?
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?
Congratulations! You have won a state lottery. The state lottery offers you the following (after-tax) payout options:
Option #1: \(12,000,000 after five years Option #2: \)2,150,000 per year for five years Option #3: $10,000,000 after three years |
Assuming you can earn 6% on your funds, which option would you prefer?
Explain the difference between the present value factor tables鈥擯resent Value of \(1 and Present Value of Ordinary Annuity of \)1.
Why are net present value and internal rate of return considered discounted cash flow methods?
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