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Chapter 26: Q17RQ (page 1464)
How does compound interest differ from simple interest?
Answer
Simple interest is calculated on principle only whereas compound interest is calculated on both the principal and the previously accrued interest.
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You are planning for early retirement. You would like to retire at age 40 and have enough money saved to be able to withdraw \(220,000 per year for the next 30 years (based on family history, you think you will live to age 70). You plan to save by making 20 equal annual instalments (from age 20 to age 40) into a fairly risky investment fund that you expect will earn 8% per year. You will leave the money in this fund until it is completely depleted when you are 70 years old.
Requirements
1. How much money must you accumulate by retirement to make your plan work? (Hint: Find the present value of the \)220,000 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?
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?
Using NPV to make capital investment decisions Holmes Industries is deciding whether to automate one phase of its production process. The manufacturing equipment has a six-year life and will cost \(910,000.
Year 1 \) 262,000 Year 2 254,000 Year 3 222,000 Year 4 215,000 Year 5 200,000 Year 6 175,000 |
Requirements
Holmes could refurbish the equipment at the end of six years for \(104,000. The refurbished equipment could be used one more year, providing \)77,000 of net cash inflows in year 7. Additionally, the refurbished equipment would have a $55,000 residual value at the end of year 7. Should Holmes invest in the equipment and refurbish it after six years? (Hint: In addition to your answer to Requirement 1, discount the additional cash outflow and inflows back to the present value.)
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.
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?
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