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Chapter 26: Q19RQ (page 1464)

How is the present value of a lump sum determined?

Short Answer

Expert verified

Answer

PV=FV11+r掳

Step by step solution

01

Meaning of Present Value

Present value compares the acquiring control of a future dollar to that of a current dollar. It is a money-related calculation that gauges the worth of a future amount of cash or stream of installments in today's dollars adjusted for interest and inflation.

02

Determination of the present value of a lump sum.

The following formula is used to calculate the present value (PV) of a lump sum: PV factor for future value for interest rate and time.

In which the future value FV is divided by a factor of 1 + I for each interval between present and future dates.

To calculate the PV, enter these figures into the present value calculator:

FV stands for the sum of future values.

鈥渘鈥� in the formula is the number of time periods (years).

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Most popular questions from this chapter

Henry Hardware is adding a new product line that will require an investment of \(1,512,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of \)310,000 the first year, \(270,000 the second year, and \)240,000 each year thereafter for eight years. Compute the payback period. Round to one decimal place.

Question: Defining capital investments and the capital budgeting process

Match each capital budgeting method with its definition.

Methods

1. Accounting rate of return

2. Internal rate of return

3. Net present value

4. Payback

Definitions

  1. Is only concerned with the time it takes to get cash outflows returned.
  2. Considers operating income but not the time value of money in its analyses.
  3. Compares the present value of cash outflows to the present value of cash inflows to determine investment worthiness.
  4. The true rate of return an investment earns.

List some common cash outflows from capital investments.

Using the payback method to make capital investment decisions

Refer to the Hunter Valley Snow Park Lodge expansion project in Short Exercise S26-4. Compute the payback for the expansion project. Round to one decimal place.

Mountain Manufacturing is considering the following capital investment proposals. Mountain鈥檚 requirement criteria include a maximum payback period of five years and a required rate of return of 12.5%. Determine if each investment is acceptable or should be rejected (ignore qualitative factors). Rank the acceptable investments in order from most desirable to least desirable

Project

A

B

C

D

E

Payback

3.15 years

4.20 years

2.00 years

3.25 years

5.00 years

NPV

\(10,250

\)42,226

(\(10,874)

\)36,251

$0

IRR

13.0%

14.2%

8.5%

14.0%

12.5%

Profitability index

1.54

1.92

0.75

2.86

1.00
See all solutions

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