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Chapter 26: Q22E (page 1469)

Using the time value of money Helen wants to take the next four years off work to travel around the world. She estimates her annual cash needs at $31,000 (if she needs more, she will work odd jobs). Helen believes she can invest her savings at 10% until she depletes her funds. Requirements

  1. How much money does Helen need now to fund her travels?
  2. After speaking with a number of banks, Helen learns she will only be able to invest her funds at 6%. How much does she need now to fund her travels?

Short Answer

Expert verified
  1. Present value of Amount Withdrawn = $98,265.66
  2. Present value of Amount Withdrawn = $107,418.48

Step by step solution

01

Meaning of Capital Investment

A sum of money utilized to help an enterprise accomplish its objectives or acquire long-term assets is alluded to as a capital investment.

02

Calculating money does Helen need now to fund her travels

The present value of the amount withdrawn in future years, assuming a 10% return on investment, is calculated as follows:

Statement showing present value @10%

Year

Withdrawal

PV @10%

Present value

1

$31,000

0.90909

$28,181.79

2

$31,000

0.82645

$25,619.95

3

$31,000

0.75131

$23,290.61

4

$31,000

0.68301

$21,173.31

Present value of Amount Withdrawn$98,265.66

The above calculations show that putting $98,265.66 into savings at a rate of 10% will cover Helen's annual cash outlay of $31,000 for four years of travel around the world.

03

Money needed by Helen to fund her travel.

The present value of the amount withdrawn in future years, assuming a 6% return on investment, is calculated as follows:

Statement showing present value @6%

Year

Withdrawal

PV @6%

Present value

1

$31,000

0.94340

$29,245.4

2

$31,000

0.89000

$27,590

3

$31,000

0.83962

$26,028.22

4

$31,000

0.79206

$24,553.86

Present value of Amount Withdrawn$107,417.48

The amount invested today that will withdraw in the future is calculated by computing the present values of the amount to be withdrawn in future years discounted at the savings rate of interest.

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Most popular questions from this chapter

Question: Using payback to make capital investment decisions Consider the following three projects. All three have an initial investment of \(800,000.

Net Cash Inflows

Project LProject MProject N

Year

Annual

Accumulated

Annual

Accumulated

Annual

Accumulated

1

\) 100,000

\( 100,000

\)

200,000

\( 200,000

\)

400,000

$ 400,000

2

100,000

200,000

250,000

450,000

400,000

800,000

3

100,000

300,000

350,000

800,000

4

100,000

400,000

400,000

1,200,000

5

100,000

500,000

500,000

1,700,000

6

100,000

600,000

7

100,000

700,000

8

100,000

800,000

Requirements

  1. Determine the payback period of each project. Rank the projects from most desirable to least desirable based on payback.
  2. Are there other factors that should be considered in addition to the payback period?

How is ARR calculated?

Using ARR to make capital investment decisions Refer to the Henry Hardware information in Exercise E26-20. Assume the project has no residual value. Compute the ARR for the investment. Round to two places.

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.

Describe the capital budgeting process.

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

  1. Compute this project鈥檚 NPV using Holmes鈥檚 14% hurdle rate. Should Holmes invest in the equipment?

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.)
See all solutions

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