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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 Present value of Amount Withdrawn = $98,265.66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 Present value of Amount Withdrawn = $107,418.48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The present value of the amount withdrawn in future years, assuming a 10% return on investment, is calculated as follows: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Present value of Amount Withdrawn$98,265.66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The present value of the amount withdrawn in future years, assuming a 6% return on investment, is calculated as follows: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Present value of Amount Withdrawn$107,417.48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invested today that will withdraw in the future is calculated by computing the present values of the amount to be withdrawn in future years discounted at the savings rate of interest.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

Explain the difference between the present value factor tables鈥擯resent Value of \(1 and Present Value of Ordinary Annuity of \)1.

Your grandfather would like to share some of his fortune with you. He offers to give you money under one of the following scenarios (you get to choose):

1. \(7,250 per year at the end of each of the next eight years

2. \)49,650 (lump sum) now

3. $98,650 (lump sum) eight years from now

Requirements

1. Calculate the present value of each scenario using an 8% discount rate. Which scenario yields the highest present value? Round to nearest whole dollar.

2. Would your preference change if you used a 10% discount rate?

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?

Match the following business activities to the steps in capital budgeting process.

Steps in the capital budgeting process:

a. Develop strategies

b. Plan

c. Direct

d. Control

Business activities:

1. A manager evaluates progress one year into the project.

2. Employees submit suggestions for new investments.

3. The company builds a new factory.

4. Top management attends a retreat to set long-term goals.

5. Proposed investments are analyzed.

6. Proposed investments are ranked.

7. New equipment is purchased.

Question: Using the payback and accounting rate of return methods to make capital investment decisions

Consider how Hunter Valley Snow Park Lodge could use capital budgeting to decide whether the \(11,000,000 Snow Park Lodge expansion would be a good investment. Assume Hunter Valley鈥檚 managers developed the following estimates concerning the expansion:

Number of additional skiers per day 121 skiers

Average number of days per year that weather conditions

allow skiing at Hunter Valley 142 days

Useful life of expansion (in years) 7 years

Average cash spent by each skier per day \) 241

Average variable cost of serving each skier per day 83

Cost of expansion 11,000,000

Discount rate 10%

Assume that Hunter Valley uses the straight-line depreciation method and expects the lodge expansion to have a residual value of $600,000 at the end of its seven-year life.

Requirements

  1. Compute the average annual net cash inflow from the expansion.
  2. Compute the average annual operating income from the expansion.
See all solutions

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