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Chapter 26: Q9SE (page 1466)

Use the Present Value of \(1 table (Appendix A, Table A-1) to determine the present value of \)1 received one year from now. Assume a 8% interest rate. Use the same table to find the present value of \(1 received two years from now. Continue this process for a total of five years. Round to three decimal places.

Requirements

1. What is the total present value of the cash flows received over the five-year period?

2. Could you characterize this stream of cash flows as an annuity? Why or why not?

3. Use the Present Value of Ordinary Annuity of \)1 table (Appendix A, Table A-2) to determine the present value of the same stream of cash flows. Compare your results to your answer to Requirement 1.

4. Explain your findings.

Short Answer

Expert verified

(1) Total present value equals $3.993.

(2) Yes, it can be classified as annuity, as similar amount is received for the fixed period of time.

(3) Present value equals $3.993, and it is same as Requirement 1.

(4) Adding the present value of similar cash flows, and calculating the present value of annuity will give the same result.

Step by step solution

01

Definition of present value

The current value of any sum of money that will be received in the future time period is known as the present value. This concept states that the value of money today is higher than the value of the same amount of money in future.

02

Calculation of present value over five years and total

Year

Future value

X

Present value factor

=

Present value

1

$1

X

0.926

=

$0.926

2

$1

X

0.857

=

$0.857

3

$1

X

0.794

=

$0.794

4

$1

X

0.735

=

$0.735

5

$1

X

0.681

=

$0.681

$3.993

03

Classification of cash flow as an annuity

The stream of cash flows can be classified as annuity because the cash flows are received at a specified time and also they are equal.

04

Present value ordinary annuity

Presentvalueordinaryannuity=Fulurevalue脳Presentvalueordinaryannuityfactor=$1脳3.993=$3.993

05

Explanation of findings

Findings of requirement 1 and requirement 3 are same because it is fact that the total of individual cash flow is same as the present value ordinary annuity determined collectively.

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Most popular questions from this chapter

Suppose Hunter Valley is deciding whether to purchase new accounting software. The payback for the $30,050 software package is two years, and the software鈥檚 expected life is three years. Hunter Valley鈥檚 required rate of return for this type of project is 10.0%. Assuming equal yearly cash flows, what are the expected annual net cash savings from the new software?

Hill Company operates a chain of sandwich shops. The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of\(8,700,000. Expected annual net cash inflows are \)1,550,000 for 10 years, with zeroresidual value at the end of 10 years. Under Plan B, Hill Company would open threelarger shops at a cost of \(8,340,000. This plan is expected to generate net cash inflowsof \)990,000 per year for 10 years, the estimated useful life of the properties. Estimatedresidual value for Plan B is $1,200,000. Hill Company uses straight-line depreciationand requires an annual return of 10%.

Requirements

1. Compute the payback, the ARR, the NPV, and the profitability index of thesetwo plans.

2. What are the strengths and weaknesses of these capital budgeting methods?

3. Which expansion plan should Hill Company choose? Why?

4. Estimate Plan A鈥檚 IRR. How does the IRR compare with the company鈥檚 requiredrate of return?

How is the present value of a lump sum determined?

David is entering high school and is determined to save money for college. David feels he can save $6,000 each year for the next four years from his part-time job. If David is able to invest at 7%, how much will he have when he starts college?

S26-6 Using the ARR method to make capital investment decisions Refer to the Hunter Valley Snow Park Lodge expansion project in Short Exercise S26-4. Calculate the ARR. Round to two decimal places.

See all solutions

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