ACG 2071 CH 12

The management of Wyoming Corporation is considering the purchase of a new machine costing $375,000. The company's desired rate of return is 6%. The present value factor for an annuity of $1 at interest of 6% for 5 years is 4.212. In addition to the foregoing information, use the following data in determining the acceptability of this investment: Year 1, 2, 3, 4, 5 Operating Income: 18,750 Net Cash Flow: 93,750 The average rate of return for this investment is

10% Average Investment = (Initial Cost + Residual Value) / 2 = (375,000 + 0) ÷ 2 = 187,500 Average Rate of Return = Average Annual Income / Average Investment = $18,750 / $187,500 = 0.1 x 100 = 10%

Internal rate of return A project is estimated to cost $172,952 and provide annual net cash flows of $52,000 for six years. Determine the internal rate of return for this project, using the Present Value of an Annuity of $1 at Compound Interest table shown above.

20% present value of an annuity factor for 6 periods = amount to be invested / equal annual net cash flows = 172,952 / 52,000 = 3.326 Look for the number 3.326 for Year 6, which is under 20% = IRR

The methods of evaluating capital investment proposals can be grouped into two general categories referred to as (1) methods that do not use present values and (2) methods that use present values.

TRUE (1) average rate of return method, cash payback method (2) net present value method, internal rate of return method

Methods that ignore present value in capital investment analysis include the cash payback method.

TRUE

The computations involved in the net present value method of analyzing capital investment proposals are more involved than those for the average rate of return method.

TRUE

The excess of the cash flowing in from revenues over the cash flowing out for expenses is termed net cash flow.

TRUE

The expected period of time between the date of an investment and the recovery in cash of the amount invested is called the cash payback period.

TRUE

The process by which management plans, evaluates, and controls investments in fixed assets is called capital investment analysis.

TRUE

Average rate of return equals average annual income divided by average investment.

TRUE

Which of the following are present value methods of analyzing capital investment proposals?

net present value and internal rate of return

Which of the following can be used to place capital investment proposals involving different amounts of investment on a comparable basis for purposes of net present value analysis?

present value index

The management of River Corporation is considering the purchase of a new machine costing $380,000. The company's desired rate of return is 6%. The present value factor for an annuity of $1 at interest of 6% for 5 years is 4.212. In addition to the foregoing information, use the following data in determining the acceptability of this investment: Year: 1, 2, 3, 4, 5 Operating Income: 20,000 Net Cash Flow: 95,000 The net present value for this investment is

$20,140 present value of annual net cash flows = amount to be received annually x present value = 95,000 x 4.212 = 400,140 net present value = present value of annual net cash flows - amount invested = 400,140 - 380,000 = 20,1240

The amount of the estimated average annual income for a proposed investment of $71,000 in a fixed asset, giving effect to depreciation (straight-line method), with a useful life of 4 years, no residual value, and an expected total income yield of $28,500, is

$7,125 total net income / useful life = 28,500 / 4 = 7,125

The amount of the average investment for a proposed investment of $171,000 in a fixed asset with a useful life of 4 years, straight-line depreciation, no residual value, and an expected total income of $34,900 for the 4 years is

$85,500 amount of the average investment = (initial cost + residual value) / 2 (171,000 + 0) / 2 = 85,500

Hayden Company is considering the acquisition of a machine that costs $582,000. The machine is expected to have a useful life of 6 years, a negligible residual value, an annual net cash inflow of $92,000, and annual operating income of $78,200. The estimated cash payback period for the machine is (round to one decimal place)

6.3 years initial cost / annual net cash inflow = 582,000 / 92,000

Cash payback period A project has estimated annual net cash flows of $21,500. It is estimated to cost $137,600. Determine the cash payback period.

6.4 years initial cost / annual net cash inflow = 137,600 / 21,500 = 6.4

Net present value A project has estimated annual net cash flows of $10,000 for 3 years and is estimated to cost $45,000. Assume a minimum acceptable rate of return of 10%. Use the Present Value of an Annuity of $1 at Compound Interest table below. Determine (a) the net present value of the project and (b) the present value index.

Net present value of the project: -20,130 Present value index: 0.55 present value of net cash flow = annual net cash flow x present value =10,000 x 2.487 (On the table, 3 years at 10%) = 24,870 net present value = present value of net cash flow - amount to be invested = 24,870 - 45,000 = -20,130 present value index = total present value of net cash flow / amount to be invested = 24,870 / 45,000 = 0.55

Care must be taken when making capital investment decisions, since a long-term commitment of funds is involved and operations could be affected for many years.

TRUE

Methods that ignore present value in capital investment analysis include the average rate of return method.

TRUE

A series of equal cash flows at fixed intervals is termed a(n)

annuity

Average rate of return Determine the average rate of return for a project that is estimated to yield total income of $573,480 over 6 years, has a cost of $913,300, and has a $148,700 residual value.

average annual income / average investment = 95,580 / 531,000 = .18 x 100 = 18% average annual income = total income / years = 573,480 / 6 = 95,580 average investment = (initial cost + residual value ) / 2 = (913,300 + 148,700) / 2 = 531,000

Which of the following are two methods of analyzing capital investment proposals that both ignore present value?

average rate of return and cash payback

The process by which management plans, evaluates, and controls investments in fixed assets is called _____ analysis.

capital investment

Which of the following is a disadvantage of the average rate of return method?

fails to consider the time value of money

The primary advantages of the average rate of return method are its ease of computation and the fact that

it emphasizes the amount of income earned over the life of the proposal