Chapter 12

The following data pertain to an investment proposal (Ignore income taxes.): Cost of the investment: $54,000 Annual cost savings: $16,000 Estimated salvage value: 7,000 Life of the project: 5 years Discount rate: 12% Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using the tables provided. The net present value of the proposed investment is closest to: Multiple Choice $7,649 Correct $3,680 $3,969 $31,000

Explanation Year Now 1-5 5 Initial investment $(54,000) Working capital Annual net cash flow $16,000 Salvage value $7,000 Total cash flows (a) $(54,000) $16,000 $7,000 Discount factor (12%) (b) 1.000 3.605 0.567 Present value of cash flows $(54,000) $57,680 $3,969 (a) × (b) Net present value $7,649

Mattice Corporation is considering investing $900,000 in a project. The life of the project would be 7 years. The project would require additional working capital of $40,000, which would be released for use elsewhere at the end of the project. The annual net cash inflows would be $190,000. The salvage value of the assets used in the project would be $50,000. The company uses a discount rate of 12%. (Ignore income taxes.) Click here to view Exhibit 12B-1 and Exhibit 12B-2 to determine the appropriate discount factor(s) using the tables provided. Required: Compute the net present value of the project. (Negative amount should be indicated by a minus sign. Round your intermediate calculations and final answer to the nearest whole dollar amount.) Answer: $(32,160)

Explanation Year Now 1-7 7 Initial investment $(900,000) Working capital $(40,000) $40,000 Annual net cash flow 190,000 Salvage value $50,000 Total cash flows (a) $(940,000) $190,000 $90,000 Discount factor (12%) (b) 1.000 4.564 0.452 Present value of cash $(940,000) $867,160 $40,680 flows (a) × (b) Net present value $(32,160)

Joetz Corporation has gathered the following data on a proposed investment project (Ignore income taxes.): Investment required in equipment $39,000 Annual cash inflows $9,600 Salvage value of equipment $0 Life of the investment 15 years Required rate of return 10% The company uses straight-line depreciation on all equipment. Assume cash flows occur uniformly throughout a year except for the initial investment. The simple rate of return for the investment (rounded to the nearest tenth of a percent) is: (Round your answer to 1 decimal place.) Multiple Choice 31.2% 17.9%Correct 26.1% 12.6%

Explanation Annual incremental cash inflow $9,600 Annual depreciation ($39,000 - $0)/15 2,600 Annual incremental net operating income $7,000 Simple rate of return = Annual incremental net operating income ÷ Initial investment = $7,000 ÷ $39,000 = 17.9% (rounded)

Knowledge Check 01 Project Marvel is a five-year project. The project has a total cash inflow of $350,000. The present value of such inflows is $275,000. The project requires an initial investment of $200,000 and additional working capital of $25,000. What is the net present value of the project? multiple choice $0 $50,000 Correct ($50,000) ($250,000)

Explanation Knowledge Check 01 Net present value of cash flows = Present value of cash inflows - Present value of cash outflows Net present value of cash flows = $275,000 - ($200,000 + $25,000) = $50,000

Knowledge Check 01 Which of the following is the term used to describe the discount rate at which the present value of a project's cash inflows will equal the present value of its cash outflows? multiple choice Internal Rate of Return Correct Minimum Required Rate of Return Simple Rate of Return

Explanation Knowledge Check 01 The internal rate of return is the rate of return of an investment project over its useful life. The internal rate of return is the discount rate that equates the present value of a project's cash outflows with the present value of its cash inflows.

Knowledge Check 01 Which of the following ignores the time value of money? multiple choice Net Present Value Internal Rate of Return Payback Period Correct Profitability Index

Explanation Knowledge Check 01 The payback period identifies the time period required to recover the cost of the investment. The payback period focuses on cash flows, it does not recognize the time value of money.

Present Value of Ordinary Annuity Period/Rate 5% 6% 7% 8% 9% 10 7.7217 7.3601 7.0236 6.7101 6.4177 11 8.3064 7.8869 7.4987 7.1390 6.8052 12 8.8633 8.3838 7.9427 7.5361 7.1607 13 9.3936 8.8527 8.3577 7.9038 7.4869 Knowledge Check 01 Clean Tel, Inc. is considering investing in an 11-year project with annual cash inflows of $1,000,000. These cash inflows have an initial investment of $7,139,000. At what discount rate would this present value be the same as the initial investment? multiple choice 6% 7% 9% 8% Correct

Explanation Knowledge Check 01 The present value of the cash inflows of the project will be same as its initial investment when discounted using the internal rate of return of the project. Dividing present value of cash inflows by the annual cash inflow, we determine the factor of the internal rate of return to be 7.1390 (or $7,139,000 ÷ $1,000,000). Using the "Present value of an Annuity of f $1 in Arrears" table (Exhibit 13B-2), we find that a factor of 7.1390 for 11 periods represents an 8% rate of return.

Knowledge Check 01 Identify the simplifying assumptions usually made in net present value analysis. (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.) check all that apply All cash flows other than the initial investment occur at the end of periods. YES All cash flows generated by the investment project are immediately reinvested at a rate of return greater than the discount rate. NO All cash flows generated by the investment project are immediately reinvested at a rate of return equal to the discount rate. YES All cash flows occur at the beginning of the periods. NO The time value of money is ignored when evaluating investment proposals under the net present value analysis. NO

Explanation Knowledge Check 01 The two simplifying assumptions made in net present value analysis are: (1) all cash flows other than the initial investment occur at the end of periods and (2) all cash flows generated by the investment project are immediately reinvested at a rate of return equal to the discount rate.

Year Investment Cash Inflow 1 $14,000 $6,000 2 4,000 3 4,000 0 4 8,000 5 9,000 6 12,000 7 2,000 Knowledge Check 01 Given here are the cash flows of an investment under consideration. What is the payback period of this investment? multiple choice 3.5 years 5 years 4 years Correct 3 years

Explanation Knowledge Check 01 Investment Cash Inflow Unrecovered Investment* 1 $14,000 $6,000 $8,000 2 $4,000 $4,000 3 $4,000 $0 $8,000 4. $8,000 $0 5 $9,000 $0 6 $12,000 $0 7 $2,000 $0 * Year X unrecovered investment = Year X-1 unrecovered investment + Year X investment - Year X cash inflow

Knowledge Check 01 A negative net present value indicates that the project's return is ________. multiple choice greater than the minimum required rate of return equal to the minimum required rate of return less than the minimum required rate of return Correct cannot determine

Explanation Knowledge Check 01 A negative net present value indicates that the project's return is less than the minimum required rate of return.

Knowledge Check 01 Which of the following is NOT one of the two broad categories of capital budgeting decisions? multiple choice Selection decisions Correct Screening decisions Preference decisions

Explanation Knowledge Check 01 Capital budgeting decisions fall into either screening decisions or preference decisions.

An investment proposal with an initial investment of $100,000 generates annual net cash inflow of $20,000 for a period of 10 years. The project has a net present value of $10,000. What is this investment proposal's payback period? multiple choice 10 years 5 years Correct 2 years 3 years

Explanation Knowledge Check 01 Payback period = Initial investment of $100,000 ÷ Annual net cash inflow of $20,000 = 5 years

Knowledge Check 01 In situations where no revenues are involved, which of the following is the most desirable alternative? multiple choice Total-cost approach Incremental-cost approach Least-cost decisions Correct

Explanation Knowledge Check 01 Some decisions do not involve any revenues and the choice is made on the basis of which alternative is least costly from a present value perspective. Hence, these are known as least-cost decisions.