Interactive Presentation Chapter 11

A company is evaluating two separate projects, both with the same $15,000 initial investment.

$9,868

An investment has a cost of $40,000, and net cash flows of $15,000 each year for four years. The net present value of the investment is $10,000. What is the profitability index?

0.25

When internal rate of return is used to evaluate a capital investment, the present value factor is computed as:

amount invested divided by net cash flows.

Salvage value is treated as:

an addition to net cash inflows at the end of the final year.

If the net present value is greater than zero, the company should:

invest

All of the following are weaknesses of the payback period: (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. Any boxes left with a question mark will be automatically graded as incorrect.)

- it ignores all cash flows after the payback period. - it ignores the time value of money.

Chilly Company is considering investing $110,000 in a new refrigerator, designed to keep food extra crispy. The refrigerator will have a useful life of 10 years, a salvage value of $10,000, and is expected to generate an annual after tax net income of $15,000 in each year of its useful life. Chilly will use the straight-line method of depreciation. What is the accounting rate of return?

25% Accounting rate of return = Annual after-tax net income of $15,000 ÷ Annual average investment of $60,000 = 0.25 or 25%. Average annual investment = ($110,000 cost plus $10,000 salvage value) / 2 = $60,000.

Jelly Company is considering purchasing a machine with a cost of $20,000 and a useful life of 10 years. Jelly expects the machine to produce net annual cash flows of $2,000 in year 1, $10,000 in year 2, $5,000 in year 3, $12,000 in year 4, and $8,000 in year 5. What is the cash payback period of the machine?

3.25 years

Mint Company is considering purchasing a machine with a cost of $10,000 and a useful life of 20 years. Mint expects the machine to produce net annual cash flows of $2,000 each year. What is the cash payback period of the machine?

5 years

An investment has a cost $40,000 with net cash flows of $20,000 each year for 4 years. The company has a required rate of return of 8%. If the first four periods' discount factors, based on 8%, taken from a "present value of 1" table are 0.9259, 0.8573, 0.7938, 0.7350, what is the break-even time of the investment?

Between years 2 and 3

An investment has a cost of $40,000 with net cash flows of $15,000 each year for 4 years. The company has a required rate of return of 8%. If the first four periods' discount factors, based on 8%, from a "present value of 1" table are 0.9259, 0.8573, 0.7938, and 0.7350, what is the net present value of the investment?

$9,680 Net present value = (Cash flow in year 1 of $15,000 × 0.9259) + (Cash flow in year 2 of $15,000 × 0.8573) + (Cash flow in year 3 of $15,000 × 0.7938) + (Cash flow in year 4 of $15,000 × 0.7350) − Amount invested of $40,000 = $9,680 (rounded).

All of the following are weaknesses of the accounting rate of return except:

it focuses on net cash flows, not income.

All of the following are strengths of the payback period except:

it ignores the time value of money.