CHAPTER 21

CAPITAL BUDGETING AND COST ANALYSIS

21-1 No. Capital budgeting focuses on an individual investment project throughout its life,
recognizing the time value of money. The life of a project is often longer than a year. Accrual
accounting focuses on a particular accounting period, often a year, with an emphasis on income
determination.
21-2 The five stages in capital budgeting are the following:
. An identification stage to determine which types of capital investments are available to
accomplish organization objectives and strategies.
!. An information-acquisition stage to gather data from all parts of the value chain in order to
evaluate alternative capital investments.
". A forecasting stage to project the future cash flows attributable to the various capital
projects.
#. An evaluation stage where capital budgeting methods are used to choose the best
alternative for the firm.
$. A financing, implementation and control stage to fund projects, get them under way and
monitor their performance.
21-3 %n essence, the discounted cash&flow method calculates the e'pected cash inflows and
outflows of a project as if they occurred at a single point in time so that they can be aggregated
(added, subtracted, etc.) in an appropriate way. This enables comparison with cash flows from
other projects that might occur over different time periods.
21-4 No. *nly +uantitative outcomes are formally analyzed in capital budgeting decisions.
,any effects of capital budgeting decisions, however, are difficult to +uantify in financial terms.
These nonfinancial or +ualitative factors (for e'ample, the number of accidents in a
manufacturing plant or employee morale) are important to consider in ma-ing capital budgeting
decisions.
21-5 .ensitivity analysis can be incorporated into /C0 analysis by e'amining how the /C0 of
each project changes with changes in the inputs used. These could include changes in revenue
assumptions, cost assumptions, ta' rate assumptions, and discount rates.
21-6 The paybac- method measures the time it will ta-e to recoup, in the form of e'pected
future net cash inflows, the net initial investment in a project. The paybac- method is simple and
easy to understand. %t is a handy method when screening many proposals and particularly when
predicted cash flows in later years are highly uncertain. The main wea-nesses of the paybac-
method are its neglect of the time value of money and of the cash flows after the paybac- period.
21-7 The accrual accounting rate&of&return (AA11) method divides an accrual accounting
measure of average annual income of a project by an accrual accounting measure of investment.
The strengths of the accrual accounting rate of return method are that it is simple, easy to
understand, and considers profitability. %ts wea-nesses are that it ignores the time value of money
and does not consider the cash flows for a project.
!&
21-8 No. The discounted cash&flow techni+ues implicitly consider depreciation in rate of
return computations2 the compound interest tables automatically allow for recovery of
investment. The net initial investment of an asset is usually regarded as a lump&sum outflow at
time zero. 3here ta'es are included in the /C0 analysis, depreciation costs are included in the
computation of the ta'able income number that is used to compute the ta' payment cash flow.
21-9 A point of agreement is that an e'clusive attachment to the mechanisms of any single
method e'amining only +uantitative data is li-ely to result in overloo-ing important aspects of a
decision.
Two points of disagreement are () /C0 can incorporate those strategic considerations that
can be e'pressed in financial terms, and (!) 45ractical considerations of strategy6 not e'pressed
in financial terms can be incorporated into decisions after /C0 analysis.
21-10 All overhead costs are not relevant in N57 analysis. *verhead costs are relevant only if
the capital investment results in a change in total overhead cash flows. *verhead costs are not
relevant if total overhead cash flows remain the same but the overhead allocated to the particular
capital investment changes.
21-11 The /ivision 8 manager should consider why the /ivision 9 project was accepted and
the /ivision 8 project rejected by the president. 5ossible e'planations are:
a. The president considers +ualitative factors not incorporated into the %11 computation
and this leads to the acceptance of the 9 project and rejection of the 8 project.
b. The president believes that /ivision 8 has a history of overstating cash inflows and
understating cash outflows.
c. The president has a preference for the manager of /ivision 9 over the manager of
/ivision 8:this is a corporate politics issue.
0actor a. means +ualitative factors should be emphasized more in proposals. 0actor b. means
/ivision 8 needs to document whether its past projections have been relatively accurate. 0actor
c. means the manager of /ivision 8 has to play the corporate politics game better.
21-12 The categories of cash flow that should be considered in an e+uipment&replacement
decision are:
a. %nitial machine investment,
b. %nitial wor-ing&capital investment,
c. After&ta' cash flow from current disposal of old machine,
!a. Annual after&ta' cash flow from operations (e'cluding the depreciation effect),
b. %ncome ta' cash savings from annual depreciation deductions,
"a. After&ta' cash flow from terminal disposal of machines, and
b. After&ta' cash flow from terminal recovery of wor-ing&capital investment.
21-13 %ncome ta'es can affect the cash inflows or outflows in a motor vehicle replacement
decision as follows:
a. Ta' is payable on gain or loss on disposal of the e'isting motor vehicle,
b. Ta' is payable on any change in the operating costs of the new vehicle vis&;&vis the
e'isting vehicle, and
c. Ta' is payable on gain or loss on the sale of the new vehicle at the project termination
date.
d. Additional depreciation deductions for the new vehicle result in ta' cash savings.
!&!
21-14 A cellular telephone company manager responsible for retaining customers needs to
consider the e'pected future revenues and the e'pected future costs of 4different investments6 to
retain customers. *ne such investment could be a special price discount. An alternative
investment is offering loyalty club benefits to long&time customers.
21-15 These two rates of return differ in their elements:
Rea-!a"e #$ !e"%!& N#'(&a !a"e #$ !e"%!&
. 1is-&free element . 1is-&free element
!. <usiness&ris- element !. <usiness&ris- element
". %nflation element
The inflation element is the premium above the real rate of return that is demanded for the
anticipated decline in the general purchasing power of the monetary unit.
21-16 E)e!*(+e+ (& *#',#%&- (&"e!e+". &# (&*#'e "a)e+/
The answers to these e'ercises are printed after the last problem, at the end of the chapter.
21-17 (!!=!$ min.) Ca,("a 0%-1e" 'e"2#-+. &# (&*#'e "a)e+/
a. The table for the present value of annuities (Appendi' <, Table #) shows:
$ periods at !> ? ".@A$
Net present value ? B@A,AAA (".@A$) = B@A,AAA
? B!@,"AA = B@A,AAA ? B$@,"AA
b. 5aybac- period ? B@A,AAA C B@A,AAA ? !.@D years
c. %nternal rate of return:
B@A,AAA ? 5resent value of annuity of B@A,AAA at 1> for $ years, or
what factor (0) in the table of present values of an annuity
(Appendi' <, Table #) will satisfy the following e+uation.
B@A,AAA ? B@A,AAA0
0 ?
AAA , @A B
AAA , @A B
? !.@@D
!&"
*n the $&year line in the table for the present value of annuities (Appendi' <, Table #), find the
column closest to !.@@D2 it is between a rate of return of !#> and !@>.
%nterpolation is necessary:
P!e+e&" 3a%e 4a*"#!+
!#> !.D#$ !.D#$
%11 rate == !.@@D
!@> !.@"$ ==
/ifference A.A A.ADE
%nternal rate of return ? !#> F
1
]
1

A . A
ADE . A
(!>)
? !#> F (A.DAG) (!>) ? !$.#!>
d. Accrual accounting rate of return based on net initial investment:
Net initial investment ? B@A,AAA
Hstimated useful life ? $ years
Annual straight&line depreciation ? B@A,AAA C $ ? B"!,AAA
return of rate
accounting Accrual
?
investment initial Net
income operating annual average e'pected in %ncrease
?
AAA , @A B
AAA , "! B AAA , @A B
?
AAA , @A B
AAA , !E B
? D.$>
Note how the accrual accounting rate of return, whichever way calculated, can produce results
that differ mar-edly from the internal rate of return.
!. *ther than the N57, rate of return and the paybac- period on the new computer system,
factors that 1iverbend should consider are:
%ssues related to the financing the project, and the availability of capital to pay for the
system.
The effect of the system on employee morale, particularly those displaced by the
system. .alesperson e'pertise and real&time help from e'perienced employees is -ey
to the success of a hardware store.
The benefits of the new system for customers (faster chec-out, fewer errors).
The upheaval of installing a new computer system. %ts useful life is estimated to be $
years. This means that 1iverbend could face this upheaval again in $ years. Also
ensure that the costs of training and other 4hidden6 start&up costs are included in the
estimated B@A,AAA cost of the new computer system.
!&#
21-18 ("A min.) Ca,("a 0%-1e"(&1 'e"2#-+. &# (&*#'e "a)e+/
The table for the present value of annuities (Appendi' <, Table #) shows:
A periods at #> ? $.!@
a. Net present value ? B!E,AAA ($.!@) = BA,AAA
? B#@,A#E = BA,AAA ? B"@,A#E
b. 5aybac- period ?
AAA , !E B
AAA , A B
? ".G" years
c. %nternal rate of return:
BA,AAA ? 5resent value of annuity of B!E,AAA at 1> for A years, or
what factor (0) in the table of present values of an annuity
(Appendi' <, Table #) will satisfy the following e+uation.
BA,AAA ? B!E,AAA0
0 ?
AAA , !E B
AAA , A B
? ".G!G
*n the A&year line in the table for the present value of annuities (Appendi' <, Table #), find the
column closest to ".G!G2 ".G!G is between a rate of return of !A> and !!>.
%nterpolation can be used to determine the e'act rate:
P!e+e&" 3a%e 4a*"#!+
!A> #.G! #.G!
%11 rate == ".G!G
!!> ".G!" ==
/ifference A.!@G A.!@"
%nternal rate of return ? !A> F
1
]
1

!@G . A
!@" . A
(!>)
? !A> F (A.GDE) (!>) ? !.G@>
d. Accrual accounting rate of return based on net initial investment:
Net initial investment ? BA,AAA
Hstimated useful life ? A years
Annual straight&line depreciation ? BA,AAA C A ? B,AAA
Accrual accounting rate of return ?
AAA , A B
AAA , B AAA , !E B
?
AAA , A B
AAA , D B
? $.#@>
!&$
!. 0actors City Iospital should consider include:
a. Juantitative financial aspects.
b. Jualitative factors, such as the benefits to its customers of a better eye&testing machine
and the employee&morale advantages of having up&to&date e+uipment.
c. 0inancing factors, such as the availability of cash to purchase the new e+uipment.
21-19 (!A min.) Ca,("a 0%-1e"(&1. (&*#'e "a)e+/
a. Net after&ta' initial investment ? BA,AAA
Annual after&ta' cash flow from operations (e'cluding the depreciation effect):
Annual cash flow from operation with new machine B!E,AAA
/educt income ta' payments ("A> of B!E,AAA) E,#AA
Annual after&ta' cash flow from operations BG,@AA
%ncome ta' cash savings from annual depreciation deductions
"A> B,AAA B","AA
These three amounts can be combined to determine the N57:
Net initial investment2
BA,AAA .AA B(A,AAA)
A&year annuity of annual after&ta' cash flows from operations2
BG,@AA $.!@ A!,!"#
A&year annuity of income ta' cash savings from annual depreciation deductions2
B","AA $.!@ D,!"
Net present value B G,##D
b. 5aybac- period
?
) "AA , " B @AA , G (B
AAA , A B
+
?
GAA , !! B
AAA , A B
? #.EA years
!&@
c. %nternal rate of return: 0 ?
GAA , !! B
AAA , A B
? #.EA"
%nterpolation can be used to determine the e'act rate:
P!e+e&" 3a%e 4a*"#!+
@> #.E"" #.E""
%11 #.EA"
E> # .#G# KKKKK
A .""G A .A"A
%11 ? @> F
.A"A
!>
.""G
1

1
]
? @.E>
d. Accrual Accounting 1ate of 1eturn:
AA11 ?
AAA , A B
AAA , B GAA , !! B
?
AAA , A B
GAA , B
? A.E!>
!a. %ncrease in N57. 0rom Table !, the present value factor for A periods at #> is A.!DA.
Therefore, the BA,AAA terminal disposal price at the end of A years would have an after&ta'
N57 of:
BA,AAA ( A."A) A.!DA ? B,EGA
b. No change in the paybac- period of #.EA years. The cash inflow occurs at the end of year
A.
c. %ncrease in internal rate of return. The BA,AAA terminal disposal price would raise the
%11 because of the additional inflow.
d. The AA11 would increase because accrual accounting income in year A would increase
by the BD,AAA (BA,AAA gain from disposal "A> BA,AAA) after&ta' gain on disposal of
e+uipment. This increase in year A income would result in higher average annual AA11 in the
numerator of the AA11 formula.
!&D
21-20 (!$ min.) Ca,("a 0%-1e"(&1 5("2 %&e6e& *a+2 $#5+. &# (&*#'e "a)e+/
. 5resent value of savings in cash operating costs:
BA,AAA L A.E@! B E,@!A
E,AAA L A.D#" $,G##
@,AAA L A.@# ",E#@
$,AAA L A.$$! !,D@A
5resent value of savings in cash operating costs !,DA
Net initial investment (!",AAA)
Net present value B( ,E"A)
!. 5aybac- period:
C%'%a"(6e I&("(a I&6e+"'e&" Ye" "# Be
Yea! Ca+2 Sa6(&1+ Ca+2 Sa6(&1+ Re*#6e!e- a" E&- #$ Yea!
A = = B!",AAA
BA,AAA BA,AAA ",AAA
! E,AAA E,AAA $,AAA
" @,AAA !#,AAA =
5aybac- period ? ! years F
B@,AAA
B$,AAA
? !.E" years
". 0rom re+uirement , the net present value is negative with a @> re+uired rate of return.
Therefore, the internal rate of return must be less than @>.
Yea!
718
Ca+2
Sa6(&1+
728
P/3/ 4a*"#!
a" 149
738
P/3/
a" 149
748 :
728 ; 738
P/3/ 4a*"#!
a" 129
758
P/3/
a" 129
768 :
728 ; 758
P/3/ 4a*"#!
a" 109
778
P/3/
a" 109
788 :
728 ; 778
BA,AAA A.EDD B E,DDA A.EG" B E,G"A A.GAG B G,AGA
! E,AAA A.D@G @,$! A.DGD @,"D@ A.E!@ @,@AE
" @,AAA A.@D$ #,A$A A.D! #,!D! A.D$ #,$A@
# $,AAA A.$G! !,G@A A.@"@ ",EA A.@E" ",#$
B!,G"! B!!,D$E B!",@G
Net present value at #> ? B!,G"! = B!",AAA ? B(,A@E)
Net present value at !> ? B!!,D$E = B!",AAA ? B(!#!)
Net present value at A> ? B!",@G = B!",AAA ? B@G
%nternal rate of return ? A> F
!#! @G
@G
+
(!>)
? A> F (A.DG) (!>) ? .##>
!&E
#. Accrual accounting rate of return based on net initial investment:
Average annual savings in cash operating costs ?
years #
B!G,AAA
? BD,!$A
Annual straight&line depreciation ?
years #
B!",AAA
? B$,D$A
Accrual accounting rate of return ?
B!",AAA
B$,D$A BD,!$A
?
B!",AAA
B,$AA
? @.$!>
!&G
21-21 ("A min.) C#',a!(+#& #$ ,!#<e*"+. &# (&*#'e "a)e+/
.
T#"a
P!e+e&" 3a%e Yea!
P!e+e&" D(+*#%&"
3a%e 4a*"#!+ a" 129 0 1 2 3
Plan I
B ("D$,AAA) .AAA B ("D$,AAA)
(",$!@,D!$ ) A.DGD B(#,#!$,AAA)
B( ",GA,D!$ )
Plan II
B(,$AA,AAA) .AAA B(,$AA,AAA)
(,""G,$AA) A.EG" B(,$AA,AAA)
(,G$,$ AA ) A.DGD B(,$AA,AAA)
B( #,A"$ ,AAA )
Plan III
B ($A,AAA) .AAA B ($A,AAA)
(,""G,$AA) A.EG" B(,$AA,AAA)
(,G$,$AA) A.DGD B(,$AA,AAA)
(,A@E ,AAA ) A.D! B(,$AA,AAA)
B( ",D$" ,AAA )
!. 5lan %%% has the lowest net present value cost. 5lan %%% is the preferred one on financial
criteria.
". 0actors to consider, in addition to N57, are:
a. 0inancial factors including:
Competing demands for cash.
Availability of financing for project.
b. Nonfinancial factors including:
1is- of building contractor not remaining solvent. 5lan %% e'poses New <io most
if the contractor becomes ban-rupt before completion because it re+uires more of
the cash to be paid earlier.
Ability to have leverage over the contractor if +uality problems arise or delays in
construction occur. 5lans % and %%% give New <io more negotiation strength by
being able to withhold sizable payment amounts if, say, +uality problems arise in
8ear .
%nvestment alternatives available. %f New <io has capital constraints, the new
building project will have to compete with other projects for the limited capital
available.
!&A
21-22 ("A min.) Pa=0a*> a&- NP3 'e"2#-+. &# (&*#'e "a)e+/
a. 5aybac- measures the time it will ta-e to recoup, in the form of e'pected future cash
flows, the net initial investment in a project. 5aybac- emphasizes the early recovery of cash as a
-ey aspect of project ran-ing. .ome managers argue that this emphasis on early recovery of cash
is appropriate if there is a high level of uncertainty about future cash flows. 5rojects with shorter
paybac-s give the organization more fle'ibility because funds for other projects become
available sooner.
Strengths
Hasy to understand
*ne way to capture uncertainty about e'pected cash flows in later years of a project
(although sensitivity analysis is a more systematic way)
Weaknesses
0ails to incorporate the time value of money
/oes not consider a projectMs cash flows after the paybac- period
b.
Project A
*utflow, B",AAA,AAA
%nflow, B,AAA,AAA (8ear ) F B,AAA,AAA (8ear !) F B,AAA,AAA

(8ear ") F B,AAA,AAA

(8ear #)
5aybac- ? " years
Project B
*utflow, B,$AA,AAA
%nflow, B#AA,AAA (8ear ) F BGAA,AAA

(8ear !) F BEAA,AAA

(8ear ")
5aybac- ? ! years F
AAA , EAA B
) AAA , GAA B AAA , #AA B AAA , $AA , (B
? !.!$ years
!&
Project C
*utflow, B#,AAA,AAA
%nflow, B!,AAA,AAA

(8ear ) F B!,AAA,AAA

(8ear !) F B!AA,AAA (8ear ") F BAA,AAA (8ear #)
5aybac- ? ! years
5aybac- 5eriod
. 5roject C ! years
!. 5roject < !.!$ years
". 5roject A " years
%f paybac- period is the deciding factor, Andrews will choose 5roject C (paybac- period ? !
years2 investment ? B#,AAA,AAA) and 5roject < (paybac- period ? !.!$ years2 investment ?
B,$AA,AAA), for a total capital investment of B$,$AA,AAA. Assuming that each of the projects is
an all&or&nothing investment, Andrews will have B$AA,AAA left over in the capital budget, not
enough to ma-e the B",AAA,AAA investment in 5roject A.
!. .olution H'hibit !&!! shows the following ran-ing:
N57
. 5roject < B !AD,EAA
!. 5roject A B @G,AAA
". 5roject C B(",$AA)
". Nsing N57 ran-ings, 5rojects < and A, which re+uire a total investment of B",AAA,AAA F
B,$AA,AAA ? B#,$AA,AAA, which is less than the B@,AAA,AAA capital budget, should be funded.
This does not match the ran-ings based on paybac- period because 5rojects < and A have
substantial cash flows after the paybac- period, cash flows that the paybac- period ignores.
Nonfinancial +ualitative factors should also be considered. 0or e'ample, are there
differential wor-er safety issues across the projectsO Are there differences in the e'tent of
learning that can benefit other projectsO Are there differences in the customer relationships
established with different projects that can benefit Andrews Construction in future projectsO
!&!
SOLUTION E?HIBIT 21-22
T#"a P!e+e&"
3a%e
P!e+e&"
3a%e
D(+*#%&"
4a*"#!+ a"
109
S>e"*2 #$ Ree6a&" Ca+2 4#5+
A ! " #
51*PHCT A
Net initial invest. B(",AAA,AAA) .AAA B(",AAA,AAA)
Annual cash inflow GAG,AAA A.GAG B,AAA,AAA
E!@,AAA A.E!@ B,AAA,AAA
D$,AAA A.D$ B,AAA,AAA
@E",AAA A.@E" B,AAA,AAA
Net present value B @G,AAA
51*PHCT <
Net initial invest. B(,$AA,AAA) .AAA B(,$AA,AAA)
Annual cash inflow "@",@AA A.GAG B #AA,AAA
D#",#AA A.E!@ B GAA,AAA
@AA,EAA A.D$ B EAA,AAA
Net present value B !AD,EAA
51*PHCT C
Net initial invest. B(#,AAA,AAA) .AAA B(#,AAA,AAA)
Annual cash inflow ,EE,AAA A.GAG B!,AAA,AAA
,@$!,AAA A.E!@ B!,AAA,AAA
$A,!AA A.D$ B !AA,AAA
@E,"AA A.@E" B AA,AAA
Net present value B (",$AA)
!&"
21-23 (!!="A min.) DC4. a**!%a a**#%&"(&1 !a"e #$ !e"%!&. 5#!>(&1 *a,("a. e6a%a"(#& #$
,e!$#!'a&*e. &# (&*#'e "a)e+/
. 5resent value of annuity of savings in cash operating costs
(B",!$A per year for E years at #>): B",!$A #.@"G B##,G@G
5resent value of B"D,$AA terminal disposal price of machine at
end of year E: B"D,$AA A."$ ",@"
5resent value of BA,AAA recovery of wor-ing capital at
end of year E: BA,AAA A."$ ",$A
Qross present value @,@#!
/educt net initial investment:
Centrifuge machine, initial investment B"D,$AA
Additional wor-ing capital investment A ,AAA #D,$ AA
Net present value B #,#!
!. Nse a trial&and&error approach. 0irst, try a @> discount rate:
B",!$A #."## B"$,D$A
(B"D,$AA F BA,AAA) A."A$ #,#EE
Qross present value $A,!"E
/educt net initial investment ( #D,$ AA )
Net present value B !, D"E
.econd, try an E> discount rate:
B",!$A #.ADE B!D,#"E
(B"D,$AA F BA,AAA) .!@@ !,@"$
Qross present value #A,AD"
/educt net initial investment ( #D,$AA )
Net present value B ( D,#!D )
!&#
<y interpolation:
%nternal rate of return ? @> F
B!, D"E
B!, D"E BD, #!D
_

+
,
L !>
? @> F (A.!@G" !>)
? @.$#>
". Accrual accounting rate of return based on net initial investment:
Net initial investment ? B"D,$AA F BA,AAA
? B#D,$AA
Annual depreciation
(B"D,$AA = B"D,$AA) C E years ? B!,$AA
Accrual accounting rate of return ?
B",!$A B!,$AA

B#D,$AA

? !.D>.
#. %f your decision is based on the /C0 model, the purchase would be made because the net
present value is positive, and the @.$#> internal rate of return e'ceeds the #> re+uired rate of
return. Iowever, you may believe that your performance may actually be measured using
accrual accounting. This approach would show a !.D> return on the initial investment, which
is below the re+uired rate. 8our reluctance to ma-e a 4buy6 decision would be +uite natural
unless you are assured of reasonable consistency between the decision model and the
performance evaluation method.
!&$
21-24 (#A min.) Ne5 e@%(,'e&" ,%!*2a+e. (&*#'e "a)e+/
. The after&ta' cash inflow per year is B!G,@AA (B!,@AA F BE,AAA), as shown below:
Annual cash flow from operations B "@,AAA
/educt income ta' payments (A.#A L B"@,AAA) #,# AA
Annual after&ta' cash flow from operations B !,@ AA
Annual depreciation on machine
R(BEE,AAA = BE,AAA) C #S B !A,AAA
%ncome ta' cash savings from annual depreciation deductions
(A.#A L B!A,AAA) E,AAA
a. .olution H'hibit !&!#A shows the N57 computation. N57 ? BD,A"
b. 5aybac- ? BEE,AAA C B!G,@AA ? !.GD years
c. .olution H'hibits !&!#< and !&!#C report the net present value of the project using #>
(small positive N57) and @> (small negative N57). The %11, the discount rate at which the
N57 of the cash flows is zero, must lie between #> and @>.
<y interpolation:
%nternal rate of return ?
BD@"
@> L !>
BD@" B!,G@A
_

+
,
? $.$G>
!. <oth the net present value and internal rate of return methods use a discounted cash flow
approach in which all e'pected future cash inflows and cash outflows of a project are measured
as if they occurred at a single point in time. The paybac- method considers only cash flows up to
the time when the e'pected future cash inflows recoup the net initial investment in a project. The
paybac- method ignores profitability and the time value of money. Iowever, the paybac-
method is becoming increasingly important in the global economy. 3hen the local environment
in an international location is unstable and therefore highly ris-y for a potential investment, a
company would li-ely pay close attention to the paybac- period for ma-ing its investment
decision. %n general, the more unstable the environment, the shorter the paybac- period desired.
!&@
SOLUTION E?HIBIT 21-24A
P!e+e&"
3a%e
T#"a D(+*#%&"
P!e+e&"4a*"#!
3a%e a" 129 S>e"*2 #$ Ree6a&" A$"e!-Ta) Ca+2 4#5+
A ! " #
a. %nitial machine
investment B(EE,AAA) .AAA B(EE,AAA)
b. %nitial wor-ing
capital investment A .AAA BA
!a. Annual after&ta'
cash flow from
operations (e'cl. depr.)
8ear G,!EG A.EG" B!,@AA
8ear ! D,!$ A.DGD B!,@AA
8ear " $,"DG A.D! B!,@AA
8ear # ",D"E A.@"@ B!,@AA
!b. %ncome ta'
cash savings
from annual
depreciation
deductions
8ear D,## A.EG" BE,AAA
8ear ! @,"D@ A.DGD BE,AAA
8ear " $,@G@ A.D! BE,AAA
8ear # $,AEE A.@"@ BE,AAA
". After&ta'
cash flow from:
a. Terminal
disposal of
machine $,AEE A.@"@ BE,AAA
b. 1ecovery of
wor-ing capital A A.@"@ BA
Net present
value if new
machine is
purchased B D,A"
!&D
SOLUTION E?HIBIT 21-24B
P!e+e&"
3a%e
T#"a D(+*#%&"
P!e+e&"4a*"#!
3a%e a" 149 S>e"*2 #$ Ree6a&" A$"e!-Ta) Ca+2 4#5+
A ! " #
a. %nitial machine
investment B(EE,AAA) .AAA B(EE,AAA)
b. %nitial wor-ing
capital investment A .AAA BA
!a. Annual after&ta'
cash flow from
operations (e'cl. depr.)
8ear E,G#" A.EDD B!,@AA
8ear ! @,@A A.D@G B!,@AA
8ear " #,$EA A.@D$ B!,@AA
8ear # !,DED A.$G! B!,@AA
!b. %ncome ta'
cash savings
from annual
depreciation
deductions
8ear D,A@ A.EDD BE,AAA
8ear ! @,$! A.D@G BE,AAA
8ear " $,#AA A.@D$ BE,AAA
8ear # #,D"@ A.$G! BE,AAA
". After&ta'
cash flow from:
a. Terminal
disposal of
machine #,D"@ A.$G! BE,AAA
b. 1ecovery of
wor-ing capital A A.$G! BA
Net present
value if new
machine is
purchased B !,G@A
!&E
SOLUTION E?HIBIT 21-24C
P!e+e&"
3a%e
T#"a D(+*#%&"
P!e+e&"4a*"#!
3a%e a" 169 S>e"*2 #$ Ree6a&" A$"e!-Ta) Ca+2 4#5+
A ! " #
a. %nitial machine
investment B(EE,AAA) .AAA B(EE,AAA)
b. %nitial wor-ing
capital investment A .AAA BA
!a. Annual after&ta'
cash flow from
operations (e'cl. depr.)
8ear E,@G A.E@! B!,@AA
8ear ! @,A#G A.D#" B!,@AA
8ear " ",E#@ A.@# B!,@AA
8ear # ,G!" A.$$! B!,@AA
!b. %ncome ta'
cash savings
from annual
depreciation
deductions
8ear @,EG@ A.E@! BE,AAA
8ear ! $,G## A.D#" BE,AAA
8ear " $,!E A.@# BE,AAA
8ear # #,#@ A.$$! BE,AAA
". After&ta'
cash flow from:
a. Terminal
disposal of
machine #,#@ A.$$! BE,AAA
b. 1ecovery of
wor-ing capital A A.$$! BA
Net present
value if new
machine is
purchased B ( D@" )
!&G
21-25 (#A min.) Ne5 e@%(,'e&" ,%!*2a+e. (&*#'e "a)e+/
. The after&ta' cash inflow per year is B!",D$A (BE,D$A F B$,AAA), as shown below:
Annual cash flow from operations B",!$A
/educt income ta' payments (A.#A B",!$A) !,$ AA
Annual after&ta' cash flow from operations B E,D$ A
Annual depreciation on motor (B@!,$AA $ years) B!,$AA
%ncome ta' cash savings from annual depreciation deductions
(A.#A B!,$AA) B $,AAA
a. .olution H'hibit !&!$ shows the N57 computation. N57? B!",G.
An alternative approach:
5resent value of $&year annuity of B!",D$A at !>
B!",D$A ".@A$ B E$,@G
5resent value of cash outlays, B@!,$AA .AAA @!,$ AA
Net present value B !",G
b. 5aybac- ? B@!,$AA C B!",D$A
? !.@" years
c. Tet 0 ? 5resent value factor for an annuity of B for $ years in Appendi' <, Table #
0 ? B@!,$AA C B!",D$A ? !.@"!
The internal rate of return can be calculated by interpolation:
P!e+e&" 3a%e 4a*"#!+ $#!
A&&%("= #$ A1 $#! 5 =ea!+
!@> !.@"$ !.@"$
%11 !.@"!
!E> !.$"!
/ifference A.A" A.AA"
%nternal rate of return ? !@> F
,
_

A" . A
AA" . A
(!>) ? !@.A@>.
!. <oth the net present value and internal rate of return methods use the discounted cash
flow approach in which all e'pected future cash inflows and outflows of a project are measured
as if they occurred at a single point in time. The net present value approach computes the surplus
generated by the project in todayMs dollars while the internal rate of return attempts to measure its
effective return on investment earned by the project. The paybac- method, by contrast, considers
nominal cash flows (without discounting) and measures the time at which the projectMs e'pected
future cash inflows recoup the net initial investment in a project. The paybac- method thus
ignores the profitability of the projectMs entire stream of future cash flows.
!&!A
SOLUTION E?HIBIT 21-25
T#"a
P!e+e&"
3a%e
P!e+e&" 3a%e
D(+*#%&"
4a*"#!+
A" 129 S>e"*2 #$ Ree6a&" A$"e!-Ta) Ca+2 4#5+
A ! " # $
a. %nitial
motor
investment B(@!,$AA) .AAA B(@!,$AA)
b. %nitial wor-ing
capital investment A .AAA BA
!a. Annual after&
ta' cash flow from
operations (e'cl. depr.)
8ear @,D## A.EG" BE,D$A
8ear ! #,G## A.DGD BE,D$A
8ear " ","$A A.D! BE,D$A
8ear # ,G!$ A.@"@ BE,D$A
8ear $ A,@" A.$@D BE,D$A
!b %ncome ta' cash
savings from
annual deprec.
deductions
8ear #,#@$ A.EG" B$,AAA
8ear ! ",GE$ A.DGD B$,AAA
8ear " ",$@A A.D! B$,AAA
8ear # ",EA A.@"@ B$,AAA
8ear $ !,E"$ A.$@D B$,AAA
". After&ta' cash
flow from:
a. Terminal
disposal of
motor A A.$@D BA
b. 1ecovery of
wor-ing capital A A.$@D BA
Net present value if
new motor is
purchased B !",G

!&!
21-26 (@A min.) Se(&1 a ,a&". (&*#'e "a)e+/
. Option
Current disposal price B"#A,AAA
/educt current boo- value A
Qain on disposal "#A,AAA
/educt #A> ta' payments "@ ,AAA
Net present value B !A# ,AAA
Option !
Crossroad receives three sources of cash inflows:
a. 1ent. 0our annual payments of BG@,AAA. The after&ta' cash inflow is:
BG@,AAA L ( = A.#A) ? B$D,@AA per year
b. /iscount on material purchases, payable at year&end for each of the four years: BE,G@A
The after&ta' cash inflow is: BE,G@A L ( = A.#A) ? B,"D@
c. .ale of plant at year&end !A!. The after&ta' cash inflow is:
BEA,AAA L ( = A.#A) ? B#E,AAA
P!e+e&" 3a%e
T#"a D(+*#%&"
P!e+e&" 4a*"#!+ a"
3a%e 129 S>e"*2 #$ Ree6a&" A$"e!-Ta) Ca+2 4#5+
A ! " #
. 1ent
B $,#"D A.EG" B$D,@AA
#$,GAD A.DGD B$D,@AA
#,A A.D! B$D,@AA
"@,@"# A.@"@ B$D,@AA
!. /iscount on
5urchases A,$G A.EG" B,"D@
G,A@D A.DGD B,"D@
E,AA A.D! B,"D@
D,!"$ A.@"@ B,"D@
". .ale of plant "A,$!E A.@"@ B#E,AAA
Net present value B !#A,ADE
!&!!
Option "
Contribution margin per jac-et:
.elling price B#!.AA
7ariable costs "".AA
Contribution margin B G.AA
2009 2010 2011 2012
Contribution margin
BG.AA L E,AAA2 !,AAA2
@,AAA2 #,AAA BD!,AAA BAE,AAA B##,AAA B"@,AAA
0i'ed overhead (cash) costs E ,AAA E ,AAA E ,AAA E ,AAA
Annual cash flow from operations @#,AAA AA,AAA "@,AAA !E,AAA
%ncome ta' payments (#A>) !$ ,@ AA #A ,AAA $# ,# AA ,! AA
After&ta' cash flow from
operations (e'cl. depcn.) B "E ,# AA B @A ,AAA B E ,@ AA B @ ,E AA
/epreciation: B@A,AAA C # ? B$,AAA per year
%ncome ta' cash savings from depreciation deduction: B$,AAA L A.#A ? B@,AAA per year
.ale of plant at end of !A!: B!A,AAA L ( = A.#A) ? BD!,AAA
.olution H'hibit !&!@ presents the N57 calculations: N57 ? B$#,G$
!&!"
SOLUTION E?HIBIT 21-26
T#"a
P!e+e&"
3a%e
P!e+e&" 3a%e
D(+*#%&"
4a*"#!+ a"
129 S>e"*2 #$ Ree6a&" A$"e!-Ta) Ca+2 4#5+
!AAE !AAG !AA !A !A!
a. %nitial plant e+uipment
upgrade investment B(@A,AAA) .AAA B@A,AAA
b. %nitial wor-ing capital
investment A .AAA BA
!a. Annual after&ta' cash
flow from operations
(e'cluding depreciation
effects)
8ear "#,!G A.EG" B"E,#AA
8ear ! #D,E!A A.DGD B@A,AAA
8ear " $E,AGG A.D! BE,@AA
8ear # A,@E$ A.@"@ B@,EAA
!b. %ncome ta' cash savings
from annual depreciation
deductions
8ear $,"$E A.EG" B@,AAA
8ear ! #,DE! A.DGD B@,AAA
8ear " #,!D! A.D! B@,AAA
8ear # ",E@ A.@"@ B@,AAA
". After&ta' cash flow
from
a. Terminal disposal
of plant #$,DG! A.@"@ BD!,AAA
b. 1ecovery of wor-ing
capital A A.@"@ BA
Net present value B $#,G$
*ption ! has the highest N57:
N57
*ption B!A#,AAA
*ption ! B!#A,ADE
*ption " B$#,G$
!. Nonfinancial factors that Crossroad should consider include the following:
*ption gives Crossroad immediate li+uidity which it can use for other projects.
*ption ! has the advantage of Crossroad having a closer relationship with the
supplier. Iowever, it limits CrossroadMs fle'ibility if Austin CorporationMs +uality is
not comparable to competitors.
*ption " has Crossroad entering a new line of business. %f this line of business is
successful, it could be e'panded to cover souvenir jac-ets for other major events. The
ris-s of selling the predicted number of jac-ets should also be considered.
!&!#
21-27 (@A min.) E@%(,'e&" !e,a*e'e&". &# (&*#'e "a)e+/
. Cash flows for modernizing alternative:
Ne" Ca+2 I&("(a Sae #$ E@%(,/
Yea! U&("+ S#- C#&"!(0%"(#&+ I&6e+"'e&"+ a" Te!'(&a"(#&
718 728 738 : 728 L A18.000
a
748 758
Pan. , !AA == == B("",@AA,AAA) ==
/ec. ", !AA $$! B G,G"@,AAA
/ec. ", !A @! ,A@,AAA
/ec. ", !A! @D! !,AG@,AAA
/ec. ", !A" D"! ",D@,AAA
/ec. ", !A# DG! #,!$@,AAA
/ec. ", !A$ E$! $,""@,AAA
/ec. ", !A@ G! @,#@,AAA B@,AAA,AAA
a
BEA,AAA = B@!,AAA ? BE,AAA cash contribution per prototype.
Cash flows for replacement alternative:
Ne" Ca+2 I&("(a Sae #$ E@%(,/
Yea! U&("+ S#- C#&"!(0%"(#&+ I&6e+"'e&"+
718 728 738 : 728 L A24.000
0
748 758
Pan. , !AA == == B($E,EAA,AAA) B",@AA,AAA
/ec. ", !AA $$! B",!#E,AAA
/ec. ", !A @! #,@EE,AAA
/ec. ", !A! @D! @,!E,AAA
/ec. ", !A" D"! D,$@E,AAA
/ec. ", !A# DG! G,AAE,AAA
/ec. ", !A$ E$! !A,##E,AAA
/ec. ", !A@ G! !,EEE,AAA B#,#AA,AAA
b
BEA,AAA = B$@,AAA ? B!#,AAA cash contribution per prototype.
!&!$
!. 5aybac- period calculations for modernizing alternative:
C%'%a"(6e Ne" I&("(a I&6e+"'e&"
Yea! Ca+2 I&$#5 Ca+2 I&$#5 U&!e*#6e!e- a" E&- #$ Yea!
718 728 738 748
Pan. , !AA == == B"",@AA,AAA
/ec. ", !AA B G,G"@,AAA B G,G"@,AAA !",@@#,AAA
/ec. ", !A ,A@,AAA !A,G$!,AAA !,@#E,AAA
/ec. ", !A! !,AG@,AAA "",A#E,AAA $$!,AAA
/ec. ", !A" ",D@,AAA
5aybac- ? " F (B$$!,AAA C B",D@,AAA)
? ".A# years
5aybac- period calculations for replace alternative:
C%'%a"(6e Ne" I&("(a I&6e+"'e&"
Yea! Ca+2 I&$#5 Ca+2 I&$#5 U&!e*#6e!e- a" E&- #$ Yea!
718 728 738 748
Pan. , !AA == == B$$,!AA,AAA
/ec. ", !AA B",!#E,AAA B",!#E,AAA #,G$!,AAA
/ec. ", !A #,@EE,AAA !D,G"@,AAA !D,!@#,AAA
/ec. ", !A! @,!E,AAA ##,A@#,AAA ,"@,AAA
/ec. ", !A" D,$@E,AAA
5aybac- ? " F (B,"@,AAA C BD,$@E,AAA)
? ".@" years
!&!@
". ,odernizing alternative:
P!e+e&" 3a%e
D(+*#%&" 4a*"#!+ Ne" Ca+2 P!e+e&"
Yea! A" 129 4#5 3a%e
Pan. , !AA .AAA B("",@AA,AAA) B("",@AA,AAA)
/ec. ", !AA A.EG" G,G"@,AAA E,ED!,E#E
/ec. ", !A A.DGD ,A@,AAA E,DDG,D$!
/ec. ", !A! A.D! !,AG@,AAA E,@!,"$!
/ec. ", !A" A.@"@ ",D@,AAA E,"DG,G"@
/ec. ", !A# A.$@D #,!$@,AAA E,AE",$!
/ec. ", !A$ A.$AD $,""@,AAA D,DD$,"$!
/ec. ", !A@ A.#$! !!,#@,AAA A,"!,A"!
Total B! D,A"$,#!#
1eplace Alternative:
P!e+e&" 3a%e
D(+*#%&" 4a*"#!+ Ne" Ca+2 P!e+e&"
Yea! A" 129 4#5 3a%e
Pan. , !AA .AAA B($$,!AA,AAA) B($$,!AA,AAA)
/ec. ", !AA A.EG" ",!#E,AAA ,E"A,#@#
/ec. ", !A A.DGD #,@EE,AAA ,DA@,""@
/ec. ", !A! A.D! @,!E,AAA ,#E","@
/ec. ", !A" A.@"@ D,$@E,AAA ,D",!#E
/ec. ", !A# A.$@D G,AAE,AAA A,DDD,$"@
/ec. ", !A$ A.$AD !A,##E,AAA A,"@D,"@
/ec. ", !A@ A.#$! "@,!EE,AAA @,#A!,D@
Total B! E,$#A,A"!
#. Nsing the paybac- period, the modernize alternative is preferred to the replace
alternative. *n the other hand, the replace alternative has a higher N57 than the modernize
alternative and so should be preferred. Iowever, the N57 amounts are based on best estimates.
5ro Chips should e'amine the sensitivity of the N57 amounts to variations in the estimates.
Nonfinancial +ualitative factors should be considered. These could include the +uality of
the prototypes produced by the modernize and replace alternatives. These alternatives may differ
in capacity and their ability to meet surges in demand beyond the estimated amounts. The
alternatives may also differ in how wor-ers increase their shop floor&capabilities. .uch
differences could provide labor force e'ternalities that can be the source of future benefits to 5ro
Chips.
!&!D
21-28 (#A min.) E@%(,'e&" !e,a*e'e&". (&*#'e "a)e+ 7*#&"(&%a"(#& #$ 21-278/
. U !. %ncome ta' rate ? "A>
#oderni$e Alternative
Annual depreciation:
B"",@AA,AAA D years ? B#,EAA,AAA a year.
%ncome ta' cash savings from annual depreciation deductions:
B#,EAA,AAA A."A ? B,##A,AAA a year.
Terminal disposal of e+uipment ? B@,AAA,AAA.
After&ta' cash flow from terminal disposal of e+uipment:
B@,AAA,AAA A.DA ? B#,!AA,AAA.
The N57 components are:
a. %nitial investment: NP3
Pan. , !AA B("",@AA,AAA) .AAA B("",@AA,AAA)
b. Annual after&ta' cash flow from operations
(e'cluding depreciation):
/ec. ", !AA G,G"@,AAA A.DA A.EG" @,!A,GG#
!A ,A@,AAA A.DA A.DGD @,#$,E!@
!A! !,AG@,AAA A.DA A.D! @,A!E,@#@
!A" ",D@,AAA A.DA A.@"@ $,E@$,G$$
!A# #,!$@,AAA A.DA A.$@D $,@$E,!A@
!A$ $,""@,AAA A.DA A.$AD $,##!,D#@
!A@ @,#@,AAA A.DA A.#$! $,G#,A!!
c. %ncome ta' cash savings from annual depreciation
deductions (B,##A,AAA each year for D years):
B,##A,AAA #.$@# @,$D!,@A
d. After&ta' cash flow from terminal sale of e+uipment:
B#,!AA,AAA A.#$! , EGE ,# AA
Net present value of modernize alternative B $,#@,G$$
!&!E
%eplace alternative
%nitial machine replacement ? B$E,EAA,AAA
.ale on Pan. , !AA, of e+uipment ? B",@AA,AAA
After&ta' cash flow from sale of old e+uipment: B",@AA,AAA A.DA ? B!,$!A,AAA
Net initial investment: B$E,EAA,AAA B!,$!A,AAA ? B$@,!EA,AAA
Annual depreciation: B$E,EAA,AAA D years ? BE,#AA,AAA a year
%ncome&ta' cash savings from annual depreciation deductions: BE,#AA,AAA A."A ? B!,$!A,AAA
After&ta' cash flow from terminal disposal of e+uipment: B#,#AA,AAA A.DA ? BA,AEA,AAA
The N57 components of the replace alternative are:
a. Net initial investment
Pan. , !AA B($@,!EA,AAA) .AAA
B($@,!EA,AAA)
b. Annual after&ta' cash flow from operations (e'cluding depreciation)
/ec. ", !AA B",!#E,AAA A.DA A.EG" E,!E,"!$
!A #,@EE,AAA A.DA A.DGD E,G#,#"$
!A! @,!E,AAA A.DA A.D! E,A"E,G$
!A" D,$@E,AAA A.DA A.@"@ D,E!,!D#
!A# G,AAE,AAA A.DA A.$@D D,$##,!D$
!A$ !A,##E,AAA A.DA A.$AD D,!$@,GG$
!A@ !,EEE,AAA A.DA A.#$! @,G!$,"@"
c. %ncome ta' cash savings from annual depreciation deductions
(B!,$!A,AAA each year for D years) B!,$!A,AAA #.$@# ,$A,!EA
d. After&ta' cash flow from terminal sale of e+uipment, BA,AEA,AAA A.#$! #,$$@,@A
Net present value of replace alternative B ",E"G,"A!
*n the basis of N57, 5ro Chips should modernize rather than replace the e+uipment. Note that
absent ta'es, the replace alternative had a higher N57 than the modernize alternative. %n ma-ing
decisions, companies should always consider after&ta' amounts.
". 5ro Chips would prefer to:
a. have lower ta' rates,
b. have revenue e'empt from ta'ation,
c. recognize ta'able revenues in later years rather than earlier years,
d. recognize ta'able cost deductions greater than actual outlay costs, and
!&!G
e. recognize cost deductions in earlier years rather than later years (including
accelerated amounts in earlier years).
!&"A
21-29 (!A min.) DC4. +e&+("(6("= a&a=+(+. &# (&*#'e "a)e+/
. 1evenues, B!$ L ,AAA,AAA B!$,AAA,AAA
7ariable cash costs, BA L ,AAA,AAA A ,AAA,AAA
Cash contribution margin $,AAA,AAA
0i'ed cash costs $ ,AAA,AAA
Cash inflow from operations B A ,AAA,AAA
Net present value:
Cash inflow from operations: BA,AAA,AAA L ".#"" B"#,""A,AAA
Cash outflow for initial investment ( "A ,AAA,AAA )
Net present value B #,""A ,AAA
!a. $> reduction in selling prices:
1evenues, B!".D$ L ,AAA,AAA B!",D$A,AAA
7ariable cash costs, BA L ,AAA,AAA A ,AAA,AAA
Cash contribution margin ",D$A,AAA
0i'ed cash costs $ ,AAA,AAA
Cash inflow from operation B E,D$ A,AAA
Net present value:
Cash inflow from operations: BE,D$A,AAA L ".#"" B"A,A"E,D$A
Cash outflow for initial investment ( "A ,AAA,AAA )
Net present value B "E,D$A
b. $> increase in the variable cost per unit:
1evenues, B!$ L ,AAA,AAA B!$,AAA,AAA
7ariable cash costs, BA.$A L ,AAA,AAA A,$AA ,AAA
Cash contribution margin #,$AA,AAA
0i'ed cash costs $ ,AAA,AAA
Cash inflow from operations B G,$AA ,AAA
Net present value:
Cash inflow from operations: BG,$AA,AAA L ".#"" B"!,@",$AA
Cash outflow for initial investment ( "A ,AAA,AAA )
Net present value B !,@",$AA
". .ensitivity analysis enables management to see those assumptions for which input
variations have sizable impact on N57. H'tra resources could be devoted to getting more
informed estimates of those inputs with the greatest impact on N57.
.ensitivity analysis also enables management to have contingency plans in place if
assumptions are not met. 0or e'ample, if a $> reduction in selling price is viewed as occurring
with A.#A probability, management may wish to line up ban- loan facilities.
!&"
21-30 (#$ min.) NP3. IRR a&- +e&+("(6("= a&a=+(+/
. Net 5resent 7alue of project:
Pe!(#-
0 1 - 10
Cash inflows B!",AAA
Cash outflows B(#!,AAA) (@,AAA )
Net cash flows B(#!,AAA) B D,AAA
Annual net cash inflows B D,AAA
5resent value factor for annuity, A periods, @> L D."@
5resent value of net cash inflows B$,$!A
%nitial investment (#!,AAA)
Net present value B G,$!A
To find %11, first divide the initial investment by the net annual cash inflow:
B#!,AAA C BD,AAA ? @.A.
The @.A represents the present value factor for a ten&period project with the given cash flows, so
loo- in Table #, Appendi' < for the present value of an annuity in arrears to find the factor
closest to @.A along the ten period row. 8ou should find that it is between A> and !>.
The internal rate of return can be calculated by interpolation:
P!e+e&" 3a%e 4a*"#!+ $#!
A&&%("= #$ A1 $#! 10 =ea!+
A> @.#$ @.#$
%11 @.AAA
!> $.@$A KK
/ifference A.#G$ A.#$
%nternal rate of return ? A> F
,
_

#G$ . A
#$ . A
(!>) ? A.@>.
Note: 8ou can use a calculator or e'cel to find the %11, and you will get an answer of
appro'imately A.$@>.
!. %f revenues are A> higher, the new Net 5resent 7alue will be:
Pe!(#-
0 1 - 10
Cash inflows B!$,"AA
Cash outflows B(#!,AAA)
(@,AAA)
Net cash inflows B(#!,AAA)
B G,"AA
!&"!
Annual net cash inflows B G,"AA
5resent value factor for annuity, A periods, @> L D."@
5resent value of net cash inflows B@E,##E
%nitial investment (#!,AAA)
Net present value B!@,##E
And the %11 will be: B#!,AAA C BG,"AA ? present value factor of #.$@, yielding a return of
D.ED> via interpolation (see below), or using a calculator, a return of D.E@>.
P!e+e&" 3a%e 4a*"#!+ $#!
A&&%("= #$ A1 $#! 10 =ea!+
@> #.E"" #.E""
%11 #.$@
E> #.#G# KK
/ifference A.""G A."D
%nternal rate of return ? @> F
,
_

""G . A
"D . A
(!>) ? D.ED>.
%f revenues are A> lower, the new net present value will be:
Pe!(#-
0 1 - 10
Cash inflows B!A,DAA
Cash outflows B(#!,AAA)
(@,AAA)
Net cash inflows B(#!,AAA)
B #,DAA
Annual net cash inflows B #,DAA
5resent value factor for annuity, A periods, @> L D."@
5resent value of net cash inflows B "#,$G!
%nitial investment (#!,AAA)
Net present value B (D,#AE)
And the %11 will be: B#!,AAA C B#,DAA ? present value factor of E.G"@, yielding a return of
!.> using interpolation (see calculations below) or, using a calculator, a return of !.AGG>.
!&""
P!e+e&" 3a%e 4a*"#!+ $#!
A&&%("= #$ A1 $#! 10 =ea!+
!> E.GE" E.GE"
%11 E.G"@
#> E. KK
/ifference A.ED! A.A#D
%nternal rate of return ? !> F
,
_

ED! . A
A#D . A
(!>) ? !.>.
". %f both revenues and costs are higher, the new Net 5resent 7alue will be:
Pe!(#-
0 1 - 10
Cash inflows B!$,"AA
Cash outflows B(#!,AAA)
(D,!A)
Net cash inflows B(#!,AAA)
B E,EA
Annual net cash inflows B E,EA
5resent value factor for annuity, A periods, @> L D."@
5resent value of net cash inflows B@A,!A$
%nitial investment (#!,AAA)
Net present value
BE,!A$
And the %11 will be: B#!,AAA C BE,EA ? present value factor of $."#, yielding a return of
#.#"> via interpolation, or using a calculator, a return of #.#A@>.
P!e+e&" 3a%e 4a*"#!+ $#!
A&&%("= #$ A1 $#! 10 =ea!+
#> $.!@ $.!@
%11 $."#
@> #.E"" KK
/ifference A."E" A.AE!
%nternal rate of return ? #> F
,
_

"E" . A
AE! . A
(!>) ? #.#">.
%f both revenues and costs are lower, the new Net 5resent 7alue will be:
Pe!(#-
0 1 - 10
Cash inflows B!A,DAA
Cash outflows B(#!,AAA)
(#,#AA)
Net cash inflows B(#!,AAA)
B @,"AA
!&"#
Annual net cash inflows B @,"AA
5resent value factor for annuity, A periods, @> L D."@
5resent value of net cash inflows B#@,"@E
%nitial investment (#!,AAA)
Net present value
B # ."@E
To compute the %11, note that the present value factor is B#!,AAA C B@,"AA? present value factor
of @.@@D, yielding a return of E.$> from interpolation or, using a calculator, a return of E.##>.
P!e+e&" 3a%e 4a*"#!+ $#!
A&&%("= #$ A1 $#! 10 =ea!+
E> @.DA @.DA
%11 @.@@D
A> @.#$ KK
/ifference A.$@$ A.A#"
%nternal rate of return ? E> F
,
_

$@$ . A
A#" . A
(!>) ? E.$>.
#. To find the N57 with a different rate of return, use the same cash flows but with a different
discount rate, this time for ten periods at E>.
Annual net cash inflows B D,AAA
5resent value factor for annuity, A periods, E> L @.D
5resent value of net cash inflows B#@,GDA
%nitial investment (#!,AAA)
Net present value B #,GDA
The N57 is positive, so they should accept this project. *f course, this result is to be e'pected
since in re+uirement , the %11 was determined to be A.@>. Therefore, for any discount rate
less than A.@>, the N57 of the stream of cash flows will be positive.
$. The sensitivity analysis shows that the return on the project is sensitive to changes in the
projected revenues and costs. Iowever, for almost all situations, the N57 has been positive and
the %11 has been greater than the re+uired rate of return. The one e'ception is the case where
the revenues decline by A>, but the costs do not. *verall, the project appears to be a good one
for Crumbly Coo-ie, provided that the li-elihood of the scenario where revenues decline
substantially but costs do not is not too high.
!&"$
21-31 ("A min.) Payback, even and uneven cash flows.
5aybac- problem:
. Annual revenue B#A,AAA
Annual costs
0i'ed BG@,AAA
7ariable #,AAA A,AAA
Net annual cash inflow B "A,AAA
5aybac- period ? %nvestment net cash inflows ? B$G,AAA C B"A,AAA ? $."A years
!.
Yea!
Re6e&%e
718
Ca+2
4()e-
C#+"+
728
Ca+2
3a!(a0e
C#+"+
738
Ne" Ca+2 I&$#5+
748 : 718 B 728 B 738
C%'%a"(6e
A'#%&"+
B GA,AAA BG@,AAA
B
G,AAA B($,AAA) B($,AAA)
! $,AAA G@,AAA ,$AA D,$AA (D,$AA)
" "A,AAA G@,AAA ",AAA !,AAA ",$AA
# $$,AAA G@,AAA $,$AA #",$AA $D,AAA
$ DA,AAA G@,AAA D,AAA $D,AAA #,AAA
6 180.000 96.000 18.000 66.000 180.000
D #A,AAA G@,AAA #,AAA "A,AAA !A,AAA
E !$,AAA G@,AAA !,$AA @,$AA !!@,$AA
G EA,AAA G@,AAA E,AAA (!#,AAA) !A!,$AA
The cumulative amount e'ceeds the initial B$G,AAA investment for the first time at the
end of year @. .o, paybac- happens in year @.
Nsing linear interpolation, a more precise measure is that paybac- happens at:
$ years F
B$G,AAA & B#,AAA
$.@E years.
B@@,AAA

!&"@
21-32 (#A min.) Re,a*e'e&" #$ a 'a*2(&e. (&*#'e "a)e+. +e&+("(6("=.
a. *riginal cost of old machine: B!A,AAA
/epreciation ta-en during the first " years
VR(B!A,AAA = B$,AAA) C DS "W #$ ,AAA
<oo- value D$,AAA
Current disposal price: @ A,AAA
Toss on disposal B $,AAA
Ta' rate L A.#A
Ta' savings in cash from loss on current disposal of old machine B @ ,AAA

b. /ifference in recurring after&ta' variable cash&operating savings, with #A> ta' rate:
(BA.!A = BA.#) (#$A,AAA) (= A.#A) ? B@,!AA (in favor of new machine)
/ifference in after&ta' fi'ed cost savings, with #A> ta' rate:
(B!!,$AA = B!,AAA) ( = A.#A) ? BGAA (in favor of new machine)
c.
O- Ca*2(&e Ne5 Ca*2(&e
%nitial machine investment B!A,AAA BEA,AAA
Terminal disposal price at end of useful life $ ,AAA " A,AAA
/epreciable base B A$ ,AAA B $A ,AAA
Annual depreciation using
straight&line (D&year life) B $,AAA
Annual depreciation using straight&line (#&year life): B "D,$AA
Yea!
718
De,!e*(a"(#&
#& O- Ca*2(&e
728
De,!e*(a"(#&
#& Ne5 Ca*2(&e
738
A--("(#&a
De,!e*(a"(#&
De-%*"(#& #& Ne5
Ca*2(&e
748 : 738 728
I&*#'e Ta) Ca+2
Sa6(&1+ $!#'
D($$e!e&*e
(& De,!e*(a"(#&
De-%*"(#& a" 409
748 409
!AAG
!AA
!A
!A!
B$,AAA
$,AAA
$,AAA
$,AAA
B"D,$AA
"D,$AA
"D,$AA
"D,$AA
B!!,$AA
!!,$AA
!!,$AA
!!,$AA
BG,AAA
G,AAA
G,AAA
G,AAA
!&"D
d.
O- Ca*2(&e Ne5 Ca*2(&e
*riginal cost B!A,AAA BEA,AAA
Total depreciation A$ ,AAA $ A,AAA
<oo- value of machines on /ec. ", !A! $,AAA "A,AAA
Terminal disposal price of machines on /ec. ", !A! A ,$ AA " A,AAA
Toss on disposal of machines #,$AA A
Add ta' savings on loss (#A> of B#,$AA2 #A> of BA) , E AA A
After&ta' cash flow from terminal disposal of
machines (BA,$AA F B,EAA2 B"A,AAA F BA) B !," AA B " A,AAA
/ifference in after&ta' cash flow from terminal disposal of machines: B"A,AAA = B!,"AA ?
BD,DAA.
!. The .mac-er Company should retain the old e+uipment because the net present value of
the incremental cash flows from the new machine is negative. The computations, using the
results of re+uirement , are presented below. %n this format the present value factors appear at
the bottom. All cash flows, year by year, are then converted into present values.
A$"e!-Ta) Ca+2 4#5+
2008
a
2009 2010 2011 2012
%nitial machine investment B(EA,AAA)
Current disposal price of old machine @A,AAA
Ta' savings from loss on disposal of
old machine @,AAA
1ecurring after&ta' cash&operating savings
7ariable B@,!AA B@,!AA B@,!AA B@,!AA
0i'ed GAA GAA GAA GAA
%ncome ta' cash savings from difference in
depreciation deductions G,AAA G,AAA G,AAA G,AAA
Additional after&ta' cash flow from
terminal disposal of new machine
over old machine KKKKKKKK KKKKKKK KKKKKKK KKKKKKK D,D AA
Net after&ta' cash flows B(#,AAA) B!@,AA B!@,AA B!@,AA B#",EAA
5resent value discount factors (at @>) .AAA A.E@! A.D#" A.@# A.$$!
5resent value B( # ,AAA ) B !!,#GE B G,"G! B @,D"A B !#,DE
Net present value B ( ",!A! )
a
Actually Panuary , !AAG
". Tet B9 be the additional recurring after&ta' cash operating savings re+uired each year to
ma-e N57 ? BA.
The present value of an annuity of B per year for # years discounted at @> ? !.DGE
(Appendi' <, Table #)
To ma-e N57 ? A, .mac-er needs to generate cash savings with N57 of B",!A!.
That is B9 (!.DGE) ? B",!A!
9 ? ",!A! C !.DGE ? B,$!
!&"E
.mac-er must generate additional annual after&ta' cash operating savings of B,$!.
!&"G
21-33 ("A="$ min.) NP3 a&- AARR. 1#a-*#&1!%e&*e (++%e+/
.
Annual cash flow from operations
BAA,AAA
%ncome ta' payments (#A>) #A,AAA
After&ta' cash flow from operations (e'cl. deprcn.) B @A,AAA
/epreciation: B"!A,AAA C @ ? B$",""" per year
%ncome&ta' cash savings from depreciation deduction: B$",""" L A.#A ? B!,""" per year
Yea!
0 1 2 3 4 5 6
%nitial investment B("!A,AAA)
%nitial wor-ing capital investment ($,AAA)
After&ta' cash flow from operations
(e'l. deprcn.) B@A,AAA B@A,AAA B@A,AAA B@A,AAA B@A,AAA B@A,AAA
%ncome&ta' cash savings from
annual depreciation deductions !,""" !,""" !,""" !,""" !,""" !,"""
After&ta' cash flow from recovery
of wor-ing capital KKKKKKKKK KKKKKKK KKKKKKK KKKKKKK KKKKKKK KKKKKKK $,AAA
Total after&ta' cash flows B("!$,AAA) BE,""" BE,""" BE,""" BE,""" BE,""" BE@,"""
Times discount factor at A> L .AAA L A.GAG L A.E!@ L A.D$ L A.@E" L A.@! L A.$@#
5resent value B("!$,AAA) BD",G"! B@D,E B@,AE B$$,$$A B$A,$AE B#E,@G!
Net present value ? B("!$,AAA) F BD",G"! F B@D,E FB@,AE F B$$,$$A F B$A,$AE F B#E,@G!
? B",G##
!. Accrual accounting rate of return (AA11): The accrual accounting rate of return ta-es the
annual accrual net income after ta' and divides by the initial investment to get a return.
%ncremental net operating income e'cluding depreciation BAA,AAA
Tess: /epreciation e'pense (B"!A,AAA C @) $","""
%ncome before ta' #@,@@D
%ncome ta' e'pense (at #A>) E,@@D
Net income per period B !E,AAA
AA11 ? B!E,AAA C B"!$,AAA ? E.@!>.
". Nate will not accept the project if he is being evaluated on the basis of accrual accounting rate
of return, because the project does not meet the A> threshold above which Nate earns a bonus.
Iowever, Nate should accept the project if he wants to act in the firmMs best interest because the
N57 is positive, implying that, based on the cash flows generated, the project e'ceeds the firmMs
re+uired A> rate of return. Thus, Nate will turn down an acceptable long&run project to avoid a
poor evaluation based on the measure used to evaluate his performance. To remedy this, the firm
could evaluate Nate instead on a project&by&project basis, by loo-ing at how well he achieves the
cash flows forecasted when he chose to accept the project.
!&#A
21-34 ("$ min.) Re*#1&(D(&1 *a+2 $#5+ $#! *a,("a (&6e+"'e&" ,!#<e*"+/
. 5artitioning relevant cash flows into categories:
() Net initial investment cash flows:
& The BGE,AAA cost of the new 0lab&<uster "AAA
& The disposal value of the old machine, B$,AAA, is a cash inflow
& The boo- value of the old machine B#,AAA (B$A,AAA X B#@,AAA), relative to the disposal
value of B$,AAA, yields a ta'able gain of B,AAA (B$,AAA X B#,AAA) that leads to a cash
outflow for ta'es of B,AAA Ta' 1ate
(!) Cash flow savings from operations:
& The "A> savings in utilities cost per year of B#,"!A ("A> L B,!AA per month L !
months) results in cash inflow from operations after ta' of B#,"!A ( X Ta' 1ate)
& The savings of half the maintenance costs per year of B$,AAA ($A> L BA,AAA) results in
a cash inflow from operations after ta' of B$,AAA ( X Ta' 1ate)
& Annual depreciation of (BGE,AAA X BA,AAA) C A years ? BE,EAA on 0lab&<uster
"AAA, relative to the (B#,AAA X BA) C A years ? B#AA depreciation on current 0it&*&
,atic leads to additional ta' savings of BE,#AA L Ta' 1ate
(") Cash flows from terminal disposal of investment:
& The BA,AAA salvage value of 0lab&<uster "AAA minus the BA salvage value of the old
0it&*&,atic is a terminal cash flow at the end of 8ear A. There are no ta' effects
because both machines are planned to be disposed of at boo- value.
(#) /ata not relevant to the capital budgeting decision:
& The BA charge for customers, since it would not change whether or not Tudmilla got
the new machine
& The BDE,AAA cost of the machine Tudmilla does not intend to buy
& The B$A,AAA original cost of the 0it&*&,atic machine
!&#
!. Net present value of the investment:
Net initial investment
%nitial investment in 0lab&<uster "AAA B(GE,AAA)
Current disposal value of 0it&*&,atic $,AAA
Ta' on gain on sale of 0it&*&,atic, #A> L B,AAA (#AA )
Net initial investment B(G",#AA)
Annual after&ta' cash flow from operations (e'cl. deprn. effects)
After&ta' savings in utilities costs, B#,"!A (XA.#A) B !,$G!
After&ta' savings in maintenance costs, B$,AAA (XA.#A) ",AAA
Annual after&ta' cash flow from operations B $,$G!
%ncome&ta' cash savings from annual additional depreciation
deductions (BE,EAA X B#AA) L #A> B ","@A
After&ta' cash flow from terminal disposal of machines B A,AAA
These four amounts can be combined to determine the N57 at an E> discount rate.
5resent value of net initial investment, B(G",#AA) L .AAA B(G",#AA)
5resent value of A&year annuity of annual after&ta' cash flow
from operations (e'cl. deprcn. effects), B$,$G! L @.DA "D,$!!
5resent value of A&year annuity of income&ta' cash savings from
annual depreciation deductions, B",AAA L @.DA !!,$#@
5resent value of after&ta' cash flow from terminal disposal of
machines, BA,AAA L A.#@" #,@"A
Net present value B(!E,DA!)
At the re+uired rate of return of E>, the net present value of the investment in the 0lab&<uster
"AAA is substantially negative. Tudmilla should therefore not ma-e the investment.
!&#!
21-35 (#A&#$ min.) Re*#1&(D(&1 *a+2 $#5+ $#! *a,("a (&6e+"'e&" ,!#<e*"+. NP3/
.
Net initial investment
%nitial e+uipment investment B($,AAA,AAA)
%nitial wor-ing&capital investment (#$,AAA )
Net initial investment
B($,A#$,AAA)

Cash flow from operations
Annual after&ta' cash flow from operations (e'cl. deprn. effects)
Cash revenues B",D$A,AAA
,aterial cash costs (,DAA,AAA)
/irect labor cash costs

B", @AA, AAA

#
_

,
(GAA,AAA)
%ncrease in cash overhead costs ("GA,AAA )
Annual cash flow from operations with new e+uipment (D@A,AAA)
/educt income&ta' payments (A."A L BD@A,AAA) (!!E,AAA )
Annual after&ta' cash flow from operations B$"!,AAA
%ncome&ta' cash savings from annual depreciation deductions
(A."ALB#@A,AAA)

"E,AAA
Total cash flow from operations (after&ta') B@DA,AAA
Cash flow from terminal disposal of investment
Cash flow from terminal disposal of machine (net of ta' of BA) B#AA,AAA
Cash flow from terminal disposal of wor-ing capital (net of ta' of BA) #$,AAA
After&ta' cash flow from terminal disposal of investment B##$,AAA

B$,AAA,AAA B#AA, AAA

/epreciation deductions ? B#@A, AAA
A

Cash flows not relevant to the capital budgeting problem

&The revenues and investment in the furniture parts division are not relevant to the project
&The costs of the furniture parts division are not relevant e'cept as the basis for
estimation of labor costs for the project
&The C0* salary is irrelevant since it is not affected by the project
These three amounts can be combined to determine the N57 at a !> discount rate:
5resent value of net initial investment, B($,A#$,AAA) L .AAA B($,A#$,AAA)
5resent value of A&year annuity of annual after&ta' cash flow from operations
(B@DA,AAA L $.@$A) ",DE$,$AA
5resent value of after&ta' cash flow from terminal disposal of investment
(B##$,AAA L A."!!) #",!GA
Net present value B(,@,!A)
.ince the net present value is negative, this is clearly not a good investment for a firm that
re+uires a !> rate of return. ,et&All should not e'pand into bicycle parts.
!&#"
21-36 (!A min.) NP3 a&- (&$a"(#&/
. 3ithout inflation or ta'es this is a simple net present value problem, using a A> discount rate
5resent value of initial investment, B(@AA,AAA) L .AAA B(@AA,AAA)
5resent value of @&year annuity of annual cash savings
(B#A,AAA L #."$$) @AG,DAA
Net present value B G,DAA

!. 3ith inflation, we adjust each yearMs cash flow for the inflation rate to get nominal cash flows
and then discount each cash flow separately using the nominal discount rate.
Nominal rate ? ( F real rate) L ( F inflation rate) X
Nominal rate ? (.A)(.A$$) X ? .@ = ? .@ or @>
Ca+2 4#5 C%'%a"(6e Ca+2 I&$#5+ P!e+e&" 3a%e
Pe!(#- 7Rea D#a!+8 I&$a"(#& Ra"e 7N#'(&a D#a!+8 4a*"#!. 169 P!e+e&" 3a%e
718 728 738 : 718 ; 728 748 758 : 738 ; 748
B#A,AAA .A$$ B#D,DAA A.E@! B!D,"D
! #A,AAA ."

$$,E!# A.D#" $,DDD

" #A,AAA .D# @#,"G# A.@# A$,"D@
# #A,AAA .!"G D",#"$ A.$$! G$,D"@
$ #A,AAA ."AD E!,GD# A.#D@ ED,AG@
@ #A,AAA ."DG G",A"E A.#A DG,#@
Total present value of annual net cash inflows in nominal dollars @A,##E
5resent value of initial investment, B(@AA,AAA) L .AAA (@AA,AAA)
Net present value B A,##E

." ? (.A$$)
!
". <oth the unadjusted and adjusted N57 are positive. <ased on financial considerations alone,
Cost&Tess should buy the new cash registers. Iowever, the effect of ta'es should also be
considered, as well as any pertinent non&financial issues, such as potential improvements in
customer response time from moving to the new cash registers.
!&##
21-37 ("$&#A min.) NP3. (&$a"(#& a&- "a)e+ 7*#&"(&%a"(#& #$ 21-368/
a. %nitial e+uipment investment B(@AA,AAA)
b. Annual cash flow from operations (e'cl. deprn. effects) B#A,AAA
/educt income ta' payments (A."A L B#A,AAA)
#!,AAA
Annual after&ta' cash flow from operations (e'cl. deprn. effects) B GE,AAA
c. %ncome ta' cash savings from annual depreciation deductions
(A."A L BAA,AAA)

B "A,AAA

B@AA,AAA BA
/epreciation deductions ? BAA, AAA
@

The terminal disposal price of the e+uipment is e+ual to the boo- value at disposal ? BA, so these
three amounts can be combined to determine the N57 at a A> discount rate.
5resent value of net initial investment, B(@AA,AAA) L .AAA B(@AA,AAA)
5resent value of @&year annuity annual after&ta' cash flow from operations,
BGE,AAA L #."$$ #!@,DGA
5resent value of @&year annuity of income ta' cash savings from
annual depreciation deductions, B"A,AAA L #."$$ "A,@$A
Net present value B (#!,$@A)
!. As in the previous problem, with inflation, we adjust each yearMs cash flow for the inflation
rate to get nominal cash flows and then discount each cash flow separately using the nominal
discount rate.
Nominal rate ? ( F real rate) L ( F inflation rate) O ? (.A)(.A$$) ? .@ ? A.@ or @>
Ca+2 4#5 C%'%a"(6e Ca+2 I&$#5+
A$"e! Ta)
Ca+2 P!e+e&" 3a%e
Pe!(#- 7Rea D#a!+8 I&$a"(#& Ra"e 7N#'(&a D#a!+8 4#5+ 4a*"#!. 169 P!e+e&" 3a%e
718 728 738 : 718 ; 728 748 : 0/7 ; 738 758 768 : 748 ; 758
B#A,AAA .A$$ B#D,DAA BA","GA A.E@!
B EG,!!
! #A,AAA ." $$,E!# AG,AD@ A.D#"
E,A##
" #A,AAA .D# @#,"G# $,AD@ A.@#
D",D@#
# #A,AAA .!"G D",#"$ !,#A$ A.$$!
@D,A$
$ #A,AAA ."AD E!,GD# !E,AE! A.#D@
@A,G@D
@ #A,AAA ."DG G",A"E "$,!D A.#A
$$,#A!
Total present value of annual net cash inflows (e'cl. depreciation. effects)
B#!D,"#
5resent value of @&year annuity of income&ta' cash savings from
annual depreciation deductions, B"A,AAA L ".@E$
A,$$A
5resent value of initial investment B(@AA,AAA) L .AAA
(@AA,AAA)
Net present value
B( @!,"@)
". 3ithout the effects of inflation, we get a negative net present value. 3hen cash flows are
adjusted for inflation, we again get a negative net present value. %n either case, regardless of
inflation e'pectations, Cost&Tess should not buy the new cash registers.
!&#$
!."E (#$ min.) Ne" ,!e+e&" 6a%e. I&"e!&a Ra"e #$ Re"%!&. Se&+("(6("= A&a=+(+/
. Qiven the annual operating cash outflows of B@A,AAA and the payment of A> of revenues
(A> L B!@A,AAA ? B!@,AAA), the net cash inflows for each period are as follows:
Pe!(#-
0 1 - 12
Cash inflows B!@A,AAA
Cash outflows
B($AA,AAA) (E@,AAA)
Net cash inflows
B($AA,AAA) B D#,AAA
The N57 of the investment is:
Annual net cash inflows
B D#,AAA
5resent value factor for annuity, ! periods, E>
L D.$"@
5resent value of net cash inflows
B$$D,@@#
%nitial investment
($AA,AAA)
Net present value
B $D,@@#
And the %11 will be: B$AA,AAA C BD#,AAA ? present value factor of @.D@, yielding a return just
over A> from the table, or using a calculator, a return of A.D>.
!. 0or revenues of B!#A,AAA, the cash flows and N57 computation are given below.
Pe!(#-
0 1 - 12
Cash inflows B!#A,AAA
Cash outflows
B($AA,AAA) (E#,AAA)
Net cash inflows
B($AA,AAA) B $@,AAA
Annual net cash inflows
B $@,AAA
5resent value factor for annuity, ! periods, E>
L D.$"@
5resent value of net cash inflows
B#!!,A@
%nitial investment
($AA,AAA)
Net present value
B (DD,GE#)
And the %11 will be: B$AA,AAA C B$@,AAA ? present value factor of E.G", yielding a return
between #> and @> from the table, or using a calculator, a return of #.ED>.
!&#@
0or revenues of B!!A,AAA:
Pe!(#-
0 1 - 12
Cash inflows B!!A,AAA
Cash outflows
B($AA,AAA) (E!,AAA)
Net cash inflows
B($AA,AAA) B "E,AAA
Annual net cash inflows B "E,AAA
5resent value factor for annuity, ! periods, E> L D.$"@
5resent value of net cash inflows B !E@,"@E
%nitial investment ($AA,AAA)
Net present value B(!",@"!)
And the %11 will be: B$AA,AAA C B"E,AAA ? present value factor of ".@, yielding a return of
less than !> from the table or X."$> using a calculator.
". 0or revenues of B!#A,AAA, lower costs of B$A,AAA, and payments of only @> of revenues
e+ual to B#,#AA:
Pe!(#-
0 1 - 12
Cash inflows B!#A,AAA
Cash outflows B($AA,AAA) (@#,#AA)
Net cash inflows B($AA,AAA) B D$,@AA
Annual net cash inflows B D$,@AA
5resent value factor for annuity, ! periods, E> L D.$"@
5resent value of net cash inflows B$@G,D!!
%nitial investment ($AA,AAA)
Net present value B @G,D!!
And the %11 will be: $AA,AAA C D$,@AA ? present value factor of @.@, yielding a return between
A> and !> from the table, or using a calculator, a return of A.@>.
!&#D
0or revenues of B!!A,AAA, lower costs of B$A,AAA, and payments of only @> of revenues e+ual
to ",!AA:
Pe!(#-
0 1 - 12
Cash inflows B!!A,AAA
Cash outflows B($AA,AAA) (@",!AA)
Net cash inflows B($AA,AAA) B $@,EAA
Annual net cash inflows B $@,EAA
5resent value factor for annuity, ! periods, E> L D.$"@
5resent value of net cash inflows B#!E,A#$
%nitial investment ($AA,AAA)
Net present value B (D,G$$)
And the %11 will be: $AA,AAA C $@,EAA ? present value factor of E.EA, yielding a return between
#> and @> from the table, or using a calculator, a return of $.!>.
#. Nnder the scenario of higher costs, 0rancesca will only be well off ma-ing the investment if
she can reach the sales revenue goal of B!@A,AAA. *therwise she will earn less than her desired
return of E>. %n fact, her return at the lower revenue scenarios will be below @>, her cost of
capital (see the %11 calculations). %f 0rancesca is able to lower the operating costs to B$A,AAA
and pay out a smaller share of her revenues, the project will be profitable unless she only reaches
the revenue level of B!!A,AAA2 in that case, she will fall short not only of her desired return, but
also her cost of capital of @>. %n summary, unless 0rancesca is either fairly certain to reach the
B!@A,AAA revenue level or fairly certain to lower her costs, it is advised that she not ma-e the
investment.
%t is not necessary to redo the N57 with different interest rates if you already calculated the %11,
since the %11 will not change with changes in desired rate of return. All you need to do is
compare the %11 of the project to different desired returns if you are changing the re+uired rate
of return and not the cash flows themselves.
!&#E