Week 13-14: Assignment

Answer:
1. Determine the payback period of the investment.
Year Investment
1 $15,000
2 $8,000
Total Investment $23,000

Year Cash Inflow Cumulative Cash Inflow

1 $1,000 $1,000
2 $2,000 $3,000
3 $2,500 $5,500
4 $4,000 $9,500
5 $5,000 $14,500
6 $6,000 $20,500
7 $5,000 $25,500
8 $4,000 $29,500
9 $3,000 $32,500
10 $2,000 $34,500
Computation between Year 6 and Year 7. Th e estimated payback period:
Total Investment $23,000
Less: Year 6 Cumulative Cash Inflow $20,500
Required amount in Year 7 $2,500
Divide: Cash Inflow Year 7 $5,000
Total 0.5 years
Add: 6 years 6 years
Payback Period 6.5 years

2. Would the payback period be affected if the cash inflow in the last year were several
times as large?
No, payback period would not be affected if the cash inflow in the last year were several times as
large. Since payback period is 6.5 years any cash inflows beyond that are not considered in
determining the payback period.

Answer:
1. Determine the net present value of the investment in the machine.

Now 1 2 3 4 5
Purchase of Machine ($27,000)
Less: operating cost $7,000 $7,000 $7,000 $7,000 $7,000
Total cash flows ($27,000) $7,000 $7,000 $7,000 $7,000 $7,000
Discount factor (12%) 1,000 0.893 0.797 0.712 0.636 0.567
Present Value ($27,000) $6,521 $5,579 $4,984 $4,452 $3,969
Net Present Value ($1,765)
 2. What is the difference between the total, undiscounted cash inflows and cash
outflows over the entire life of the machine?

Cash flow Years Total Cash Flows

Annual cost saving $7,000 5 $35,000

Initial Investment ($27,000) 1 ($27,000)

Net cash flow $8,000

Answer:
1. What would be the total annual cash inflows associated with the new machine for
capital budgeting purposes?

Formula: Total Annual Cash Inflows = Savings in Part Time help annually + Additional
contribution Margin from Expected Sales.

Total Annual Cash Inflows = $3,800  + ( 1000 x $1.20)

Total Annual Cash Inflows =  $3,800 + $1,200

Total Annual Cash Inflows = $5,000

2. Find the internal rate of return promised by the new machine to the nearest whole percent
= $18,600 / $5,000
=3.72
Initial rate of return = 16%
3. In addition to the data given previously, assume that the machine will have a $9,125 salvage
value at the end of six years. Under these conditions, compute the internal rate of return to the
nearest whole percent. (Hint: You may find it helpful to use the net present value approach; find
the discount rate that will cause the net present value to be closest to zero.)
Internal Rate of return, including salvage value = 22%

Answer:
What dollar value per year would these intangible benefits have to have to make the equipment
an acceptable investment?
Formula: Annual Value = Required increase in present value/ the factor for 15 years
= $630,000 / 4.675
= $134,759
Answer:
1. Compute the project profitability index for each investment proposal.
Formula: Project Profitability Index = Present Value of Future Cash Flow / Initial Investment
Investment A Investment B
= $36,000 / $90,000 = $38,000 / $100,000
=0.4 =0.38

Investment C Investment D
= $35,000 / $70,000 = $40,000 / $120,000
=0.5 =0.33

2. Rank the proposals in terms of preference.

Investment Proposal C
Investment Proposal A
Investment Proposal B
Investment Proposal D
Answer:
Compute the simple rate of return on the new automated bottling machine.
Operating cost of old machine $30,000
Less: operating cost of new machine $12,000
Less: annual depreciation of new machine $12,000
($120,000 / 10 years)
Annual Incremental net operating $6,000
income
Cost of new machine $120,000
Scrap value of old machine $40,000
Initial Investment $80,000

Formula: Simple rate of return = Annual Incremental net operating income / Initial Investment
= $6,000 / $80,000
= 0.075 or 7.5%
Answer:
Which investment alternative (if either) would you recommend that the company accept? Show
all computations using the net present value format. Prepare separate computations for each
project.

Project A
Item Years Amount of 14% Factor Present Value
Cash Flow of Cash Flows

Cost of the ($100,000) 1.000 ($100,000)

equipment

Annual Cash 1-6 $21,000 3.889 $81,669

Inflows

Salvage value 6 $8,000 0.456 $3,648

of the
equipment
Net Present ($14,683)
Value
 Project B
Item Years Amount of 14% Factor Present Value
Cash Flow of Cash Flows

Cost of the ($100,000) 1.000 ($100,000)

equipment

Annual Cash 1-6 $16,000 3.889 $62,224

Inflows

Salvage value 6 $100,000 0.456 $45,600

of the
equipment
Net Present $7,824
Value

The $100,000 should be invested in Project B rather than in Project A. Project B has a
positive net present value whereas Project A has a negative net present value.
Answer:
1. Assume that Nick’s Novelties, Inc., will not purchase new games unless they provide a
payback period of five years or less. Would the company purchase the new games?

Net Operating Income $40,000

Add: non cash deduction for $35,000

depreciation
Annual net cash flow $75,000

Formula: Payback Period = Investment required / Annual net cash flow

= $300,000/ $75,000
= 4 years

Yes, they can purchase new games.

 2. Compute the simple rate of return promised by the games. If the company requires a
simple rate of return of at least 12%, will the games be purchased?

Formula: Simple rate of return = Annual Incremental net operating income / Initial
Investment

= $40,000 / $300,000
=0.1333 or 13.33%

Yes, the machines would be purchased. The 13.33% return exceeds 12%.