Kaleo has made up his mind—he wants a pool in the family’s backyard! He figures his kids and spouse will be thrilled. However, to cover the cost of the pool, they’ll have to pack up and live away from home for a few weeks during the summer to rent their home to vacationers. He crunched the numbers based on the following estimates. 1. Cost of pool/installation $50,000 2. Life of the pool (no salvage value) 20 years 3. Annual net cash inflows from renting (net of cash expenses for renting and pool maintenance) $6,500 4. Tax rate 23% 5. Average rate of return 8% Kaleo’s daughter, Sarah, found the above information written on a sheet of paper in his office, along with the following notes. “This is a no-brainer! We’ll recover the cost of this pool in just 7 years, even though we plan to live here until we’re old and gray, or at least as long as the pool hangs on. If we can rent our house out for just 3 weeks each year, it’ll be almost pure profit that we can put toward paying off the pool. I studied time value of money a little bit in college; the present value of this investment is positive, so therefore we should definitely move ahead with it. My family will think they’re in heaven.” Required 1. What is the primary basis for Kaleo’s decision to move ahead with the pool? Is it primarily based on quantitative or qualitative considerations? 2. Determine the simple payback period using (1) before-tax dollars and (2) after-tax dollars. Does Kaleo’s payback period agree with either of these? 3. Determine the NPV of this investment. Is Kaleo’s recognition of a positive NPV consistent with your determination? Is there any quantitative basis for moving ahead with the pool? (Hint: Since the home will be rented for only 3 weeks of the year in this option, depreciation expense on Kaleo’s tax return can only be claimed for that period of time.) 4. To generate even more benefit from the pool, Kaleo is considering a full one-month (4 weeks) rental for the family’s home. He realizes there are pros and cons to this scenario but figures it would be worth it to have one more option to discuss when he brings this up with his family. Under this scenario, determine the NPV of the investment. Discuss the pros and cons to this scenario. 5. Do you think Kaleo’s family will agree to the pool investment at all? Explain your rationale, as well as any additional assumptions that should be clarified.

Kaleo has made up his mind—he wants a pool in the family’s backyard! He figures his kids and spouse will be thrilled. However, to cover the cost of the pool, they’ll have to pack up and live away from home for a few weeks during the summer to rent their home to vacationers. He crunched the numbers based on the following estimates. 1. Cost of pool/installation $50,000 2. Life of the pool (no salvage value) 20 years 3. Annual net cash inflows from renting (net of cash expenses for renting and pool maintenance) $6,500 4. Tax rate 23% 5. Average rate of return 8% Kaleo’s daughter, Sarah, found the above information written on a sheet of paper in his office, along with the following notes. “This is a no-brainer! We’ll recover the cost of this pool in just 7 years, even though we plan to live here until we’re old and gray, or at least as long as the pool hangs on. If we can rent our house out for just 3 weeks each year, it’ll be almost pure profit that we can put toward paying off the pool. I studied time value of money a little bit in college; the present value of this investment is positive, so therefore we should definitely move ahead with it. My family will think they’re in heaven.” Required 1. What is the primary basis for Kaleo’s decision to move ahead with the pool? Is it primarily based on quantitative or qualitative considerations? 2. Determine the simple payback period using (1) before-tax dollars and (2) after-tax dollars. Does Kaleo’s payback period agree with either of these? 3. Determine the NPV of this investment. Is Kaleo’s recognition of a positive NPV consistent with your determination? Is there any quantitative basis for moving ahead with the pool? (Hint: Since the home will be rented for only 3 weeks of the year in this option, depreciation expense on Kaleo’s tax return can only be claimed for that period of time.) 4. To generate even more benefit from the pool, Kaleo is considering a full one-month (4 weeks) rental for the family’s home. He realizes there are pros and cons to this scenario but figures it would be worth it to have one more option to discuss when he brings this up with his family. Under this scenario, determine the NPV of the investment. Discuss the pros and cons to this scenario. 5. Do you think Kaleo’s family will agree to the pool investment at all? Explain your rationale, as well as any additional assumptions that should be clarified.

Excel Applications for Accounting Principles

4th Edition

ISBN:9781111581565

Author:Gaylord N. Smith

Publisher:Gaylord N. Smith

Chapter26: Capital Budgeting (capbud)

Section: Chapter Questions

Problem 5R

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