Answered: Using payback, ARR, NPV, IRR, and…

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter12: Capital Budgeting: Decision Criteria

Section: Chapter Questions

Problem 16P: Shao Airlines is considering the purchase of two alternative planes. Plane A has an expected life of...

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Using payback, ARR, NPV, IRR, and profitability index to make capital investment decisions

Hill Company operates a chain of sandwich shops. The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of $8,700,000. Expected annual net cash inflows are $1,550,000 for 10 years, with zero residual value at the end of 10 years. Under Plan B, Hill Company would open three larger shops at a cost of $8,340,000. This plan is expected to generate net cash inflows of $990,000 per year for 10 years, the estimated useful life of the properties. Estimated residual value for Plan B is $1,200,000. Hill Company uses straight-line depreciation and requires an annual return of 10%.

Requirements

Compute the payback, the ARR, the NPV, and the profitability index of these two plans.
What are the strengths and weaknesses of these capital budgeting methods?
Which expansion plan should Hill Company choose? Why?
Estimate Plan A’s IRR. How does the IRR compare with the company’s required rate of return?

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