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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
BuyFindarrow_forward

Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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Net Present Value

Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows.

  1. a. Campbell Manufacturing is considering the purchase of a new welding system. The cash benefits will be $480,000 per year. The system costs $2,700,000 and will last 10 years.
  2. b. Evee Cardenas is interested in investing in a women’s specialty shop. The cost of the investment is $270,000. She estimates that the return from owning her own shop will be $52,500 per year. She estimates that the shop will have a useful life of 6 years.
  3. c. Barker Company calculated the NPV of a project and found it to be $63,900. The project’s life was estimated to be 8 years. The required rate of return used for the NPV calculation was 10%. The project was expected to produce annual after-tax cash flows of $135,000.

Required:

  1. 1. Compute the NPV for Campbell Manufacturing, assuming a discount rate of 12%. Should the company buy the new welding system?
  2. 2. CONCEPTUAL CONNECTION Assuming a required rate of return of 8%, calculate the NPV for Evee Cardenas’ investment. Should she invest? What if the estimated return was $135,000 per year? Would this affect the decision? What does this tell you about your analysis?
  3. 3. What was the required investment for Barker Company’s project?

1.

To determine

Calculate NPV using discount rate as 12% for Company CM. Also suggest whether to buy the new welding system or not.

Explanation

Net Present Value:

The remaining balance of the present value of a project’s inflows and outflows is known as net present value (NPV). It is a discounting model of capital investment decision. A project with a positive NPV increases the wealth of a firm whereas a project with a negative NPV decreases the wealth of a firm.

Use the following formula to calculate NPV:

NPV=Presentvalueofcashinflow(P)Presentvalueofcashoutflow(I)

Substitute $2,712,106 for P and $2,700,000 for I in the above formula.

NPV=$2,712,106$2,700,000=$12,106

Therefore, net present value is $12,106

2.

To determine

Calculate NPV using discount rate as 8% for Company EC and suggest whether to invest.

3.

To determine

Calculate required investment for BC’s project.

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