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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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Payback, Accounting Rate of Return, Present Value, Net Present Value, Internal Rate of Return

All scenarios are independent of all other scenarios. Assume that all cash flows are after-tax cash flows.

  1. a. Kambry Day is considering investing in one of the following two projects. Either project will require an investment of $20,000. The expected cash flows for the two projects follow. Assume that each project is depreciable.

Chapter 12, Problem 37E, Payback, Accounting Rate of Return, Present Value, Net Present Value, Internal Rate of Return All

  1. b. Wilma Golding is retiring and has the option to take her retirement as a lump sum of $450,000 or to receive $30,000 per year for 20 years. Wilma’s required rate of return is 6%.
  2. c. David Booth is interested in investing in some tools and equipment so that he can do independent drywalling. The cost of the tools and equipment is $30,000. He estimates that the return from owning his own equipment will be $9,000 per year. The tools and equipment will last 6 years.
  3. d. Patsy Folson is evaluating what appears to be an attractive opportunity. She is currently the owner of a small manufacturing company and has the opportunity to acquire another small company’s equipment that would provide production of a part currently purchased externally. She estimates that the savings from internal production will be $75,000 per year. She estimates that the equipment will last 10 years. The owner is asking $400,000 for the equipment. Her company’s cost of capital is 8%.

Required:

  1. 1. CONCEPTUAL CONNECTION What is the payback period for each of Kambry Day s projects? If rapid payback is important, which project should be chosen? Which would you choose?
  2. 2. CONCEPTUAL CONNECTION Which of Kambry’s projects should be chosen based on the ARR? Explain why the ARR performs better than the payback period in this setting.
  3. 3. Assuming that Wilma Golding will live for another 20 years, should she take the lump sum or the annuity?
  4. 4. Assuming a required rate of return of 8% for David Booth, calculate the NPV of the investment. Should David invest?
  5. 5. Calculate the IRR for Patsy Folson’s project. Should Patsy acquire the equipment?

1.

To determine

Find out the payback period for the new equipment for each of KD’s projects. Recommend the project to be chosen if rapid payback is important. Also, recommend the project should be chosen.

Explanation

Payback Period:

The time taken by an investment to recover its original value is known as payback period. It is calculated by dividing the original amount of investment by annual cash flow from the investment.

Calculate payback period for Project A:

Year

Unrecovered investment($)

(Beginning of year)

Annual cash

Flow($)

Time needed for payback

(Years)

120,0006,0001.0
214,0008,0001.0
36,000110,0000.60
 0 2.60

Table (1)

Therefore, payback period is 2.60 years.

Calculate payback period for Project B:

Year

Unrecovered investment($)

(Beginning of year)

Annual cash

Flow($)

Time needed for payback

(Years)

120,0006,0001.0
214,0008,0001.0
36,000110,0000...

2.

To determine

Find out the project to be chosen on the basis of accounting rate of return (ARR). Also, explain the reason for better performance of ARR in this setting than payback period.

3.

To determine

Calculate present value of the annuity to recommend that Person WG should accept the lump sum amount or annuity.

4.

To determine

Find out the NPV of the investment if the RRR is 8%. Also, recommend that Person D should invest or not.

5.

To determine

Find out the IRR for Person PF’s project. Also recommend that Person PF should acquire the equipment or not.

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