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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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Patterson Company is considering two competing investments. The first is for a standard piece of production equipment. The second is for computer-aided manufacturing (CAM) equipment. The investment and after-tax operating cash flows follow:

Chapter 12, Problem 53P, Patterson Company is considering two competing investments. The first is for a standard piece of

Patterson uses a discount rate of 18% for all of its investments. Patterson’s cost of capital is 10%.

Fabre Company, Patterson Company’s competitor, is considering the same investments as Patterson. Refer to the data in Problem 12-52 above. Assume that Fabre’s cost of capital is 14%.

Required:

  1. 1. Calculate the NPV of each alternative by using the 14% rate.
  2. 2. CONCEPTUAL CONNECTION Now assume that if the standard equipment is purchased, the competitive position of the firm will deteriorate because of lower quality (relative to competitors who did automate). Marketing estimates that the loss in market share will decrease the projected net cash inflows by 50% for Years 3 through 10. Recalculate the NPV of the standard equipment given this outcome. What is the decision now? Discuss the importance of assessing the effect of intangible benefits.

1.

To determine

Find out the NPV of each method by using a discount rate of 14%.

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.

Calculate NPV for standard equipment:

2.

To determine

Re-compute the NPV of standard equipment by considering the outcome resulting from the purchase of it. State the decision and the importance of assessing the effect of intangible benefits.

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