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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883

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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883
Textbook Problem

Evaluate alternative capital investment decisions

The investment committee of Iron Skillet Restaurants Inc. is evaluating two restaurant sites.The sites have different useful lives, hut each requires an investment of $1.000,000. Theestimated net cash flows from each site are as follows:

The committee has selected a rate of 20% for purposes of net present value analysis.It also estimates that the residual value at the end of each restaurant’s useful life is $0,but at the end of the fourth year. Site A’s residual value would be $300.000.

Instructions
Prepare a report to the investment committee, providing your advice on the relative meritsof the two sites.

To determine

Concept Introduction:

NPV:

Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

  NPV = Present value of cash inflows  Present value of cash out flows

To Indicate:

The Comparison of two sites

Explanation

The Net present value for each site is calculated as follows:

    Site ANet Cash Flows PVF (20%) PV
    A B =A*B
    Year 0 $ (1,000,000) 1.0000 $ (1,000,000)
    Year 1 $ 400,000 0.8333 $ 333,333
    Year 2 $ 400,000 0.6944 $ 277,778
    Year 3 $ 400,000 0.5787 $ 231,481
    Year 4 $ 700,000 0...

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