Concept explainers
Problem 10-23A Comparing
Barlae Auto Repair, Inc. is evaluating a project to purchase equipment that will not only expand the company’s capacity but also improve the quality of its repair services. The board of directors requires all capital investments to meet or exceed the minimum requirement of a 10 percent rate of return. However, the board has not clearly defined the rate of return. The president and controller are pondering two different
Required
Round rates to six decimal points.
- a. If it uses the unadjusted rate of
return (use average investment ) to evaluate this project, should the company invest in the equipment? - b. If it uses the internal rate of return to evaluate this project, should the company invest in the equipment?
- c. Which method is better for this capital investment decision?
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- Capital rationing decision for a service company involving four proposals Renaissance Capital Group is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated income from operations, and net cash flow for each proposal are as follows: The company's capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average rate of return of 12% is required on all projects. If the preceding standards are met, the net present value method and present value indexes are used to rank the remaining proposals. Instructions 1. Compute the cash payback period for each of the four proposals. 2. Giving effect to straight-line depreciation on the investments and assuming no estimated residual value, compute the average rate of return for each of the four proposals. Round to one decimal place. 3. Using the following format, summarize the results of your computations in parts (1) and (2). By placing the calculated a mounts in the first two columns on the left and by placing a check mark in the appropriate column to the right, indicate which proposals should be accepted for further analysis and which should be rejected. 4. For the proposals accepted for further analysis in part (3), compute the net present value. Use a rate of 15% and the present value of 1 table appearing in this chapter (Exhibit 2). 5. Compute the present value index for each of the proposals in part (4). Round to two decimal places. 6. Rank the proposals from most attractive to least attractive, based on the present values of net cash flows computed in part (4). 7. Rank the proposals from most attractive to least attractive, based on the present value indexes computed in part (5). 8. Based on the analyses, comment on the relative attractiveness of the proposals ranked in parts (6) and (7).arrow_forwardCapital rationing decision for a service company involving four proposals Clearcast Communications Inc. is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated income from operations, and net cash flow for each proposal are as follows: The companys capital rationing policy requires a maximum cash payback period of three yean. In addition, a minimum average rate of return of 12% is required on all projects. If the preceding standards are mil, the net present value method and present value indexes are used to rank the remaining proposals. Instructions 1. Compute the cash payback period for each of the four proposals. 2. Giving effect to straight-line depreciation on the investments and assuming no estimated residual value, compute the average rate of return for each of the four proposals. (Round to one decimal place.) 3. Using the following formal, summarize the results of your computations in parts (l) and (2). By placing the calculated amounts in the first two columns on the left and by placing a check mark in the appropriate column to the right, indicate which proposals should he accepted for further analysis and which should be rejected. 4. For the proposals accepted for further analysts in part (3), compute the net present value. Use a rate of 12% and the present value of 1 table appearing in this chapter (Exhibit 2). 5. Compute the present value index for each of the proposals in part (4). (Round to two decimal places.) 6. Rank the proposals from most attractive to least attractive, based on the present values of net cash flows computed in part (4). 7. Rank the proposals from most attractive to least attractive, based on the present value indexes computed in part (5). 8. Based on the analyses, comment on the relative attractiveness of the proposals ranked in parts (6) and (7).arrow_forwardCapital rationing decision for a service company involving four proposals Clearcast Communications Inc. is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated income from operations, and net cash flow for each proposal are as follows: The companys capital rationing policy requires a maximum cash payback period of three yean. In addition, a minimum average rate of return of 12% is required on all projects. If the preceding standards are mil, the net present value method and present value indexes are used to rank the remaining proposals. Instructions 1. Compute the cash payback period for each of the four proposals. 2. Giving effect to straight-line depreciation on the investments and assuming no estimated residual value, compute the average rate of return for each of the four proposals. (Round to one decimal place.) 3. Using the following formal, summarize the results of your computations in parts (l) and (2). By placing the calculated amounts in the first two columns on the left and by placing a check mark in the appropriate column to the right, indicate which proposals should he accepted for further analysis and which should be rejected. 4. For the proposals accepted for further analysts in part (3), compute the net present value. Use a rate of 12% and the present value of 1 table appearing in this chapter (Exhibit 2). 5. Compute the present value index for each of the proposals in part (4). (Round to two decimal places.) 6. Rank the proposals from most attractive to least attractive, based on the present values of net cash flows computed in part (4). 7. Rank the proposals from most attractive to least attractive, based on the present value indexes computed in part (5). 8. Based on the analyses, comment on the relative attractiveness of the proposals ranked in parts (6) and (7).arrow_forward
- Average rate of return method, net present value method, and analysis for a service company The capital Investment committee of Touch of Eden Landscaping Company is considering two capital investments. The estimated income from operations and net cash flows from each investment are as follows: Each project requires an investment of 60,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 12% for purposes of the net present value analysis. Instructions 1. Compute the following: a. The average rate of return for each investment. Round to one decimal place. b. The net present value for each investment. Use the present value of 1 table appearing in this chapter (Exhibit 2). Round present values to the nearest dollar. 2. Prepare a brief report for the capital investment committee, advising it on the relative merits of the two investments .arrow_forwardExercise 10-10A (Algo) Using the internal rate of return to compare investment opportunities LO 10-3 Velma and Keota (V&K) is a partnership that owns a small company. It is considering two alternative investment opportunities. The first investment opportunity will have a three-year useful life, will cost $8,922.67, and will generate expected cash inflows of $3,400 per year. The second investment is expected to have a useful life of three years, will cost $7,989.00, and will generate expected cash inflows of $3,100 per year. Assume that V&K has the funds available to accept only one of the opportunities. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required Calculate the internal rate of return of each investment opportunity. (Do not round intermediate calculations.) Based on the internal rates of return, which opportunity should V&K select?arrow_forwardChapter 4 Exercise Pg.170 Question 2Perform a financial analysis for a project using the format provided in Figure 4-5. Assume the projected costs and benefits for this project are spread over four years as follows: Estimated costs are $200,000 in year 1 and $30,000 each year in years 2, 3, and 4. Estimated benefits are $0 in year 1 and $100,000 each year in years 2, 3, and 4. Use a 9 percent discount rate and round the discount factors to two decimal places. Create a spreadsheet (or use the business case financials template provided on the companion Web site) to calculate and clearly display the NPV, ROI, and year in which payback occurs. In addition, write a paragraph explaining whether you would recommend investing in this project, based on your financial.arrow_forward
- Problem 6-2 Calculating Project NPV The Fancy Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated here. The corporate tax rate is 24 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project. Year 0 Year 1 Year 2 Year 3 Year 4 Investment $ 27,700 Sales revenue $ 14,800 $ 16,400 $ 17,800 $ 14,300 Operating costs 3,600 3,450 5,600 4,200 Depreciation 6,925 6,925 6,925 6,925 Net working capital spending 370 270 365 220 ? a. Compute the incremental net income of the investment for each year. (Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.) b. Compute the incremental cash flows of the investment for each year. (A negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your…arrow_forwardExercise 13-9 Net Present Value Analysis and Simple Rate of Return [LO13-2, LO13-6] Derrick Iverson is a divisional manager for Holston Company. His annual pay raises are largely determined by his division’s return on investment (ROI), which has been above 20% each of the last three years. Derrick is considering a capital budgeting project that would require a $4,140,000 investment in equipment with a useful life of five years and no salvage value. Holston Company’s discount rate is 16%. The project would provide net operating income each year for five years as follows: Sales $ 3,400,000 Variable expenses 1,450,000 Contribution margin 1,950,000 Fixed expenses: Advertising, salaries, and other fixedout-of-pocket costs $ 670,000 Depreciation 828,000 Total fixed expenses 1,498,000 Net operating income $ 452,000 Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount…arrow_forwardProblem 10.24Blanda Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. If the firm uses a 9 percent discount rate for their production systems,Year System 1 System 20 -$14,800 -$45,662 1 15,037 32,200 2 15,037 32,200 3 15,037 32,200 Compute the IRR for both production system 1 and production system 2. (Round answers to 2 decimal places, e.g. 15.25.)a). IRR of system 1 is __% and IRR of system 2 is ___% b).Which has the higher IRR, System 1 or System 2? c). Compute the NPV for both production system 1 and production system 2. (Round answers to 2 decimal places, e.g. 15.25 or 15.25%.)NPV of system 1 is $ ____ and NPV of system 2 is ____d). Which production system has the higher NPV? System 1 or System 2?arrow_forward
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