# Alternative capital investments The investment committee of Auntie M’s Restaurants Inc. is evaluating two restaurant sites. The sites have different useful lives, but each requires an investment of \$900,000. The estimated net cash flows from each site are as follows: Year Net Cash Flows Wichita Topeka 1 \$310,000 \$400,000 2 310,000 400,000 3 310,000 400,000 4 310,000 400,000 5 310,000 6 310,000 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, Wichita’s residual value would be \$500,000. Instructions 1. For each site, compute the net present value. Use the present value of an annuity of \$1table appearing in this chapter (Exhibit 5). (Ignore the unequal lives of the projects.) 2. For each site, compute the net present value, assuming that Wichita is adjusted to a four-year life for purposes of analysis. Use the present value of \$1 table appearing in this chapter (Exhibit 2). 3. Prepare a report the investment committee, giving your advice on therelative merits of the two sites.

### Accounting

27th Edition
WARREN + 5 others
Publisher: Cengage Learning,
ISBN: 9781337272094

### Accounting

27th Edition
WARREN + 5 others
Publisher: Cengage Learning,
ISBN: 9781337272094

#### Solutions

Chapter
Section
Chapter 26, Problem 26.5BPR
Textbook Problem

## Alternative capital investments The investment committee of Auntie M’s Restaurants Inc. is evaluating two restaurant sites. The sites have different useful lives, but each requires an investment of \$900,000. The estimated net cash flows from each site are as follows: Year Net Cash Flows Wichita Topeka 1 \$310,000 \$400,000 2 310,000 400,000 3 310,000 400,000 4 310,000 400,000 5 310,000   6 310,000    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, Wichita’s residual value would be \$500,000.Instructions 1.    For each site, compute the net present value. Use the present value of an annuity of \$1table appearing in this chapter (Exhibit 5). (Ignore the unequal lives of the projects.) 2.    For each site, compute the net present value, assuming that Wichita is adjusted to a four-year life for purposes of analysis. Use the present value of \$1 table appearing in this chapter (Exhibit 2). 3.        Prepare a report the investment committee, giving your advice on therelative merits of the two sites.

Expert Solution

1.

To determine

Net present value method

Net present value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value, the interest rate is determined by the business, based on the net income from the investment, and it is also called as the discounted cash flow method.

To determine: The net present value of each investment, using the present value of \$1 table in Exhibit 5, ignoring the unequal lives of the project.

### Explanation of Solution

Calculation of the net present value of Wichita is as follows:

 AM Restaurant Net Present Value of Wichita Particulars Amount In \$ (except present value of annuity) Annual net cash flow \$310,000 Present value of annuity of \$1 at 20% for 6 years (Exhibit 5) 3.326 Present Value of annual net cash flow \$1,031,060 Less: Amount to be invested -\$900,000 Annual net cash flow \$131,060

Tab...

Expert Solution

2.

To determine

To calculate: The net present value of each project assuming the office expansion is adjusted to a four year life, using the present value of \$1 table in Exhibit 2.

Expert Solution

3.

To determine

To prepare: The report the merits of the two investments to the capital investment committee.

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