27th Edition
WARREN + 5 others
ISBN: 9781337272094




27th Edition
WARREN + 5 others
ISBN: 9781337272094
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.


 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.


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.


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



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.


To determine

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

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