1 2.

P
Exercise 11-1 Net Present Value Method [LO1]
The management of Opry Company, a wholesale distributor of suntan products, is considering the purchase of a $25,000
machine that would reduce operating costs in its warehouse by $4,000 per year. At the end of the machines 10-year use
life, it will have no scrap value. The companys required rate of return is 12%. (Ignore income taxes.)

Required:

Determine the net present value of the investment in the machine.(Negative amount should b
indicated by a minus sign. Round discount factor(s) to 3 decimal places, other intermediate
calculations and final answer to the nearest whole dollar.)

Net present value

$ (2,399.00)

What is the difference between the total, undiscounted cash inflows and cash outflows over th
entire life of the machine?

Net cash flow

$ 15,000.00

Explanation:
1

Item
Annual cost savings

Year(s)
1 to 10

Cash flow
$ 4,000

Initial investment
Net present value

Now

$(25,000)

12 % Factor
5.650
1.000

Present Value of
Cash Flows
$
22,600
$
$

(25,000)
(2,400)

Item
Annual cost savings
Initial investment
Net cash flow

Cash flow
$ 4,000

Years

$(25,000)

10

Present Value of
Cash Flows
$
40,000
$
$

(25,000)
15,000

ase of a $25,000
nes 10-year useful

mount should be
r intermediate

outflows over the

2
Exercise 11-2 Preference Ranking [LO2]
Information on four investment proposals is given below:
Investment Proposal
A
B
C
D
Investment required $
(85,000) $ (200,000) $
(90,000) $ (170,000)
Present value of cash inflows
$
119,000 $ 250,000 $
135,000 $ 221,000
Net present value
Life of the prject

34,000

5 years

50,000
7 years

45,000
6 years

51,000
7 years

Required:
1

Compute the project profitability index for each investment proposal. (Round your
answers to 2 decimal places.)

Proposal
A
B
C
D
2

Project
Profitability
Index
0.40
0.25
0.50
0.30

Rank the proposals in terms of preference.

ABCD
DCBA
CADB
BCAD
Explanation:
1.
The project profitability index for each proposal is:

Proposal
A
B
C
D

2
The ranking is:

Net Present
Value (a)
$34,000
$50,000
$45,000
$51,000

Project
Investment
Perofitability
Rquired (b)
Index (a)/b
$
85,000
0.40
$ 200,000
0.25
$
90,000
0.50
$ 170,000
0.30

Proposal
C
A
D
B

Project
Profitability
Index
0.50
0.40
0.30
0.25

Note that proposals D and B have the highest net present values of the four proposals,
but they rank at the bottom of the list in terms of the project profitability index.

2. P
Exercise 11-3 Payback Method [LO3]
The management of Weimar, Inc., a civil engineering design company, is considering an
investment in a high-quality blueprint printer with the following cash flows:
Year
Investment
$
38,000
1
$
6,000
2
3
4
5
6
7
8
9
10

$
$
$
$
$
$
$
$
$
$

Cash Inflow
2,000
4,000
8,000
9,000
12,000
10,000
8,000
6,000
5,000
5,000

Required:
1

Determine the payback period of the investment. (Round your answer to the nearest whole number.)

Payback period
2

6 years

Would the payback period be affected if the cash inflow in the last year were several times
larger?
No
Yes
Explanation:
1
The payback period is determined as follows:

1
2
3
4
5
6
7
8
9
10

Cash
Unrecovered
Investment
inflow
Investment
$
38,000 $ 2,000 $
36,000
$
6,000 $ 4,000 $
38,000
$ 8,000 $
30,000
$ 9,000 $
21,000
$ 12,000 $
9,000
$ 10,000 $
$ 8,000 $
$ 6,000 $
$ 5,000 $
$ 5,000 $
-

The investment in the project is fully recovered in the 6th year. To be more exact, the
payback period is approximately 5.9 years (5 years + (9,000 / 10,000)).
2
Because the investment is recovered prior to the last year, the amount of the cash inflow in the
last year has no effect on the payback period.

4 2. P
Exercise 11-4 Simple Rate of Return Method [LO4]
The management of Wallingford MicroBrew is considering the purchase of an automated bottling machine for
$80,000. The machine would replace an old piece of equipment that costs $33,000 per year to operate. The new
machine would cost $10,000 per year to operate. The old machine currently in use could be sold now for a scrap
value of $5,000. The new machine would have a useful life of 10 years with no salvage value.

Required:
Compute the simple rate of return on the new automated bottling machine. Use straight-line
depreciation method.
Simple rate of return

20%

Explanation:
The annual incremental net operating income is determined by comparing the operating cost of the old machine to the
operating cost of the new machine and the depreciation that would be taken on the new machine:
Operating cost of old machine
Less operating cost of new machine
Less annual depreciation on the new
machine ($80,000 10 years)
Annual incremental net operating income
Cost of the new machine
Less scrap value of old machine
Initial investment

Simple rate of return

$
$

33,000
10,000

8,000

15,000

80,000
5,000
75,000

Annual incremental net operating income

Initial investment
$15,000
$75,000

= 20%

ttling machine for

o operate. The new
sold now for a scrap
e.

of the old machine to the

hine:

2. P
Exercise 11-5 Payback Period and Simple Rate of Return [LO3, LO4]
[The following information applies to the questions displayed below.]
The Heritage Amusement Park would like to construct a new ride called the Sonic Boom, which the

Ticket revenues
Less operating expenses:
Maintenance
Salaries
Depreciation
Insurance
Total operating expenses
Net operating income

1-a.

2-a.

$ 187,000
$ 63,000

5 years

No

2. P
Compute the simple rate of return promised by the new ride.
Simple rate of return

2-b.

40,000
90,000
27,000
30,000

Assume that the Heritage Amusement Park will not construct a new ride unless the ride provides a
payback period of six years or less. Does the Sonic Boom ride satisfy this requirement?
Yes

$
$
$
$

Exercise 11-5 Part 1

Required:
Compute the pay back period associated with the new ride.
Payback period

1-b.

$ 250,000

14%

If Heritage Amusement Park requires a simple rate of return of at least 12%, does the Sonic Boom ride
meet this criterion?
Yes

No

Explanation:
1-a.
Computation of the annual cash inflow associated with the new ride:

Net operating income

Add: Noncash deduction for
Annual net cash inflow

$
$

63,000
27,000

90,000

The payback computation would be:

Payback period

Investment required
Net annual cash inflow
$450,000
$90,000 per = 5 years
year

1-b.
Yes, the new ride meets the requirement. The payback period is less than the maximum 6
years required by the Park.

Explanation:

2-a.
The simple rate of return would be:

Simple rate of return

Annual incremental net operating income

Initial investment
$63,000
$450,000

= 14%

2-b.

Yes, the new ride satisfies the criterion. Its 14% return exceeds the Parks requirement of a
12% return.

2. P
Exercise 11-6 Comparison of Projects Using Net Present Value [LO1]
Sharp Company has $15,000 to invest. The company is trying to decide between two alternative uses of
the funds as follows:

Investment required
Annual cash inflows
Single cash inflow at the end of 10 years
Life of the project

Invest in
Invest in
Project A Project B
$ 15,000 $ 15,000
$
$ 60,000
10 years
11 years

Sharp Company uses a 16% discount rate. (Ignore income taxes.)

Required:
a.
Determine the net present value. (Negative amounts should be indicated by a minus sign.
Round discount factor(s) to 3 decimal places, other intermediate calculations and final
answers to the nearest whole dollar.)
Net Present Value
$
4,332.00
$ (1,380.00)

Project A
Project B
b.

Which investment would you recommend that the company accept?

Project A
Project B

Explanation:
a.
Item
Project A:
Investment required
Annual cash inflows
Net present value

Project B:
Investment

Year(s)

Amount of
cash flow

Now
1 to 10

$ (15,000)
$
4,000

1.000 $
4.833 $
$

(15,000)
19,332
4,332

Now

$ (15,000)

1.000 $

(15,000)

16 %
Factor

Present
Value of

Cash inflow
Net present value

10

60,000

0.227 $
$

13,620
(1,380)

b.
Project A should be selected. Project B does not provide the required 16% return, as shown by its
negative net present value.

rnative uses of

wn by its

8 2. P

Exercise 11-8 Net Present Value Analysis of Two Alternatives [LO1]

Wriston Company has $300,000 to invest. The company is trying to decide between two alternative uses of the funds. The alterna
as follows:

Cost of equipment required

Working capital investment required
Annual cash inflows
Salvage value of equipment in seven years
Life of the project

$
$
$
$

A
300,000
80,000
20,000
7 years

B
$
$ 300,000
$ 60,000
$
7 years

The working capital needed for project B will be released for investment elsewhere at the end of seven years. Wriston Company
uses a 20% discount rate. (Ignore income taxes.)

Calculate net present value for each project. (Negative amounts should be indicated by a minus sign. Leave no cells blank - be ce
a. enter "0" wherever required. Round discount factor(s) to 3 decimal places, other intermediate calculations and final answers to th
whole dollar.)

Net Present Value

$
(6,020.00)
$
-

Project A
Project B

b. Which investment alternative (if either) would you recommend that the company accept?
Project A
Project B

Explanation:
a.
Item
Project A:
Cost of the equipment
Annual cash inflows
Salvage value of the eq.
Net present value
Project B:
Working capital Investment
Annual Cash inflow
Working capital Release
Net present value
b.

Year(s)

Amount of
cash flow

Present Value of
20 % Factor
Cash flows

Now
1 to 7
7

$
$
$

(300,000)
80,000
20,000

1.000
3.605
0.279
0.279

$
$
$
$

(300,000)
288,400
5,580
(6,020)

Now
1 to 7
7

$
$
$

(300,000)
60,000
300,000

1.000 $
3.605 $
0.219 $
$

(300,000)
216,300
83,700
-

The $300,000 should be invested in Project B rather than in Project A. Project B has a zero net present
value, which means that it promises exactly a 20% rate of return. Project A is not acceptable at all, since
it has a negative net present value.

funds. The alternatives are

Wriston Company

cells blank - be certain to

final answers to the nearest

2. P

Exercise 11-9 Basic Net Present Value Analysis [LO1]

On January 2, Fred Critchfield paid $18,000 for 900 shares of the common stock of Acme Company. M
Critchfield received an $0.80 per share dividend on the stock at the end of each year for four years. At
four years, he sold the stock for $22,500. Mr. Critchfield has a goal of earning a minimum return of 12
his investments. (Ignore income taxes.)

Required:
a.

Determine the net present value. (Negative amount should be indicated by a minus sign.Round dis
decimal places, other intermediate calculations and final answer to the nearest whole dollar.)

Net present value

b.

(1,503)

Did Mr. Critchfield earn a 12% return on the stock?

Yes

Item
Purchase of the stock
Annual dividends
Sale of the stock
Net present value

No
Amount Cash
flow

Year(s)
now

1 to 4

12 %
Factor
5.650

Present Value
of Cash Flows
$
(18,000)

720

1.000

2,187

22,500

0.636

$
$

14,310
(1,503)

(18,000)

*900 shares $0.80 per share per year = $720 per year.
b.

No, Mr. Critchfield did not earn a 12% return on the stock. The negative net present value indicates that
the rate of return on the investment is less than the discount rate of 12%.

mon stock of Acme Company. Mr.

d of each year for four years. At the end of
earning a minimum return of 12% on all of

ed by a minus sign.Round discount factor(s) to 3

the nearest whole dollar.)