Beruflich Dokumente
Kultur Dokumente
Solutions to Questions
14-6 Net present value is the present 14-11 No. As the discount rate increases,
value of cash inflows less the present the present value of a given future cash
value of the cash outflows. The net flow decreases. For example, the present
present value can be negative if the value factor for a discount rate of 12% for
present value of the outflows is greater cash to be received ten years from now is
than the present value of the inflows. 0.322, whereas the present value factor
for a discount rate of 14% over the same
period is 0.270. If the cash to be received
14-12 The internal rate of return is more 14-16 A tax deductible cash outflow
than 14% since the net present value is results in some tax savings. The after-tax
positive. The internal rate of return would cost of such an outflow is net of this tax
be 14% only if the net present value savings. In capital budgeting decisions, all
(evaluated using a 14% discount rate) is tax-deductible cash expenses should be
zero. The internal rate of return would be included on an after-tax cost basis
less than 14% if the net present value because the after-tax amount represents
(evaluated using a 14% discount rate) is the actual net cash outflow.
negative.
14-17 The depreciation tax shield refers
14-13 The project profitability index is to the tax deductibility of depreciation,
computed by dividing the net present which is not a cash outflow. In capital
value of the cash flows from an budgeting, the depreciation tax shield
investment project by the investment triggers a cash inflow (tax reduction) equal
required. The index measures the profit (in to the depreciation deduction multiplied
terms of net present value) provided by by the tax rate.
each dollar of investment in a project. The
higher the project profitability index, the 14-18 An increase in the tax rate would
more desirable is the investment project. tend to make the new investment less
attractive, since net after-tax cash inflows
14-14 The payback period is the length of would be reduced.
time for an investment to fully recover its
own initial cost out of the cash receipts 14-19 One cash inflow would be the
that it generates. proceeds from the sale of the piece of
The payback method acts as a equipment. The other cash inflow would
screening tool in weeding out investment be the income tax reduction that results
proposals. The payback method is useful from the loss on the equipment.
when a company has cash flow problems.
The payback method is also used in 14-20 The purchase of the equipment
industries where obsolescence is very should be shown as a cash outflow of
rapid. $40,000. The initial cost of an asset is not
immediately deductible for tax purposes.
14-15 Neither the payback method nor Rather, the cost is deducted in later
the simple rate of return method considers periods in the form of depreciation.
the time value of money. Under both
1.
Present
12% Value of
Cash Facto Cash
Item Year(s) Flow r Flows
Annual cost $ 22,60
savings............... 1-10 $4,000 5.650 0
$(25,000
Initial investment. . Now ) 1.000 (25,000)
Net present value. $ (2,400)
2.
Total
Cash Cash
Item Flow Years Flows
Annual cost $ 40,00
savings............... $4,000 10 0
$(25,00
Initial investment. . 0) 1 (25,000)
$ 15,00
Net cash flow........ 0
3. The cash flows are not even over the six-year life of the truck
because of the extra $13,000 cash inflow that occurs in the
sixth year. Therefore, the approach used above cannot be used
to compute the internal rate of return. Using trial-and-error or
some other method, the internal rate of return turns out to be
about 11%:
Amount Present
Year(s of Cash 11% Value of
) Flows Factor Cash Flows
Initial investment. . Now $(45,000) 1.000 $(45,000)
Annual cash
inflows................ 1-6 $9,000 4.231 38,079
Salvage value....... 6 $13,000 0.535 6,955
Net present value. $ 34
As expected, the extra cash inflow in the sixth year increases
the internal rate of return.
Present
Amount 16% Value of
Year(s of Cash Facto Cash
Item ) Flows r Flows
Project A:
Investment
required.............. Now $(15,000) 1.000 $(15,000)
Annual cash
inflows................ 1-10 $4,000 4.833 19,332
Net present value. $ 4,332
Project B:
Investment........... Now $(15,000) 1.000 $(15,000)
Cash inflow........... 10 $60,000 0.227 13,620
Net present value. $(1,380)
Project A should be selected. Project B does not provide the
required 16% return, as shown by its negative net present value.
Present
Amount of 12% Value of
Year(s) Cash Flows Factor Cash Flows
Purchase of the stock Now $(18,000) 1.000 $(18,000)
Annual dividends*..... 1-4 $720 3.037 2,187
Sale of the stock....... 4 $22,500 0.636 14,310
Net present value...... $( 1,503)
*900 shares $0.80 per share per year = $720 per year.
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%.
b. From Exhibit 14B-1, the factor for 10% for 3 periods is 0.751.
Therefore, the present value of the required investment is:
$12,000 0.751 = $9,012.
3. Present
Optio Amount of 10% Value of
n Year(s) Cash Flows Factor Cash Flows
A Now $500,000 1.000 $500,000
B 1-8 $60,000 5.335 $320,100
8 $200,000 0.467 93,400
$413,500
Mark should accept option A. On the surface, option B appears
to be a better choice since it promises a total cash inflow of
$680,000 ($60,000 8 = $480,000; $480,000 + $200,000 =
$680,000), whereas option A promises a cash inflow of only
$500,000. However, the cash inflows under option B are spread
out over eight years, whereas the cash flow under option A is
received immediately. Since the $500,000 under option A can
be invested at 10%, it would actually accumulate to more than
$680,000 at the end of eight years. Consequently, the present
value of option A is higher than the present value of option B.
(1)
(2)
After- Present
(2) Tax 10% Value
(1) Tax Cash Facto of Cash
Items and Computations Year(s) Amount Effect Flows r Flows
Project A:
$(50,000 $(50,000
Investment in photocopier........ Now $(50,000) ) 1.000 )
Net annual cash inflows............ 1-8 $9,000 1 0.30 $6,300 5.335 33,611
Depreciation deductions*......... 1-8 $6,250 0.30 $1,875 5.335 10,003
Salvage value of the
photocopier............................ 8 $5,000 1 0.30 $3,500 0.467 1,635
Net present value..................... $( 4,751)
Project B:
$(50,000 $(50,000
Investment in working capital... Now $(50,000) ) 1.000 )
Net annual cash inflows............ 1-8 $9,000 1 0.30 $6,300 5.335 33,611
Release of working capital........ 8 $50,000 $50,000 0.467 23,350
$ 6,96
Net present value..................... 1
* $50,000 8 years = $6,250 per year
1. Note: All present value factors have been taken from Exhibit
14B-1 in Appendix 14B, using a 16% discount rate.
$134,65
Investment in the equipment............ 0
Less present value of Year 1 and
Year 2 cash inflows:
$38,79
Year 1: $45,000 0.862............... 0
Year 2: $60,000 0.743............... 44,580 83,370
$
Present value of Year 3 cash inflow. . . 51,280
Therefore, the expected cash inflow for Year 3 is:
$51,280 0.641 = $80,000.
Present
Amount Value of
Year(s of Cash 20% Cash
Item ) Flows Factor Flows
Project A:
$(300,00 $(300,00
Cost of the equipment.......... Now 0) 1.000 0)
Annual cash inflows.............. 1-7 $80,000 3.605 288,400
Salvage value of the
equipment.......................... 7 $20,000 0.279 5,580
$ (6,020
Net present value................. )
Project B:
$(300,00 $(300,00
Working capital investment. . Now 0) 1.000 0)
Annual cash inflows.............. 1-7 $60,000 3.605 216,300
Working capital released....... 7 $300,000 0.279 83,700
Net present value................. $ 0
2. Using this cost savings figure, and other data provided in the
text, the net present value analysis is:
Present
Amount 18% Value of
of Cash Facto Cash
Year(s) Flows r Flows
$(900,000 $ (900,000
Cost of the machine........ Now ) 1.000 )
Installation and $(650,000
software....................... Now ) 1.000 (650,000)
Salvage of the old
machine....................... Now $70,000 1.000 70,000
Annual cost savings........ 1-10 $285,000 4.494 1,280,790
Overhaul required........... 6 $(90,000) 0.370 (33,300)
Salvage of the new
machine....................... 10 $210,000 0.191 40,110
$ (192,400
Net present value........... )
No, the etching machine should not be purchased. It has a
negative net present value at an 18% discount rate.
3. The intangible benefits would have to be worth at least
$42,813 per year as shown below:
Required increase in net present value $192,400
= = $42,813
Factor for 10 years 4.494
Thus, the new etching machine should be purchased if
management believes that the intangible benefits are worth at
least $42,813 per year to the company.
Present
Amount Value of
Year(s of Cash 14% Cash
Item ) Flows Factor Flows
$(850,00 $(850,000
Cost of equipment required. Now 0) 1.000 )
$(100,00
Working capital required..... Now 0) 1.000 (100,000)
Net annual cash receipts..... 1-5 $230,000 3.433 789,590
Cost of road repairs............. 3 $(60,000) 0.675 (40,500)
Salvage value of
equipment........................ 5 $200,000 0.519 103,800
Working capital released..... 5 $100,000 0.519 51,900
Net present value................ $(45,210)
No, the project should not be accepted; it has a negative net
present value. This means that the rate of return on the
investment is less than the companys required rate of return of
14%.
Since the project has a positive net present value, the contract should be accepted.
2. Present
Amount Value of
Year(s of Cash 16% Cash
Item ) Flows Factor Flows
$(90,000
Cost of the machine Now ) 1.000 $(90,000)
Overhaul required.. . 5 $(7,500) 0.476 (3,570)
Annual cash inflows 1-8 $24,000 4.344 104,256
Salvage value......... 8 $6,000 0.305 1,830
Net present value. . . $ 12,516
2. Amount of Present
Year(s Cash 12% Value of
Item ) Flows Factor Cash Flows
$(194,000
Cost of equipment....... Now $(194,000) 1.000 )
Working capital
invested.................... Now $(6,000) 1.000 (6,000)
Net annual cash
receipts.................... 1-6 $63,900 4.111 262,693
Salvage of equipment. 6 $19,400 0.507 9,836
Working capital
released.................... 6 $6,000 0.507 3,042
Net present value....... $ 75,571
190,00
1. Labor savings.................................. 0
10,00
Ground mulch savings.................... 0 200,000
Less out-of-pocket costs:
Operator....................................... 70,000
Insurance...................................... 1,000
Fuel.............................................. 9,000
12,00
Maintenance contract................... 0 92,000
Annual savings in cash operating
costs............................................. 108,000
Higher quality.
Reduction in inventories.
$142,950
= 3.177
$45,000
From Exhibit 14B-2 in Appendix 14B, reading along the 7-
period line, a factor of 3.177 is closest to 3.161, the factor for
25%, and is between that factor and the factor for 24%.
Thus, to the nearest whole percent, the internal rate of
return is 25%.
$142,950
= 4.765
$30,000
From Exhibit 14B-2 in Appendix 14B, reading along the 7-
period line, a factor of 4.765 is closest to 4.712, the factor for
11%. Thus, to the nearest whole percent, the internal rate of
return is 11%.
5. Since the cash flows are not even over the five-year period
(there is an extra $61,375 cash inflow from sale of the
equipment at the end of the fifth year), some other method
must be used to compute the internal rate of return. Using trial-
and-error or more sophisticated methods, it turns out that the
actual internal rate of return will be 12%:
Present
Amount 12% Value of
of Cash Facto Cash
Item Year(s) Flows r Flows
Investment in the $(142,95
equipment...................... Now 0) 1.000 $(142,950)
Annual cash inflow............ 1-5 $30,000 3.605 108,150
Sale of the equipment....... 5 $61,375 0.567 34,800
Net present value............. $ 0
1. The net cash inflow from sales of the detectors for each year
would be:
Year
1 2 3 4-12
Sales in units............... 4,000 7,000 10,000 12,000
Sales in dollars $ 180,00 $ 315,00 $450,00 $540,00
(@ $45 each)............ 0 0 0 0
Less variable expenses
The net present value of Alternative 2 is higher than the net present value of Alternative 1.
That certainly gives the edge to Alternative 2. However, the additional net present value is
2. The incremental-cost
approach:
Amoun Present
t of Value
Year(s Cash 16% of Cash
) Flows Factor Flows
2. No, the investment project should not be undertaken. It has a negative net present
value.
1. This is a least-cost problem; it can be worked either by the total-cost approach or by the
incremental-cost approach. Regardless of which approach is used, we must first compute
the annual production costs that would result from each of the machines. The
computations are:
Year
1 2 3 4-10
Units produced...................................... 20,000 30,000 40,000 45,000
Model 2600: Total cost at $0.90 per $27,00 $36,00 $40,50
unit..................................................... $18,000 0 0 0
Model 5200: Total cost at $0.70 per $21,00 $28,00 $31,50
unit..................................................... $14,000 0 0 0
Using these data, the solution by the total-cost approach would be:
Amount of Present
Year(s Cash 18% Value of
Item ) Flows Factor Cash Flows
Alternative 1: Purchase the model 2600
machine:
Cost of new machine.................................. Now $(180,000) 1.000 $(180,000)
Cost of new machine.................................. 6 $(200,000) 0.370 (74,000)
Market value of replacement machine........ 10 $100,000 0.191 19,100
Production costs (above)............................ 1 $(18,000) 0.847 (15,246)
""................................................ 2 $(27,000) 0.718 (19,386)
""................................................ 3 $(36,000) 0.609 (21,924)
""................................................ 4-10 $(40,500) 2.320 * (93,960)
Repairs and maintenance........................... 1-10 $(6,000) 4.494 (26,964)
Present value of cash outflows.................... $(412,380)
The McGraw-Hill Companies, Inc., 2008. All rights reserved.
64 Managerial Accounting, 12th Edition
Case 14-40 (continued)
Amount of Present
Cash 18% Value of
Item Year(s) Flows Factor Cash Flows
Alternative 2: Purchase the model 5200
machine:
$(250,000
Cost of new machine.............................. Now ) 1.000 $(250,000)
Production costs (above)........................ 1 $(14,000) 0.847 (11,858)
""............................................ 2 $(21,000) 0.718 (15,078)
""............................................ 3 $(28,000) 0.609 (17,052)
""............................................ 4-10 $(31,500) 2.320 * (73,080)
Repairs and maintenance....................... 1-10 $(4,600) 4.494 (20,672)
Present value of cash outflows................ $(387,740)
Net present value in favor of Alternative 2 $ 24,640
* Present value factor for 10 periods.............................................. 4.494
Present value factor for 3 periods............................................... 2.174
Present value factor for 7 periods starting 4 periods in the
future........................................................................................ 2.320