Wey_Mgrl_7e_ExB_C12_1stPass.

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Exercises: Set B 1

EXERCISES: SET B
E12-1B Jerrod Corporation is considering purchasing a new delivery truck. The truck has Compute cash payback and
many advantages over the company’s current truck (not the least of which is that it runs). net present value.
The new truck would cost $48,000. Because of the increased capacity, reduced mainte- (LO 1, 2)
nance costs, and increased fuel economy, the new truck is expected to generate cost sav-
ings of $8,000. At the end of 8 years the company will sell the truck for an estimated
$20,000. Traditionally the company has used a rule of thumb that a proposal should not
be accepted unless it has a payback period that is less than 70% of the asset’s estimated
useful life. Marcus Owens, a new manager, has suggested that the company should not rely
solely on the payback approach, but should also employ the net present value method
when evaluating new projects. The company’s cost of capital is 9%.

Instructions
(a) Compute the cash payback period and net present value of the proposed investment.
(b) Does the project meet the company’s cash payback criteria? Does it meet the net pres-
ent value criteria for acceptance? Discuss your results.

E12-2B Kobi Manufacturing Company is considering three new projects, each requir- Compute cash payback period
ing an equipment investment of $25,000. Each project will last for 3 years and produce the and net present value.
following cash inflows. (LO 1, 2)

Year AA BB CC
1 $ 7,000 $ 9,600 $13,000
2 9,000 9,600 9,000
3 12,000 9,600 11,000
Total $28,000 $28,800 $33,000

The equipment’s salvage value is zero. Kobi uses straight-line depreciation. Kobi will not
accept any project with a payback period over 2.5 years. Kobi’s minimum required rate of
return is 12%.

Instructions
(a) Compute each project’s payback period, indicating the most desirable project and the
least desirable project using this method. (Round to two decimals.)
(b) Compute the net present value of each project. Does your evaluation change? (Round
to nearest dollar.)

E12-3B REM Corp. is considering purchasing one of two new diagnostic machines. Compute net present value
Either machine would make it possible for the company to bid on jobs that it currently and profitability index.
isn’t equipped to do. Estimates regarding each machine are provided below. (LO 2, 3)

Machine X Machine Y
Original cost $98,000 $170,000
Estimated life 8 years 8 years
Salvage value –0– –0–
Estimated annual cash inflows $25,000 $40,000
Estimated annual cash outflows $5,000 $12,000

Instructions
Calculate the net present value and profitability index of each machine. Assume a 10%
discount rate. Which machine should be purchased?

E12-4B Warwick Inc. manufactures snowsuits. Warwick is considering purchasing a new Calculate net present value
sewing machine at a cost of $2.4 million. Its existing machine was purchased five years and apply decision rule.
ago at a price of $1.8 million; six months ago, Warwick spent $55,000 to keep it opera- (LO 2)
tional. The existing sewing machine can be sold today for $260,000. The new sewing
machine would require a one-time, $85,000 training cost. Operating costs would decrease
by the following amounts for years 1 to 7:
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2 12 Planning for Capital Investments

Year 1 $390,000
2 400,000
3 411,000
4 426,000
5 434,000
6 435,000
7 436,000

The new sewing machine would be depreciated according to the declining-balance

Instructions
Use the net present value method to determine whether Warwick should purchase the new
machine to replace the existing machine, and state the reason for your conclusion.
(CGA adapted)
Calculate payback period, E12-5B BTMS Inc. wants to purchase a new machine for $30,000, excluding $500 of
internal rate of return, and installation costs. The old machine was bought five years ago and had an expected economic
apply decision rules. life of 10 years without salvage value. This old machine now has a book value of $2,000, and
(LO 1, 4) BTMS Inc. expects to sell it for that amount. The new machine would decrease operating
costs by $8,000 each year of its economic life. The straight-line amortization method would
be used for the new machine, for a five-year period with no salvage value.

Instructions
(a) Determine the cash payback period.
(b) Determine the approximate internal rate of return.
(c) Assuming the company has a required rate of return of 10%, state your conclusion on
whether the new machine should be purchased.
(CGA adapted)
Determine internal rate of E12-6B Hall Corporation is involved in the business of injection molding of plastics. It is
return. considering the purchase of a new computer-aided design and manufacturing machine for
(LO 4) $436,000. The company believes that with this new machine it will improve productivity
and increase quality, resulting in an increase in net annual cash flows of $115,000 for the
next 5 years. Management requires a 12% rate of return on all new investments.

Instructions
Calculate the internal rate of return on this new machine. Should the investment be
accepted?
Determine internal rate of E12-7B Austin Company is considering three capital expenditure projects. Relevant data
return. for the projects are as follows.
(LO 4) Annual Life of
Project Investment Income Project
225X $231,000 $11,400 6 years
226X 270,000 17,000 8 years
227X 288,000 20,000 9 years

Annual income is constant over the life of the project. Each project is expected to have
zero salvage value at the end of the project. Austin Company uses the straight-line
method of depreciation.

Instructions
(a) Determine the internal rate of return for each project. Round the internal rate of
return factor to three decimals.
(b) If Austin Company’s minimum required rate of return is 9%, which projects are
acceptable?

Calculate annual rate E12-8B Attello Company is considering opening a new hair salon in Orlando, Florida. The
of return. cost of building a new salon is $500,000. A new salon will normally generate annual reve-
(LO 5) nues of $87,500, with annual expenses (including depreciation) of $40,000. At the end of
20 years the salon will have a salvage value of $100,000.
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Exercises: Set B 3

Instructions
Calculate the annual rate of return on the project.
E12-9B Thad Service Center just purchased an automobile hoist for $18,600. The hoist Compute cash payback period
has a 5-year life and an estimated salvage value of $1,400. Installation costs were $3,900, and annual rate of return.
and freight charges were $900. Thorstad uses straight-line depreciation. (LO 1, 5)
The new hoist will be used to replace mufflers and tires on automobiles. Thad esti-
mates that the new hoist will enable his mechanics to replace five extra mufflers per week.
Each muffler sells for $75 installed. The cost of a muffler is $35, and the labor cost to
install a muffler is $15.

Instructions
(a) Compute the payback period for the new hoist.
(b) Compute the annual rate of return for the new hoist. (Round to one decimal.)

E12-10B Cochran Company is considering a capital investment of $230,000 in addi- Computer annual rate of
tional productive facilities. The new machinery is expected to have a useful life of 5 return, cash payback period,
and net present value.
years with no salvage value. Depreciation is by the straight-line method. During the life
of the investment, annual net income and cash inflows are expected to be $20,000 and (LO 1, 2, 5)
$60,000, respectively. Cochran has a 12% cost of capital rate, which is the minimum
acceptable rate of return on the investment.

Instructions
(Round to two decimals.)
(a) Compute (1) the cash payback period and (2) the annual rate of return on the pro-
posed capital expenditure.
(b) Using the discounted cash flow technique, compute the net present value.

E12-11B RGB Corporation is reviewing an investment proposal. The initial cost and esti- Calculate payback, annual
mates of the book value of the investment at the end of each year, the net cash flows for rate of return, and net present
each year, and the net income for each year are presented in the schedule below. All cash value.
flows are assumed to take place at the end of the year. The salvage value of the investment (LO 1, 2, 5)
at the end of each year is equal to its book value. There would be no salvage value at the
end of the investment’s life.

Investment Proposal
Initial Cost Annual Annual
Year and Book Value Cash Flows Net Income
0 $105,000
1 70,000 $45,000 $16,000
2 42,000 40,000 18,000
3 21,000 35,000 20,000
4 7,000 30,000 22,000
5 0 25,000 24,000

RGB Corporation uses a 15% target rate of return for new investment proposals.

Instructions
(a) What is the cash payback period for this proposal?
(b) What is the annual rate of return for the investment?
(c) What is the net present value of the investment?
(CMA-Canada adapted)