# Chapter 9

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```					                                 Chapter 9
Capital Budgeting Decisions

E5.             Cash     Present Value
Flow        Factor              Total
\$100         .6209               \$62.09

E6.            Cash      Present Value
Flow         Factor               Total
\$100         3.7908              \$379.08

E7. The numbers decrease from left to right in a given row because cash received
in the future is worth less the higher your required rate of return.

The numbers decrease from top to bottom in a given column because cash
received further in the future is less valuable today.

E8.            Cash      Present Value
Flow         Factor             Total
\$200         3.7908           \$ 758.16
500          .6209              310.45
\$1,068.61
E9. Plan A
Total
\$100,000.00

Plan B
Cash         Present Value
Flow            Factor             Total
\$ 10,000          6.7101          \$ 67,101.00
100,000            .4632            46,320.00
\$113,421.00

Plan C
Cash         Present Value
9-2                                          Chapter 9 Capital Budgeting Decisions

Flow              Factor              Total
\$20,000            6.7101            \$134,202.00

Plan C should be selected as it has the highest present value.

E10.         Cash           Present Value
Flow              Factor              Total
(\$10,000)           1.0000           (\$10,000.00)
4,000            3.0373             12,149.20
\$ 2,149.20

The net present value is positive so the project should be undertaken.
Chapter 9 Capital Budgeting Decisions   9-3

E11. The investment should not be undertaken because it has a negative NPV.

Cash       Present Value
Flow          Factor              Total
\$6,000.00
(3,500.00)
950.00
(1,800.00)
1,650.00        5.2161            \$8,606.56

(20,000.00)       1.0000            (20,000.00)
5,000.00         .2697              1,348.50
(\$ 10,044.94)

E12. Machine A should be purchased because it has the highest positive NPV.

Machine A
Cash        Present Value
Flow           Factor             Total
\$15,000.00         4.3553           \$65,329.50
(50,000.00)       1.0000           (50,000.00)
\$15,329.50

Machine B
Cash        Present Value
Flow           Factor             Total
\$20,000.00         4.3553           \$87,106.00
(75,000.00)       1.0000           (75,000.00)
\$12,106.00
9-4                                       Chapter 9 Capital Budgeting Decisions

E13. The investment should not be undertaken because the internal rate of return
of 12% is less than the required rate of 18%.

Initial outlay                         \$79,100.00
Annuity amount                          14,000.00
Outlay ÷ annuity amount                   5.6500
Internal rate of return                    12%

E14. a.
Initial outlay                          \$79,137.00
Annuity amount                           22,500.00
Outlay ÷ annuity amount                   3.5172
Internal rate of return                    13%

b. Nadine should make the investment because its return of 13% is greater
than the required return of 12%.

E15. Annual depreciation
\$200,000 ÷ 5 years                      \$40,000.00

Annual tax savings
\$40,000  .40                          \$16,000.00

Present value of \$16,000 per year
for 5 years at 10%
\$16,000  3.7908                       \$60,652.80
Chapter 9 Capital Budgeting Decisions   9-5

E16.           Year                             Income (Loss)
1                                 (\$100,000)
2                                   (50,000)
3                                   120,000
4                                   200,000

The \$100,000 loss in year 1 will offset income in year 3 resulting in a tax
savings of \$40,000 (i.e., \$100,000  40% tax rate) in year 3.

With respect to the \$50,000 loss in year 2, \$20,000 of it can be used to offset
income in year 3 (resulting in a tax savings of \$8,000 in year 3) and \$30,000
of it can be used to offset income in year 4 (resulting in a tax savings of
\$12,000 in year 4).

Cash         Present Value
Flow            Factor               Total
\$40,000.00          .6750             \$27,000.00
8,000.00          .6750               5,400.00
12,000.00          .5921               7,105.20
\$39,505.20
9-6                                       Chapter 9 Capital Budgeting Decisions

E17. The annual cash inflow is \$5,700, calculated as follows:
Revenue                                                  \$15,500
Less:
Cost other than depreciation                               8,000
Depreciation                                               3,000
Income before taxes                                        4,500
Less taxes at 40%                                          1,800
Net income                                                 2,700
Plus depreciation                                          3,000
Cash flow                                                 \$5,700

The net present value is positive, so the smoker should be purchased.

Cash        Present Value
Flow           Factor              Total
\$5,700.00        4.5638            \$26,013.66
(21,000.00)       1.0000            (21,000.00)
\$ 5,013.66

E18. The payback period is 8.2 years as follows:

Cost                                   \$41,000.00
Cash inflows                             5,000.00
Cost ÷ cash inflows                      8.2 years

E19. The accounting rate of return is 30%:

Average income                          \$30,000.00
Average investment (\$200,000 ÷ 2)       100,000.00
Accounting rate of return                  30.00%
Chapter 9 Capital Budgeting Decisions   9-7

E20. As indicated, the NPV is close to zero (\$145.00) at a rate of 14%. Thus, the
IRR is approximately 14%. Given that the required rate of return is only
13%, the e-commerce business should be developed.

PV at         Cash               PV
13%           Flow             Factor            Total
\$(1,000,000)          1.0000        \$(1,000,000)
(500,000)          0.8850           (442,500)
200,000           0.7831            156,620
630,000           0.6931            436,653
750,000           0.6133            459,975
800,000           0.5428            434,240
\$ 44,988

PV at         Cash               PV
14%           Flow             Factor            Total
\$(1,000,000)          1.0000        \$(1,000,000)
(500,000)          0.8772           (438,600)
200,000           0.7695            153,900
630,000           0.6750            425,250
750,000           0.5921            444,075
800,000           0.5194            415,520
\$      145

PV at         Cash               PV
15%           Flow             Factor            Total
\$(1,000,000)          1.0000        \$(1,000,000)
(500,000)          0.8696           (434,800)
200,000           0.7561            151,220
630,000           0.6575            414,225
750,000           0.5718            428,850
800,000           0.4972            397,760
\$ (42,745)
9-8                                        Chapter 9 Capital Budgeting Decisions

E21. As indicated below, the NPV is zero with a required rate of return of 9
percent. Thus, the IRR is 9 percent.

PV at         Cash               PV
9%            Flow             Factor             Total
\$(2,200,100)          1.0000         \$(2,200,100)
200,000           0.9174             183,480
400,000           0.8417             336,680
600,000           0.7722             463,320
800,000           0.7084             566,720
1,000,000           0.6499             649,900
\$        0

E22. The online business may help the company manage a potentially stodgy
image associated with its mall locations. Also, the online business may
actually generate a number of large sales for the brick and mortar locations.
Some customers will shop the Web site to make price and quality
comparisons, but they will be unwilling to make, for example, a \$5,000
purchase of a diamond ring over the Internet. Thus, after seeing
merchandise on the Web site, they may visit one of Sherman’s mall stores to
make a purchase. These potential benefits would be difficult to quantify.

E23. The annual value of the “soft” benefit must be at least \$88,492.44 for the
project to have a zero net present value. Given there is general agreement
that the annual “soft” benefit will be at least \$90,000, Pritchard should invest
in the flexible manufacturing system.

A. Present value needed to yield a zero NPV              \$500,000.00
B. Present value of an annuity factor at 12%                   5.6502
A ÷ B Required annual value of “soft benefit”             \$88,492.44

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