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Chapter 26: Q11SE (page 1447)

David is entering high school and is determined to save money for college. David feels he can save $6,000 each year for the next four years from his part-time job. If David is able to invest at 7%, how much will he have when he starts college?

Short Answer

Expert verified

David will have $26,640 in hand when he starts college.

Step by step solution

01

Definition of Future Value

Future value is a metric that determines the growth or future value of the investment when invested at a specified interest rate for a specified period. The annuity factor is used to determine future value.

02

Calculation of future value

Calculation of future value:

Futurevalue=Suminvested×Futurevalueordinaryannuityfactorof7%atYear4=$6,000×4.440=$26,640

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Most popular questions from this chapter

Explain the difference between the present value factor tables—Present Value of \(1 and Present Value of Ordinary Annuity of \)1.

S26-2 Using payback to make capital investment decisions

Carter Company is considering three investment opportunities with the following payback periods:

Project A

Project B

Project C

Payback period

2.7 years

6.4 years

3.8 years

Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being equal.

Hudson Manufacturing is considering three capital investment proposals. At this time, Hudson only has funds available to pursue one of the three investments.

Equipment A

Equipment B

Equipment C

Present value of net cash inflows

\(1,647,351

\)1,969,888

\(2,064,830

Initial investment

(1,484,100)

(1,641,573)

(1,764,812)

NPV

\)163,251

\(328,315

\)300,018

Which investment should Hudson pursue at this time? Why?

What is the decision rule for ARR?

Howard Company operates a chain of sandwich shops. The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of \(8,500,000. Expected annual net cash inflows are \)1,600,000 for 10 years, with zero residual value at the end of 10 years. Under Plan B, Howard Company would open three larger shops at a cost of \(8,100,000. This plan is expected to generate net cash inflows of \)1,000,000 per year for 10 years, which is the estimated useful life of the properties. Estimated residual value for Plan B is $990,000. Howard Company uses straight-line depreciation and requires an annual return of 6%.

Requirements

1. Compute the payback, the ARR, the NPV, and the profitability index of these two plans.

2. What are the strengths and weaknesses of these capital budgeting methods?

3. Which expansion plan should Howard Company choose? Why?

4. Estimate Plan A’s IRR. How does the IRR compare with the company’s required rate of return?
See all solutions

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