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Chapter 26: Q13SE (page 1467)
Refer to Short Exercise S26-4. Assume the expansion has no residual value. What is the project’s NPV (round to nearest dollar)? Is the investment attractive? Why or why not?
The investment is attractive and the net present value is$2,215,432.21.
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Refer to the Hunter Valley Snow Park Lodge expansion project in Short Exercise S26- 4. What is the project’s NPV (round to nearest dollar)? Is the investment attractive? Why or why not?
Hamilton Company is considering two capital investments. Both investments have an initial cost of \(7,000,000 and total net cash inflows of \)16,000,000 over 10 years. Hamilton requires a 20% rate of return on this type of investment. Expected net cash inflows are as follows:
Year | Plan Alpha | Plan Beta |
1 | \(1,600,000 | \)1,600,000 |
2 | \(1,600,000 | 2,200,000 |
3 | \)1,600,000 | 2,800,000 |
4 | \(1,600,000 | 2,200,000 |
5 | \)1,600,000 | 1,600,000 |
6 | \(1,600,000 | 1,500,000 |
7 | \)1,600,000 | 1,300,000 |
8 | \(1,600,000 | 1,100,000 |
9 | \)1,600,000 | 900,000 |
10 | \(1,600,000 | 800,000 |
Total | \)16,000,000 | \(16,000,000 |
Requirements
1. Use Excel to compute the NPV and IRR of the two plans. Which plan, if any, should the company pursue?
2. Explain the relationship between NPV and IRR. Based on this relationship and the company’s required rate of return, are your answers as expected in Requirement 1? Why or why not?
3. After further negotiating, the company can now invest with an initial cost of \)6,500,000. Recalculate the NPV and IRR. Which plan, if any, should the company pursue?
Question: Using payback to make capital investment decisions Consider the following three projects. All three have an initial investment of \(800,000.
| Net Cash Inflows | ||||||
| Project L | Project M | Project N | ||||
Year | Annual | Accumulated | Annual | Accumulated | Annual | Accumulated |
1 | \) 100,000 | \( 100,000 | \) 200,000 | \( 200,000 | \) 400,000 | $ 400,000 |
2 | 100,000 | 200,000 | 250,000 | 450,000 | 400,000 | 800,000 |
3 | 100,000 | 300,000 | 350,000 | 800,000 | ||
4 | 100,000 | 400,000 | 400,000 | 1,200,000 | ||
5 | 100,000 | 500,000 | 500,000 | 1,700,000 | ||
6 | 100,000 | 600,000 | ||||
7 | 100,000 | 700,000 | ||||
8 | 100,000 | 800,000 | ||||
Requirements
Describe the capital budgeting process.
Henderson Manufacturing, Inc. has a manufacturing machine that needs attention. The company is considering two options. Option 1 is to refurbish the current machineat a cost of \(1,200,000. If refurbished, Henderson expects the machine to last anothereight years and then have no residual value. Option 2 is to replace the machine at acost of \)4,600,000. A new machine would last 10 years and have no residual value.Henderson expects the following net cash inflows from the two options:
YearRefurbish CurrentPurchase New
MachineMachine
1 \( 350,000 \) 3,780,000
2 340,000 510,000
3 270,000 440,000
4 200,000 370,000
5 130,000 300,000
6 130,000 300,000
7 130,000 300,000
8 130,000 300,000
9 300,000
10 300,000
Total \( 1,680,000 \) 6,900,000
Henderson uses straight-line depreciation and requires an annual return of 10%.
Requirements
1. Compute the payback, the ARR, the NPV, and the profitability index of these twooptions.
2. Which option should Henderson choose? Why?
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