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Chapter 26: Q15RQ (page 1464)
Why is it preferable to receive cash sooner rather than later?
Answer
The basic rule is that cash received now can be invested to generate revenue sooner than cash received later.
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Use the NPV method to determine whether Hawkins Products should invest in the
following projects:
• Project A: Costs \(285,000 and offers seven annual net cash inflows of \)55,000. Hawkins Products requires an annual return of 14% on investments of this nature.
• Project B: Costs \(395,000 and offers 10 annual net cash inflows of \)77,000. Hawkins Products demands an annual return of 12% on investments of this nature.
Requirements
1. What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
2. What is the maximum acceptable price to pay for each project?
3. What is the profitability index of each project? Round to two decimal places.
What is the internal rate of return?
List some common cash outflows from capital investments.
Hicks Company is considering an investment opportunity with the following expected net cash inflows: Year 1, \(235,000; Year 2, \)195,000; Year 3, \(125,000. The company uses a discount rate of 6%, and the initial investment is \)365,000. Calculate the NPV of the investment. Should the company invest in the project? Why or why not?
Using payback, ARR, and NPV with unequal cash flows
Hughes Manufacturing, Inc. has a manufacturing machine that needs attention. The company is considering two options. Option 1 is to refurbish the current machine at a cost of \(2,600,000. If refurbished, Hughes expects the machine to last another eight years and then have no residual value. Option 2 is to replace the machine at a cost of \)3,800,000. A new machine would last 10 years and have no residual value. Hughes expects the following net cash inflows from the two options:
Year | Refurbish current machine | Purchase new machine |
1 | \(1,760,000 | \)2,970,000 |
2 | 440,000 | 490,000 |
3 | 360,000 | 410,000 |
4 | 280,000 | 330,000 |
5 | 200,000 | 250,000 |
6 | 200,000 | 250,000 |
7 | 200,000 | 250,000 |
8 | 200,000 | 250,000 |
9 | 250,000 | |
10 | 250,000 | |
Total | \(3,640,000 | \)5,700,000 |
Hughes 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 two options.
2. Which option should Hughes choose? Why?
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