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Chapter 26: Q20E (page 1469)

Henry Hardware is adding a new product line that will require an investment of \(1,512,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of \)310,000 the first year, \(270,000 the second year, and \)240,000 each year thereafter for eight years. Compute the payback period. Round to one decimal place.

Short Answer

Expert verified

The payback period is 5.9 years.

Step by step solution

01

Meaning of Capital Investment

Capital investment is a sum of cash to assist a company in accomplishing its objectivesor buying long-term resources.

02

Computing payback period

Calculating annual cash flow

Annualcashflowsfromthetwoyears=Firstyear+Secondyear=$310,000+$270,000=$580,000

Calculating payback period

Paybackperiod=InitialInvestmentAnnualcashflows=$1,512,000-$580,000$240,000=$932,000$240,000=3.9years

The payback period is 5.9 years (2 years + 3.9 years)

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Most popular questions from this chapter

What is net present value?

What are post-audits? When are they conducted?

Match the following business activities to the steps in capital budgeting process.

Steps in the capital budgeting process:

a. Develop strategies

b. Plan

c. Direct

d. Control

Business activities:

1. A manager evaluates progress one year into the project.

2. Employees submit suggestions for new investments.

3. The company builds a new factory.

4. Top management attends a retreat to set long-term goals.

5. Proposed investments are analyzed.

6. Proposed investments are ranked.

7. New equipment is purchased.

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?

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?
See all solutions

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