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Chapter 26: Q26RQ (page 1464)
How is IRR calculated with equal net cash inflows?
By subtracting the anticipated future cash flows from the initial beginning value, dividing the result by the actual value, and multiplying the result by 100, one can determine the internal rate of return.
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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?
P26-40 Using payback, ARR, NPV, and IRR to make capital investment decisions
This problem continues the Piedmont Computer Company situation from Chapter 25. Piedmont Computer Company is considering purchasing two different types of servers. Server A will generate net cash inflows of \(25,000 per year and have a zero residual value. Server A’s estimated useful life is three years, and it costs \)45,000. Server B will generate net cash inflows of \(25,000 in year 1, \)15,000 in year 2, and \(5,000 in year 3. Server B has a \)5,000 residual value and an estimated useful life of three years. Server B also costs $45,000. Piedmont Computer Company’s required rate of return is 14%.
Requirements
1. Calculate payback, accounting rate of return, net present value, and internal rate of return for both server investments. Use Microsoft Excel to calculate NPV and IRR.
2. Assuming capital rationing applies, which server should Piedmont Computer Company invest in?
Why is it preferable to receive cash sooner rather than later?
Question: Using the payback and accounting rate of return methods to make capital investment decisions
Consider how Hunter Valley Snow Park Lodge could use capital budgeting to decide whether the \(11,000,000 Snow Park Lodge expansion would be a good investment. Assume Hunter Valley’s managers developed the following estimates concerning the expansion:
Number of additional skiers per day 121 skiers Average number of days per year that weather conditions allow skiing at Hunter Valley 142 days Useful life of expansion (in years) 7 years Average cash spent by each skier per day \) 241 Average variable cost of serving each skier per day 83 Cost of expansion 11,000,000 Discount rate 10% |
Assume that Hunter Valley uses the straight-line depreciation method and expects the lodge expansion to have a residual value of $600,000 at the end of its seven-year life.
Requirements
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.
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