Deck 26: Capitalinvestment Analysis

Question 1

Ethics and professional conduct in business
Danielle Hastings was recently hired as a cost analyst by CareNet Medical Supplies Inc. One of Danielle's first assignments was to perform a net present value analysis for a new warehouse. Danielle performed the analysis and calculated a present value index of 0.75. The plant manager, Jerrod Moore, is very intent on purchasing the warehouse because he believes that more storage space is needed. Jerrod asks Danielle into his office and the following conversation takes place:
Jerrod: Danielle, you're new here, aren't you
Danielle: Yes, I am.
Jerrod: Well, Danielle, I'm not at all pleased with the capital investment analysis that you performed on this new warehouse. I need that warehouse for my production. If I don't get it, where am I going to place our output
Danielle: Well, we need to get product into our customers' hands.
Jerrod: I agree, and we need a warehouse to do that.
Danielle: My analysis does not support constructing a new warehouse. The numbers don't lie; the warehouse does not meet our investment return targets. In fact, it seems to me that purchasing a warehouse does not add much value to the business. We need to be producing product to satisfy customer orders, not to fill a warehouse.
Jerrod: The headquarters people will not allow me to build the warehouse if the numbers don't add up. You know as well as I that many assumptions go into your net present value analysis. Why don't you relax some of your assumptions so that the financial savings will offset the cost
Danielle: I'm willing to discuss my assumptions with you. Maybe I overlooked something.
Jerrod: Good. Here's what I want you to do. I see in your analysis that you don't project greater sales as a result of the warehouse. It seems to me that if we can store more goods, then we will have more to sell. Thus, logically, a larger warehouse translates into more sales. If you incorporate this into your analysis, I think you'll see that the numbers will work out. Why don't you work it through and come back with a new analysis. I'm really counting on you on this one. Let's get off to a good start together and see if we can get this project accepted.
What is your advice to Danielle

Answer 1

The capital budgeting decision process is a complete multifaceted and analytical process.
Capital budgeting analysis estimates, such as the cash flows, discount rate, time period and total investment amount. This results of analysis should be used to either support or reject a project, capital budgeting should not be used to justify an assumed net present value. The analyst should not work backward, filling assumed numbers that will produce the desired net present value. Such a reverse approach reduces the credibility of the entire process.
In the given case, Danielle who is new analyst analysis the purchasing of warehouse according to standards and reject the construction because purchase of warehouse does not add much value to business and does not increase sales as a result of warehouse. But Jerrod who is plant manager argued the Danielle that warehouse is needed to store the production and if we can store more goods, then we will have more sales.
On the basis of above information, the contention of Jerrod is not correct because purchasing of warehouses does not guaranty to increase sales. Hence Danielle is advised t not to consider the Jerrod plea.

Question 2

What are the principal objections to the use of the average rate of return method in evaluating capital investment proposals

Answer 2

The average rate of return has the following disadvantages:
The principal objections to the use of the average rate of return method are its failure to consider the expected cash flows from the proposals and the timing of these flows.

Question 3

Average rate of return
The following data are accumulated by Bio Metrics Inc. in evaluating two competing capital investment proposals:

Determine the expected average rate of return for each proposal.

Answer 3

Average rate of return (ARR): The ARR is based on accounting concept of return on investment or rate of return. The ARR may be defined as the annualized net income earned on the average funds invested in a project. In other words, the annual returns of a project are expressed as a percentage of the net investment in the project.
Testing equipment
=$3,120
=$52,000
--
=6%
The ARR of 6% should be compared to the minimum rate of return required by Bio Metrics Inc.'s management. If the ARR equals or exceeds the minimum rate, the project should be accepted.
Vehicle
=$1,920
=$16,000
=12%
The ARR of 12% should be compared to the minimum rate of return required by Bio Metrics Inc.'s management. If the ARR equals or exceeds the minimum rate, the project should be accepted.

Question 4

Average rate of return
Determine the average rate of return for a project that is estimated to yield total income of $148,500 over five years, has a cost of $300,000, and has a $30,000 residual value.
Determine the average rate of return for a project that is estimated to yield total income of $36,000 over three years, has a cost of $70,000, and has a $10,000 residual value.

Question 5

Average rate of return method, net present value method, and analysis
The capital investment committee of Touch of Eden Landscaping Company is considering two capital investments. The estimated income from operations and net cash flows from each investment are as follows:

Each project requires an investment of $80,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 12% for purposes of the net present value analysis.
Instructions
1. Compute the following:
a. The average rate of return for each investment. Round to one decimal place.
b. The net present value for each investment. Use the present value of $1 table appearing in this chapter (Exhibit 1).
2. Prepare a brief report for the capital investment committee, advising it on the relative merits of the two investments.

Question 6

Average rate of return method, net present value method, and analysis
The capital investment committee of Ellis Transport and Storage Inc. is considering two investment projects. The estimated income from operations and net cash flows from each investment are as follows:

Each project requires an investment of $368,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% for purposes of the net present value analysis.
Instructions
1. Compute the following:
a. The average rate of return for each investment. Round to one decimal place.
b. The net present value for each investment. Use the present value of $1 table appearing in this chapter (Exhibit 1).
2. Prepare a brief report for the capital investment committee, advising it on the relative merits of the two projects.

Question 7

Personal investment analysis
A Masters of Accountancy degree at Central University costs $12,000 for an additional fifth year of education beyond the bachelor's degree. Assume that all tuition is paid at the beginning of the year. A student considering this investment must evaluate the present value of cash flows from possessing a graduate degree versus holding only the undergraduate degree. Assume that the average student with an undergraduate degree is expected to earn an annual salary of $50,000 per year (assumed to be paid at the end of the year) for 10 years. Assume that the average student with a graduate Masters of Accountancy degree is expected to earn an annual salary of $66,000 per year (assumed to be paid at the end of the year) for nine years after graduation. Assume a minimum rate of return of 10%.
1. Determine the net present value of cash flows from an undergraduate degree. Use the present value table provided in this chapter in Exhibit 2.
2. Determine the net present value of cash flows from a Masters of Accountancy degree, assuming no salary is earned during the graduate year of schooling.
3. What is the net advantage or disadvantage of pursuing a graduate degree under these assumptions

Question 8

Discuss the principal limitations of the cash payback method for evaluating capital investment proposals.

Question 9

Average rate of return-cost savings
Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $132,000 with a $16,000 residual value and a 10-year life. The equipment will replace one employee who has an average wage of $34,000 per year. In addition, the equipment will have operating and energy costs of $5,380 per year.
Determine the average rate of return on the equipment, giving effect to straight-line depreciation on the investment.

Question 10

Cash payback period
A project has estimated annual net cash flows of $135,800. It is estimated to cost $787,640. Determine the cash payback period. Round to one decimal place.
A project has estimated annual net cash flows of $9,300. It is estimated to cost $41,850. Determine the cash payback period. Round to one decimal place.

Question 11

Cash payback period, net present value method, and analysis
Celebration Apparel Inc. is considering two investment projects. The estimated net cash flows from each project are as follows:

Each project requires an investment of $750,000. A rate of 15% has been selected for the net present value analysis.
Instructions
1. Compute the following for each product:
a. Cash payback period.
b. The net present value. Use the present value of $1 table appearing in this chapter (Exhibit 1).
2. Prepare a brief report advising management on the relative merits of each project.

Question 12

Cash payback period, net present value method, and analysis obj. 2 , 3
Social Circle Publications Inc. is considering two new magazine products. The estimated net cash flows from each product are as follows:

Each product requires an investment of $125,000. A rate of 10% has been selected for the net present value analysis.
Instructions
1. Compute the following for each product:
a. Cash payback period.
b. The net present value. Use the present value of $1 table appearing in this chapter (Exhibit 1).
2. Prepare a brief report advising management on the relative merits of each of the two products.

Question 13

Changing prices
Global Electronics Inc. invested $1,000,000 to build a plant in a foreign country. The labor and materials used in production are purchased locally. The plant expansion was estimated to produce an internal rate of return of 20% in U.S. dollar terms. Due to a currency crisis, the currency exchange rate between the local currency and the U.S. dollar doubled from two local units per U.S. dollar to four local units per U.S. dollar.
a. Assume that the plant produced and sold product in the local economy. Explain what impact this change in the currency exchange rate would have on the project's internal rate of return.
b. Assume that the plant produced product in the local economy but exported the product back to the United States for sale. Explain what impact the change in the currency exchange rate would have on the project's internal rate of return under this assumption.

Question 14

Why would the average rate of return differ from the internal rate of return on the same project

Question 15

Average rate of return-new product
Ray Zor Inc. is considering an investment in new equipment that will be used to manufacture a smartphone. The phone is expected to generate additional annual sales of 4,000 units at $410 per unit. The equipment has a cost of $525,000, residual value of $75,000, and an eight-year life. The equipment can only be used to manufacture the phone. The cost to manufacture the phone is shown below.

Determine the average rate of return on the equipment.

Question 16

Net present value
A project has estimated annual net cash flows of $12,200 for five years and is estimated to cost $39,800. Assume a minimum acceptable rate of return of 12%. Using Exhibit 2, determine (1) the net present value of the project and (2) the present value index, rounded to two decimal places.
A project has estimated annual net cash flows of $96,200 for four years and is estimated to cost $315,500. Assume a minimum acceptable rate of return of 10%. Using Exhibit 2, determine (1) the net present value of the project and (2) the present value index, rounded to two decimal places.

Question 17

Net present value method, present value index, and analysis
Northern Highlands Railroad Company is evaluating three capital investment proposals by using the net present value method. Relevant data related to the proposals are summarized as follows:

Instructions
1. Assuming that the desired rate of return is 20%, prepare a net present value analysis for each proposal. Use the present value of $1 table appearing in this chapter (Exhibit 1).
2. Determine a present value index for each proposal. Round to two decimal places.
3. Which proposal offers the largest amount of present value per dollar of investment Explain.

Question 18

Net present value method, present value index, and analysis
First United Bank Inc. is evaluating three capital investment projects by using the net present value method. Relevant data related to the projects are summarized as follows:

Instructions
1. Assuming that the desired rate of return is 15%, prepare a net present value analysis for each project. Use the present value of $1 table appearing in this chapter (Exhibit 1).
2. Determine a present value index for each project. Round to two decimal places.
3. Which project offers the largest amount of present value per dollar of investment Explain.

Question 19

Qualitative issues in investment analysis
The following are some selected quotes from senior executives:
CEO , Worthington Industries (a high-technology steel company): "We try to find the best technology, stay ahead of the competition, and serve the customer. … We'll make any investment that will pay back quickly … but if it is something that we really see as a must down the road, payback is not going to be that important."
Chairman of Amgen Inc. (a biotech company): "You cannot really run the numbers, do net present value calculations, because the uncertainties are really gigantic. … You decide on a project you want to run, and then you run the numbers [as a reality check on your assumptions]. Success in a business like this is much more dependent on tracking rather than on predicting, much more dependent on seeing results over time, tracking and adjusting and readjusting, much more dynamic, much more flexible."
Chief Financial Officer of Merck Co., Inc. (a pharmaceutical company): "… at the individual product level-the development of a successful new product requires on the order of $230 million in R D, spread over more than a decade-discounted cash flow style analysis does not become a factor until development is near the point of manufacturing scale-up effort. Prior to that point, given the uncertainties associated with new product development, it would be lunacy in our business to decide that we know exactly what's going to happen to a product once it gets out."
Explain the role of capital investment analysis for these companies.

Question 20

Your boss has suggested that a one-year payback period is the same as a 100% average rate of return. Do you agree

Question 21

Calculate cash flows
Cornucopia Inc. is planning to invest in new manufacturing equipment to make a new garden tool. The new garden tool is expected to generate additional annual sales of 4,000 units at $68 each. The new manufacturing equipment will cost $107,000 and is expected to have a 10-year life and $13,000 residual value. Selling expenses related to the new product are expected to be 5% of sales revenue. The cost to manufacture the product includes the following on a per-unit basis:

Determine the net cash flows for the first year of the project, Years 2-9, and for the last year of the project.

Question 22

Internal rate of return
A project is estimated to cost $74,035 and provide annual net cash flows of $17,000 for six years. Determine the internal rate of return for this project, using Exhibit 2.
A project is estimated to cost $362,672 and provide annual net cash flows of $76,000 for nine years. Determine the internal rate of return for this project, using Exhibit 2.

Question 23

Net present value method, internal rate of return method, and analysis
The management of Southern Power and Light Inc. is considering two capital investment projects. The estimated net cash flows from each project are as follows:

The wind turbines require an investment of $971,840, while the bio fuel equipment requires an investment of $1,109,500. No residual value is expected from either project.
Instructions
1. Compute the following for each project:
a. The net present value. Use a rate of 6% and the present value of an annuity of $1 table appearing in this chapter (Exhibit 2).
b. A present value index. Round to two decimal places.
2. Determine the internal rate of return for each project by (a) computing a present value factor for an annuity of $1 and (b) using the present value of an annuity of $1 table appearing in this chapter (Exhibit 2).
3. What advantage does the internal rate of return method have over the net present value method in comparing projects

Question 24

Net present value method, internal rate of return method, and analysis
The management of Style Networks Inc. is considering two TV show projects. The estimated net cash flows from each project are as follows:

After Hours requires an investment of $913,600, while Sun Fun requires an investment of $880,730. No residual value is expected from either project.
Instructions
1. Compute the following for each project:
a. The net present value. Use a rate of 10% and the present value of an annuity of $1 table appearing in this chapter (Exhibit 2).
b. A present value index. Round to two decimal places.
2. Determine the internal rate of return for each project by (a) computing a present value factor for an annuity of $1 and (b) using the present value of an annuity of $1 table appearing in this chapter (Exhibit 2).
3. What advantage does the internal rate of return method have over the net present value method in comparing projects

Question 25

Net present value method
Metro-Goldwyn-Mayer Studios Inc. (MGM) is a major producer and distributor of theatrical and television filmed entertainment. Regarding theatrical films, MGM states, "Our feature films are exploited through a series of sequential domestic and international distribution channels, typically beginning with theatrical exhibition. Thereafter, feature films are first made available for home video (online downloads) generally six months after theatrical release; for pay television, one year after theatrical release; and for syndication, approximately three to five years after theatrical release."
Assume that MGM produces a film during early 2014 at a cost of $340 million, and releases it halfway through the year. During the last half of 2014, the film earns revenues of $420 million at the box office. The film requires $90 million of advertising during the release. One year later, by the end of 2015, the film is expected to earn MGM net cash flows from online downloads of $60 million. By the end of 2016, the film is expected to earn MGM $20 million from pay TV; and by the end of 2017, the film is expected to earn $10 million from syndication.
a. Determine the net present value of the film as of the beginning of 2014 if the desired rate of return is 20%. To simplify present value calculations, assume all annual net cash flows occur at the end of each year. Use the table of the present value of $1 appearing in Exhibit 1 of this chapter. Round to the nearest whole million dollars.
b. Under the assumptions provided here, is the film expected to be financially successful

Question 26

Why would the cash payback method understate the attractiveness of a project with a large residual value

Question 27

Cash payback period
Nations Trust is evaluating two capital investment proposals for a drive-up ATM kiosk, each requiring an investment of $380,000 and each with an eight-year life and expected total net cash flows of $608,000. Location 1 is expected to provide equal annual net cash flows of $76,000, and Location 2 is expected to have the following unequal annual net cash flows:

Determine the cash payback period for both location proposals.

Question 28

Net present value-unequal lives
Project A requires an original investment of $22,500. The project will yield cash flows of $5,000 per year for nine years. Project B has a calculated net present value of $3,500 over a six-year life. Project A could be sold at the end of six years for a price of $12,000. (a) Determine the net present value of Project A over a six-year life, with residual value, assuming a minimum rate of return of 12%. (b) Which project provides the greatest net present value
Project 1 requires an original investment of $55,000. The project will yield cash flows of $15,000 per year for seven years. Project 2 has a calculated net present value of $5,000 over a four-year life. Project 1 could be sold at the end of four years for a price of $38,000. (a) Determine the net present value of Project 1 over a four-year life, with residual value, assuming a minimum rate of return of 20%. (b) Which project provides the greatest net present value

Question 29

Alternative capital investments
The investment committee of Sentry Insurance Co. is evaluating two projects, office expansion and upgrade to computer servers. The projects have different useful lives, but each requires an investment of $490,000. The estimated net cash flows from each project are as follows:

The committee has selected a rate of 12% for purposes of net present value analysis. It also estimates that the residual value at the end of each project's useful life is $0; but at the end of the fourth year, the office expansion's residual value would be $180,000.
Instructions
1. For each project, compute the net present value. Use the present value of an annuity of $1 table appearing in this chapter (Exhibit 2). (Ignore the unequal lives of the projects.)
2. For each project, compute the net present value, assuming that the office expansion is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table appearing in this chapter (Exhibit 1).
3. Prepare a report to the investment committee, providing your advice on the relative merits of the two projects.

Question 30

Alternative capital investments
The investment committee of Auntie M's Restaurants Inc. is evaluating two restaurant sites. The sites have different useful lives, but each requires an investment of $900,000. The estimated net cash flows from each site are as follows:

The committee has selected a rate of 20% for purposes of net present value analysis. It also estimates that the residual value at the end of each restaurant's useful life is $0; but at the end of the fourth year, Witchita's residual value would be $500,000.
Instructions
1. For each site, compute the net present value. Use the present value of an annuity of $1 table appearing in this chapter (Exhibit 2). (Ignore the unequal lives of the projects.)
2. For each site, compute the net present value, assuming that Witchita is adjusted to a four-year life for purposes of analysis. Use the present value of $1 table appearing in this chapter (Exhibit 1).
3. Prepare a report to the investment committee, providing your advice on the relative merits of the two sites.

Question 31

Capital investment analysis
Group Project
In one group, find a local business, such as a copy shop, that rents time on desktop computers for an hourly rate. Determine the hourly rate. In the other group, determine the price of a mid-range desktop computer at http://www.dell.com. Combine this information from the two groups and perform a capital budgeting analysis. Assume that one student will use the computer for 40 hours per semester for the next three years. Also assume that the minimum rate of return is 10%. Use the interest tables in Appendix A in performing your analysis. [ Hint: Use the appropriate present value of an annuity of $1 factor for 5% compounded for six semiannual periods (periods=6).]
Does your analysis support the student purchasing the computer

Question 32

Why would the use of the cash payback period for analyzing the financial performance of theatrical releases from a motion picture production studio be supported over the net present value method

Question 33

Cash payback method
Lily Products Company is considering an investment in one of two new product lines. The investment required for either product line is $540,000. The net cash flows associated with each product are as follows:

a. Recommend a product offering to Lily Products Company, based on the cash payback period for each product line.
b. Why is one product line preferred over the other, even though they both have the same total net cash flows through eight periods

Question 34

Capital rationing decision involving four proposals
Renaissance Capital Group is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated income from operations, and net cash flow for each proposal are as follows:


The company's capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average rate of return of 12% is required on all projects. If the preceding standards are met, the net present value method and present value indexes are used to rank the remaining proposals.
Instructions
1. Compute the cash payback period for each of the four proposals.
2. Giving effect to straight-line depreciation on the investments and assuming no estimated residual value, compute the average rate of return for each of the four proposals. Round to one decimal place.
3. Using the following format, summarize the results of your computations in parts (1) and (2). By placing the calculated amounts in the first two columns on the left and by placing a check mark in the appropriate column to the right, indicate which proposals should be accepted for further analysis and which should be rejected.

4. For the proposals accepted for further analysis in part (3), compute the net present value. Use a rate of 15% and the present value of $1 table appearing in this chapter (Exhibit 1).
5. Compute the present value index for each of the proposals in part (4). Round to two decimal places.
6. Rank the proposals from most attractive to least attractive, based on the present values of net cash flows computed in part (4).
7. Rank the proposals from most attractive to least attractive, based on the present value indexes computed in part (5).
8. Based on the analyses, comment on the relative attractiveness of the proposals ranked in parts (6) and (7).

Question 35

Capital rationing decision involving four proposals
Clearcast Communications Inc. is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated income from operations, and net cash flow for each proposal are as follows:

The company's capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average rate of return of 12% is required on all projects. If the preceding standards are met, the net present value method and present value indexes are used to rank the remaining proposals.
Instructions
1. Compute the cash payback period for each of the four proposals.
2. Giving effect to straight-line depreciation on the investments and assuming no estimated residual value, compute the average rate of return for each of the four proposals. Round to one decimal place.
3.Using the following format, summarize the results of your computations in parts (1) and (2). By placing the calculated amounts in the first two columns on the left and by placing a check mark in the appropriate column to the right, indicate which proposals should be accepted for further analysis and which should be rejected.

4. For the proposals accepted for further analysis in part (3), compute the net present value. Use a rate of 12% and the present value of $1 table appearing in this chapter (Exhibit 1).
5. Compute the present value index for each of the proposals in part (4). Round to two decimal places.
6. Rank the proposals from most attractive to least attractive, based on the present values of net cash flows computed in part (4).
7. Rank the proposals from most attractive to least attractive, based on the present value indexes computed in part (5). Round to two decimal places.
8. Based on the analyses, comment on the relative attractiveness of the proposals ranked in parts (6) and (7).

Question 36

A net present value analysis used to evaluate a proposed equipment acquisition indicated a $7,900 net present value. What is the meaning of the $7,900 as it relates to the desirability of the proposal

Question 37

Net present value method
The following data are accumulated by Bannister Company in evaluating the purchase of $48,500 of equipment, having a four-year useful life:

a. Assuming that the desired rate of return is 15%, determine the net present value for the proposal. Use the table of the present value of $1 appearing in Exhibit 1 of this chapter.
b. Would management be likely to look with favor on the proposal Explain.

Question 38

Two projects have an identical net present value of $9,000. Are both projects equal in desirability

Question 39

Net present value method
AM Express Inc. is considering the purchase of an additional delivery vehicle for $55,000 on January 1, 2014. The truck is expected to have a five-year life with an expected residual value of $15,000 at the end of five years. The expected additional revenues from the added delivery capacity are anticipated to be $58,000 per year for each of the next five years. A driver will cost $42,000 in 2014, with an expected annual salary increase of $1,000 for each year thereafter. The annual operating costs for the truck are estimated to be $3,000 per year.
a. Determine the expected annual net cash flows from the delivery truck investment for 2014-2018.
b. Calculate the net present value of the investment, assuming that the minimum desired rate of return is 12%. Use the present value of $1 table appearing in Exhibit 1 of this chapter.
c. Is the additional truck a good investment based on your analysis

Question 40

What are the major disadvantages of the use of the net present value method of analyzing capital investment proposals

Question 41

Net present value method-annuity
Keystone Hotels is considering the construction of a new hotel for $120 million. The expected life of the hotel is 30 years, with no residual value. The hotel is expected to earn revenues of $47 million per year. Total expenses, including depreciation, are expected to be $32 million per year. Keystone management has set a minimum acceptable rate of return of 14%.
a. Determine the equal annual net cash flows from operating the hotel.
b. Calculate the net present value of the new hotel, using the present value of an annuity of $1 table found in Appendix A. Round to the nearest million dollars.
c. Does your analysis support construction of the new hotel

Question 42

What are the major disadvantages of the use of the internal rate of return method of analyzing capital investment proposals

Question 43

Net present value method-annuity
Briggs Excavation Company is planning an investment of $132,000 for a bulldozer. The bulldozer is expected to operate for 1,500 hours per year for five years. Customers will be charged $110 per hour for bulldozer work. The bulldozer operator costs $28 per hour in wages and benefits. The bulldozer is expected to require annual maintenance costing $8,000. The bulldozer uses fuel that is expected to cost $46 per hour of bulldozer operation.
a. Determine the equal annual net cash flows from operating the bulldozer.
b. Determine the net present value of the investment, assuming that the desired rate of return is 10%. Use the present value of an annuity of $1 table in the chapter (Exhibit 2). Round to the nearest dollar.
c. Should Briggs invest in the bulldozer, based on this analysis
d. Determine the number of operating hours such that the present value of cash flows equals the amount to be invested.

Question 44

What are the major advantages of leasing a fixed asset rather than purchasing it

Question 45

Net present value method
Carnival Corporation has recently placed into service some of the largest cruise ships in the world. One of these ships, the Carnival Breeze , can hold up to 3,600 passengers, and it can cost $750 million to build. Assume the following additional information:
• There will be 330 cruise days per year operated at a full capacity of 3,600 passengers.
• The variable expenses per passenger are estimated to be $140 per cruise day.
• The revenue per passenger is expected to be $340 per cruise day.
• The fixed expenses for running the ship, other than depreciation, are estimated to be $80,000,000 per year.
• The ship has a service life of 10 years, with a residual value of $140,000,000 at the end of 10 years.
a. Determine the annual net cash flow from operating the cruise ship.
b. Determine the net present value of this investment, assuming a 12% minimum rate of return. Use the present value tables provided in the chapter in determining your answer.

Question 46

Give an example of a qualitative factor that should be considered in a capital investment analysis related to acquiring automated factory equipment.

Question 47

Present value index
Double K Doughnuts has computed the net present value for capital expenditure at two locations. Relevant data related to the computation are as follows:

a. Determine the present value index for each proposal.
b. Which location does your analysis support

Question 48

Net present value method and present value index
Diamond Turf Inc. is considering an investment in one of two machines. The sewing machine will increase productivity from sewing 150 baseballs per hour to sewing 290 per hour. The contribution margin per unit is $0.32 per baseball. Assume that any increased production of baseballs can be sold. The second machine is an automatic packing machine for the golf ball line. The packing machine will reduce packing labor cost. The labor cost saved is equivalent to $21 per hour. The sewing machine will cost $260,000, have an eight-year life, and will operate for 1,800 hours per year. The packing machine will cost $85,000, have an eight-year life, and will operate for 1,400 hours per year. Diamond Turf seeks a minimum rate of return of 15% on its investments.
a. Determine the net present value for the two machines. Use the present value of an annuity of $1 table in the chapter (Exhibit 2). Round to the nearest dollar.
b. Determine the present value index for the two machines. Round to two decimal places.
c. If Diamond Turf has sufficient funds for only one of the machines and qualitative factors are equal between the two machines, in which machine should it invest

Question 49

Average rate of return, cash payback period, net present value method
Great Plains Railroad Inc. is considering acquiring equipment at a cost of $450,000. The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of $75,000. The company's minimum desired rate of return for net present value analysis is 10%.
Compute the following:
a. The average rate of return, giving effect to straight-line depreciation on the investment. Round whole percent to one decimal place.
b. The cash payback period.
c. The net present value. Use the present value of an annuity of $1 table appearing in this chapter (Exhibit 2). Round to the nearest dollar.

Question 50

Cash payback period, net present value analysis, and qualitative considerations
The plant manager of Taiwan Electronics Company is considering the purchase of new automated assembly equipment. The new equipment will cost $1,400,000. The manager believes that the new investment will result in direct labor savings of $350,000 per year for 10 years.
a. What is the payback period on this project
b. What is the net present value, assuming a 10% rate of return Use the present value of an annuity of $1 table in Exhibit 2.
c. What else should the manager consider in the analysis

Question 51

Internal rate of return method
The internal rate of return method is used by Merit Construction Co. in analyzing a capital expenditure proposal that involves an investment of $82,220 and annual net cash flows of $20,000 for each of the six years of its useful life.
a. Determine a present value factor for an annuity of $1, which can be used in determining the internal rate of return.
b. Using the factor determined in part (a) and the present value of an annuity of $1 table appearing in this chapter (Exhibit 2), determine the internal rate of return for the proposal.

Question 52

Internal rate of return method
The Canyons Resort , a Utah ski resort, recently announced a $415 million expansion of lodging properties, lifts, and terrain. Assume that this investment is estimated to produce $99 million in equal annual cash flows for each of the first 10 years of the project life.
a. Determine the expected internal rate of return of this project for 10 years, using the present value of an annuity of $1 table found in Exhibit 2.
b. What are some uncertainties that could reduce the internal rate of return of this project

Question 53

Internal rate of return method-two projects
Munch N' Crunch Snack Company is considering two possible investments: a delivery truck or a bagging machine. The delivery truck would cost $43,056 and could be used to deliver an additional 95,000 bags of pretzels per year. Each bag of pretzels can be sold for a contribution margin of $0.45. The delivery truck operating expenses, excluding depreciation, are $1.35 per mile for 24,000 miles per year. The bagging machine would replace an old bagging machine, and its net investment cost would be $61,614. The new machine would require three fewer hours of direct labor per day. Direct labor is $18 per hour. There are 250 operating days in the year. Both the truck and the bagging machine are estimated to have seven-year lives. The minimum rate of return is 13%. However, Munch N' Crunch has funds to invest in only one of the projects.
a. Compute the internal rate of return for each investment. Use the present value of an annuity of $1 table appearing in this chapter (Exhibit 2).
b. Provide a memo to management, with a recommendation.

Question 54

Net present value method and internal rate of return method
Buckeye Healthcare Corp. is proposing to spend $186,725 on an eight-year project that has estimated net cash flows of $35,000 for each of the eight years.
a. Compute the net present value, using a rate of return of 12%. Use the present value of an annuity of $1 table in the chapter (Exhibit 2).
b. Based on the analysis prepared in part (a), is the rate of return (1) more than 12%, (2) 12%, or (3) less than 12% Explain.
c. Determine the internal rate of return by computing a present value factor for an annuity of $1 and using the present value of an annuity of $1 table presented in the text (Exhibit 2).

Question 55

Identify error in capital investment analysis calculations
Artscape Inc. is considering the purchase of automated machinery that is expected to have a useful life of five years and no residual value. The average rate of return on the average investment has been computed to be 20%, and the cash payback period was computed to be 5.5 years.
Do you see any reason to question the validity of the data presented Explain.

Question 56

Net present value-unequal lives
Bunker Hill Mining Company has two competing proposals: a processing mill and an electric shovel. Both pieces of equipment have an initial investment of $750,000. The net cash flows estimated for the two proposals are as follows:

The estimated residual value of the processing mill at the end of Year 4 is $280,000.
Determine which equipment should be favored, comparing the net present values of the two proposals and assuming a minimum rate of return of 15%. Use the present value tables presented in this chapter (Exhibits 1 and 2).

Question 57

Net present value-unequal lives
Daisy's Creamery Inc. is considering one of two investment options. Option 1 is a $75,000 investment in new blending equipment that is expected to produce equal annual cash flows of $19,000 for each of seven years. Option 2 is a $90,000 investment in a new computer system that is expected to produce equal annual cash flows of $27,000 for each of five years. The residual value of the blending equipment at the end of the fifth year is estimated to be $15,000. The computer system has no expected residual value at the end of the fifth year.
Assume there is sufficient capital to fund only one of the projects. Determine which project should be selected, comparing the (a) net present values and (b) present value indices of the two projects. Assume a minimum rate of return of 10%. Round the present value index to two decimal places. Use the present value tables presented in this chapter (Exhibits 1 and 2).