- The management of Kunkel Company is considering the purchase of a $29,000 machine that would reduce operating costs by $6,500 per year. At the end of the machine’s five-year useful life, it will have zero salvage value. The company’s required rate of return is 16%.
Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using table.
Required:
- Determine the net present value of the investment in the machine.
- What is the difference between the total, undiscounted cash inflows and cash outflows over the entire life of the machine?
- Perit Industries has $120,000 to invest. The company is trying to decide between two alternative uses of the funds. The alternatives are:
| Project A | Project B | |||
| Cost of equipment required | $ 120,000 | $ 0 | ||
| Working capital investment required | $ 0 | $ 120,000 | ||
| Annual cash inflows | $ 21,000 | $ 30,000 | ||
| Salvage value of equipment in six years | $ 8,200 | $ 0 | ||
| Life of the project | 6 | years | 6 | years |
- The working capital needed for project B will be released at the end of six years for investment elsewhere. Perit Industries’ discount rate is 15%.
Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables.
Required:
- Compute the net present value of Project A. (Enter negative values with a minus sign. Round your final answer to the nearest whole dollar amount.)
- Compute the net present value of Project B. (Enter negative values with a minus sign. Round your final answer to the nearest whole dollar amount.)
- Which investment alternative (if either) would you recommend that the company accept?
3.[The following information applies to the questions displayed below.]
Nick’s Novelties, Incorporated, is considering the purchase of new electronic games to place in its amusement houses. The games would cost a total of $310,000, have a fifteen-year useful life, and have a total salvage value of $31,000. The company estimates annual revenues and expenses associated with the games as follows:
| Revenues | $ 280,000 | |
| Less operating expenses: | ||
| Commissions to amusement houses | $ 90,000 | |
| Insurance | 58,000 | |
| Depreciation | 18,600 | |
| Maintenance | 70,000 | 236,600 |
| Net operating income | $ 43,400 |
Required:
- Compute the payback period associated with the new electronic games.
- Assume Nick’s Novelties, Incorporated, will not purchase new games unless they provide a payback period of five years or less. Would the company purchase the new games?
4.Nick’s Novelties, Incorporated, is considering the purchase of new electronic games to place in its amusement houses. The games would cost a total of $310,000, have a fifteen-year useful life, and have a total salvage value of $31,000. The company estimates annual revenues and expenses associated with the games as follows:
| Revenues | $ 280,000 | |
| Less operating expenses: | ||
| Commissions to amusement houses | $ 90,000 | |
| Insurance | 58,000 | |
| Depreciation | 18,600 | |
| Maintenance | 70,000 | 236,600 |
| Net operating income | $ 43,400 |
- Compute the simple rate of return promised by the games.
- If the company requires a simple rate of return of at least 13%, will the games be purchased?
- Henrie’s Drapery Service is investigating the purchase of a new machine for cleaning and blocking drapes. The machine would cost $102,990, including freight and installation. Henrie’s estimated the new machine would increase the company’s cash inflows, net of expenses, by $30,000 per year. The machine would have a five-year useful life and no salvage value.
Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using table.
Required:
- What is the machine’s internal rate of return? (Round your answer to the nearest whole percentage, i.e. 0.123 should be considered as 12%.)
- Using a discount rate of 14%, what is the machine’s net present value? Interpret your results.
- Suppose the new machine would increase the company’s annual cash inflows, net of expenses, by only $26,475 per year. Under these conditions, what is the internal rate of return? (Round your answer to the nearest whole percentage, i.e. 0.123 should be considered as 12%.)
- Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his division’s return on investment (ROI), which has been above 23% each of the last three years. Casey is considering a capital budgeting project that would require a $4,700,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 19%. The project would provide net operating income each year for five years as follows:
| Sales | $ 4,400,000 | |
| Variable expenses | 2,000,000 | |
| Contribution margin | 2,400,000 | |
| Fixed expenses: | ||
| Advertising, salaries, and other fixed out-of-pocket costs | $ 800,000 | |
| Depreciation | 940,000 | |
| Total fixed expenses | 1,740,000 | |
| Net operating income | $ 660,000 |
Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables.
Required:
- What is the project’s net present value?
- What is the project’s internal rate of return to the nearest whole percent?
- What is the project’s simple rate of return?
4-a. Would the company want Casey to pursue this investment opportunity?
4-b. Would Casey be inclined to pursue this investment opportunity?