Six Questions of Present value

Question #1 Using payback to make capital investment decisions

Robinson Hardware is adding a new product line that will require an investment of $1,454,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of $300,000 the first year, $270,000 the second year, and $260,000 each year thereafter for eight years. Compute the payback period.            5.4yrs

Question #2 Using ARR to make capital investment decisions

Refer to the Robinson Hardware information in Question #1. Assume the project has no residual value. Compute the ARR for the investment. Round to two places.                          16.45%

Question #3 Using the time value of money

Janice wants to take the next five years off work to travel around the world. She estimates her annual cash needs at $28,000 (if she needs more, she will work odd jobs). Janice believes she can invest her savings at 8% until she depletes her funds.         2. 124,656

Requirements

1. How much money does Janice need now to fund her travels?

2. After speaking with a number of banks, Janice learns she will only be able to invest her funds at 4%. How much does she need now to fund her travels?

Question #4 Using NPV and profitability index to make capital investment decisions

Use the NPV method to determine whether Kyler Products should invest in the following projects:

 Project A: Costs $260,000 and offers seven annual net cash inflows of $57,000. Kyler Products requires an annual return of 16% on investments of this nature.

 Project B: Costs $375,000 and offers 10 annual net cash inflows of $75,000.

Kyler Products demands an annual return of 14% on investments of this nature.            1. Project B $16,200 NPV          

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.

Question #5 Using IRR to make capital investment decisions

Refer to the data regarding Kyler Products in question #4. Compute the IRR of each project and use this information to identify the better investment.

Project A 12% – 14% IRR

Question #6 Using payback, ARR, NPV, and IRR to make capital investment decisions

 Davis Consulting 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 $40,000. Server B will generate net cash inflows of $25,000 in year 1, $11,000 in year 2, and $4,000 in year 3. Server B has a $4,000 residual value and an estimated life of three years. Server B also costs $40,000. Davis’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 Davis invest in?