Calculate Present Value [LO 2]
Juanita Martinez is ready to retire and has a choice of three pension plans. Plan A provides for an immediate cash payment of $250,000. Plan B provides for the payment of $25,000 per year for 10 years and the payment of $250,000 at the end of year 10. Plan C will pay $42,000 per year for 10 years. Juanita Martinez desires a return of 12 percent.
/
/ Determine the present value of each plan. (Round present value factor calculations to 4 decimal places, e.g. 0.2525. Round all other calculations and final answer to 0 decimal places, e.g. 5,250.)
Present Value
Plan A / $
Plan B / $
Plan C / $
/
/ Select the best plan.
Plan B Plan C Plan A
AE9-8
Calculate Net Present Value [LO 2]
An investment that costs $60,000 will return $27,000 per year for 5 years.
/
/ Determine the net present value of the investment if the required rate of return is 8 percent. (Ignore taxes.) (Round present value factor calculations to 4 decimal places, e.g. 0.2525. Round all other calculations and the final answer to 2 decimal places, e.g.25.21.)
Net Present Value / $
/
/ Should the investment be undertaken?
Yes No
AE9-9
Calculate the Internal Rate of Return [LO 3]
An investment that costs $154,149 will reduce operating costs by $26,000 per year for 20 years.
/
/ Determine the internal rate of return of the investment (ignore taxes). (Round present value factor calculations to 4 decimal places, e.g. 2.2512 and the final answer to 0 decimal places, e.g. 25%.)
Internal rate of return / %
/
/ Should the investment be undertaken if the required rate of return is 19 percent?
Yes No
AE9-11
Depreciation Tax Shield [LO 4]
Strauss Corporation is making a $68,000 investment in equipment with a 5-year life. The company uses the straight-line method of depreciation and has a tax rate of 40 percent. The company’s required rate of return is 12 percent.
What is the present value of the tax savings related to depreciation of the equipment? (Round the present value factor calculations to 4 decimal places, e.g. 0.2525. Round all other calculations and the final answer to 2 decimal places, e.g. 25.21.)
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AE9-12Cash Flow Implications of Tax Losses [LO 4]
WesternGear.com is expected to have operating losses of $300,000 in its first year of business and $100,000 in its second year. However, the company expects to have income before taxes of $350,000 in its third year and $350,000 in its fourth year. The company’s required rate of return is 15 percent.
Assume a tax rate of 40 percent and that current losses can be used to offset taxable income in future years. What is the present value of tax savings related to the operating losses in years 1 and 2? (Round present value factor calculations to 4 decimal places, e.g. 0.2525. Round all other calculations and final answer to 0 decimal places, e.g. 5,252.)
AE9-14
Calculate the Payback Period [LO 6]
The Sunny Valley Wheat Cooperative is considering the construction of a new silo. It will cost $61,750 to construct the silo. Determine the payback period if the expected cash inflows are $19,000 per year. (Enter the final answer to 2 decimal places, e.g. 7.23.)
AE9-16
IRR and Unequal Cash Flows [LO 3]
Newport Department Store is considering development of an e-commerce business. The company estimates that development will require an initial outlay of $1,240,000. Other cash flows will be as follows:
Year 1 / ($521,100)
Year 2 / $170,000
Year 3 / $620,000
Year 4 / $670,000
Year 5 / $870,000
/
/ Assuming the company limits its analysis to five years, estimate the internal rate of return of the e-commerce business. (Round the present value factor calculations to 4 decimal places, e.g. 0.2525. Round the final answer to 0 decimal places, e.g. 25%.)
Internal rate of return / %
P9-7
Net Present Value, Internal Rate of Return, Payback, Accounting Rate of Return, and Taxes [LO 2, 3, 4, 6]
Adrian Sonnetson, the owner of Adrian Motors, is considering the addition of a paint and body shop to his automobile dealership. Construction of a building and the purchase of necessary equipment is estimated to cost $800,000 and both the building and equipment will be depreciated over 10 years using the straight-line method. The building and equipment have zero estimated residual value at the end of 10 years. Sonnetson’s required rate of return for this project is 12 percent. Net income related to each year of the investment is as follows:
Revenue / $500,000
Less:
Material cost / 70,000
Labor / 150,000
Depreciation / 80,000
Other / 10,000
Income before taxes / 190,000
Taxes at 40% / 76,000
Net income / $114,000
/
/ Determine the net present value of the investment in the paint and body shop. (Round the present value factor calculations to 4 decimal places, e.g. 0.2525. Round all other calculations the final answer to 2 decimal places, e.g. 25.21.)
Net present value / $
Should Sonnetson invest in the paint and body shop?
No Yes
AP9-12
Comprehensive Capital Budgeting Problem [LO 2,6]
Van Doren Corporation is considering producing a new product, Autodial. Marketing data indicate that the company will be able to sell 60,000 units per year at $30. The product will be produced in a section of an existing factory that is currently not in use.
To produce Autodial, Van Doren must buy a machine that costs $550,000. The machine has an expected life of 5 years and will have an ending residual value of $20,000. Van Doren will depreciate the machine over 5 years using the straight-line method for both tax and financial reporting purposes.
In addition to the cost of the machine, the company will incur incremental manufacturing costs of $480,000 for component parts, $528,000 for direct labor, and $270,000 of miscellaneous costs. Also, the company plans to spend $150,000 annually to advertise Autodial. Van Doren has a tax rate of 40 percent, and the company’s required rate of return is 13 percent.
/
/ Compute the net present value.(Round present value factor calculations to 4 decimal places, e.g. 0.2525. Round other all calculations and the final answer to 0 decimal places, e.g. 5,250.)
Net present value / $
/
/ Compute the payback period.(Round all calculations and the final answer to 2 decimal places, e.g. 25.21.)
Payback period / years
/
/ Compute the accounting rate of return.(Round the final answer to 0 decimal places e.g. 25%.)
Accounting rate of return / %
P9-17
Conflict Between Performance Evaluation and Use of NPV [LO 7]
Division managers at Creighton Aerospace are evaluated and rewarded based on ROI (return on investment) targets. In the current year, Delmar Richards, the president of the commercial products division, has an ROI target of 12 percent. If the division has an ROI of 12 percent or greater, Delmar will receive 250,000 options on Creighton stock in addition to a base salary of $400,000.
The commercial products division is considering a major investment in product development, which has a net present value of $25,000,000. However, the investment will have a negative effect on reported profit over the next two years, after which the investment will begin to have a significant positive effect on firm profitability for the next eight years.
/
/ Discuss the potential conflict between the company’s evaluation/compensation system and Delamr's focus on the NPV of the investment in product development.
/
/ Suppose Delmar currently holds stock in Creighton Aerospace with a market value of $1,250,000 and has options on 500,000 shares (awarded in previous years). Is this likely to exacerbate or mitigate the conflict you discussed in part (a)?