Chapter 25

The following data are accumulated by Environmental Services Inc. in evaluating two competing capital investment proposals: \begin{tabular}{lll} & Testing Equipment & Centrifuge \\ \hline Amount of investment & \(\$ 42,000\) & \(\$ 56,000\) \\ Useful life & 4 years & 5 years \\ Estimated residual value & \(-0-\) & \(-0-\) \\ Estimated total income over the useful life & \(\$ 10,500\) & \(\$ 12,250\) \end{tabular} Determine the expected average rate of return for each proposal.

General Bearings Company is considering an investment in equipment that will replace direct labor. The equipment has a cost of \(\$ 94,000\), with a \(\$ 6,000\) residual value and an 8-year life. The equipment will replace one employee who has an average wage of \(\$ 26,000\) per year. In addition, the equipment will have operating and energy costs of \(\$ 8,250\) per year. Determine the average rate of return on the equipment, giving effect to straightline depreciation on the investment.

Pocket Communications Inc. is considering an investment in new equipment that will be used to manufacture a PDA (personal data assistant). The PDA is expected to generate additional annual sales of 4,500 units at \(\$ 325\) per unit. The equipment has a cost of \(\$ 870,000\), residual value of \(\$ 30,000\), and a 10 -year life. The equipment can only be used to manufacture the PDA. The cost to manufacture the PDA is shown below. \(\begin{array}{lr}\text { Cost per unit: } & \$ 42.00 \\ \text { Direct labor } & 195.00 \\ \text { Direct materials } & 58.00 \\ \text { Factory overhead (including depreciation) } & \$ 295.00 \\ \text { Total cost per unit }\end{array}\) Determine the average rate of return on the equipment.

Green Thumb Inc. is planning to invest \(\$ 238,000\) in a new garden tool that is expected to generate additional sales of 8,000 units at \(\$ 36\) each. The \(\$ 238,000\) investment includes \(\$ 54,000\) for initial launch-related expenses and \(\$ 184,000\) for equipment that has a 15 -year life and a \(\$ 10,000\) 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 per unit costs: \begin{tabular}{lr} Direct labor & \(\$ 6.00\) \\ Direct materials & \(11.75\) \\ Fixed factory overhead-depreciation & \(1.45\) \\ Variable factory overhead & \(1.80\) \\ \(\quad\) Total & \(\$ 21.00\) \\ \hline \end{tabular} Determine the net cash flows for the first year of the project, years 2-14, and for the last year of the project.

First Charter Bank Corporation is evaluating two capital investment proposals for a drive-up ATM, each requiring an investment of \(\$ 250,000\) and each with an 8 -year life and expected total net cash flows of \(\$ 400,000\). Location 1 is expected to provide equal annual net cash flows of \(\$ 50,000\), and Location 2 is expected to have the following unequal annual net cash flows: \(\begin{array}{lrrr}\text { Year 1 } & \$ 80,000 & \text { Year 5 } & \$ 37,500 \\ \text { Year 2 } & 70,000 & \text { Year 6 } & 37,500 \\ \text { Year 3 } & 50,000 & \text { Year 7 } & 37,500 \\ \text { Year 4 } & 50,000 & \text { Year 8 } & 37,500\end{array}\) Determine the cash payback period for both proposals.

Personal Care Products Company is considering an investment in one of two new product lines. The investment required for either product line is \(\$ 550,000\). The net cash flows associated with each product are as follows: \begin{tabular}{crr} & Liquid Soap & Cosmetics \\ \hline Year 1 & \(\$ 150,000\) & \(\$ 110,000\) \\ 2 & 140,000 & 110,000 \\ 3 & 130,000 & 110,000 \\ 4 & 130,000 & 110,000 \\ 5 & 100,000 & 110,000 \\ 6 & 90,000 & 110,000 \\ 7 & 70,000 & 110,000 \\ 8 & 70,000 & 110,000 \\ Total & \(\$ 880,000\) & \(\$ 880,000\) \\ \hline \end{tabular} a. Recommend a product offering to Personal Care 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?

Animated Media Inc. has computed the net present value for capital expenditure proposals \(A\) and \(B\), using the net present value method. Relevant data related to the computation are as follows: \begin{aligned} &\begin{array}{lcr} & \text { Proposal A } & \text { Proposal B } \\ \hline \text { Total present value of net cash flow } & \$ 308,256 & \$ 158,895 \\ \text { Amount to be invested } & 321,100 & 148,500 \\ \text { Net present value } & \$(12,844) & \$ 10,395 \\ \hline \end{array}\\\ &\text { Determine the present value index for each proposal. } \end{aligned}

Western Rail Inc. is considering acquiring equipment at a cost of \(\$ 468,800\). The equipment has an estimated life of 10 years and no residual value. It is expected to provide yearly net cash flows of \(\$ 93,760\). The company's minimum desired rate of return for net present value analysis is \(12 \%\). Compute the following: a. The average rate of return, giving effect to straight-line depreciation on the investment. b. The cash payback period. c. The net present value. Use the table of the present value of an annuity of \(\$ 1\) appearing in this chapter. Round to the nearest dollar.

The internal rate of return method is used by Rustic Renovations Inc. in analyzing a capital expenditure proposal that involves an investment of \(\$ 74,520\) and annual net cash flows of \(\$ 15,000\) for each of the 8 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 (a) and the present value of an annuity of \(\$ 1\) table appearing in this chapter, determine the internal rate of return for the proposal.

Mr. Pop Popcorn Company is considering two possible investments: a delivery truck or a bagging machine. The delivery truck would cost \(\$ 36,506\) and could be used to deliver an additional 40,000 bags of popcorn per year. Each bag of popcorn can be sold for a contribution margin of \(\$ 0.35\). The delivery truck operating expenses, excluding depreciation, are \(\$ 0.32\) per mile for 16,000 miles per year. The bagging machine would replace an old bagging machine, and its net investment cost would be \(\$ 27,555\). The new machine would require 2 fewer hours of direct labor per day. Direct labor is \(\$ 14\) per hour. There are 260 operating days in the year. Both the truck and the bagging machine are estimated to have 6-year lives. The minimum rate of return is \(11 \%\). However, Mr. Pop has funds to invest in only one of the projects. a. Compute the internal rate of return for each investment. Use the table of present values of an annuity of \(\$ 1\) in the chapter. b. I?rovide a memo to management with a recommendation.

Empire Healthcare Corp. is proposing to spend \(\$ 84,434\) on a 7 -year project whose estimated net cash flows are \(\$ 18,500\) for each of the seven years. a. Compute the net present value, using a rate of return of \(15 \%\). Use the table of present values of an annuity of \(\$ 1\) in the chapter. b. Based on the analysis prepared in (a), is the rate of return (1) more than \(15 \%\), (2) 15\%, or (3) less than 15\%? Explain. c. Determine the internal rate of return by computing a present value factor for an annuity of \(\$ 1\) and using the table of the present value of an annuity of \(\$ 1\) presented in the text.

International Foods 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 4 local units per U.S. dollar to 8 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. 1 Assume that the plant produced product in the local economy but exported the product back to the U.S. 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.