Capital Budgeting Chapter 14 Question 1 The depreciation expense of 595 000 is the only non cash expense Projected Net Operating Income 5 Year Projected Net operating income Sales Variable expenses Contribution Margin Fixed Expense Depreciation Total fixed expenses Net operating income 735 000 595 000 2 735 000 1 000 000 1 735 000 1 330 000 405 000 Noncash Expenses Annual net cash flow Question 1 Depreciation expense of 595 000 is the only non cash expense Question 2 Annual net cash inflows Annual net cash inflows Net operating income Add Noncash deduction for depreciation Annual net cash inflow 405 000 595 000 1 000 000 Present value of the annual net cash inflows Question 3 Annual net cash inflows Net operating income Add Noncash deduction for depreciation Annual net cash inflow 405 000 595 000 1 000 000 Year s Cash Flow 14 Factor PV of Cash Annual net cash inflow 1 5 1 000 000 3 433 Flows 3 433 000 Present Value Formula Present Value Ordinary Annuity Question 4 Project s Net Present Value Now 2 975 000 Years 1 5 Purchase of equipment Sales Variable expenses Out of pocket costs Total cash flows Discount factor Present value Net present value 2 975 000 1 000 2 975 000 2 735 000 1 000 000 735 000 1 000 000 3 433 3 433 000 3 433 000 2 975 000 458 000 Present Value Factors Year Present Value Present Value Factor 1 2 3 4 5 8772 7695 6750 5921 5194 Total 3 4332 or 3 433 Question 5 Profitability Index Project Present value of cash inflows Investment required 3 433 000 2 975 000 1 1539 or 1 15 profitability index Project profitability index Question 6 Internal Rate of Return PV factor for the Investment required internal rate of return Annual net cash flows PV factor for the 2 975 000 internal rate of return 1 000 000 2 975 Exhibit 14B 2 2 975 is closest to 2 991 20 Question 7 Payback Period Annual net cash inflow 1 5 1 000 000 3 433 3 433 000 Year s Cash Flow 14 Factor PV of Cash Flows Year Investment Cash Inflow Unrecovered Investment 2 975 000 1 000 000 1 000 000 1 000 000 1 000 000 1 000 000 1 975 000 975 000 0 0 0 1 2 3 4 5 Payback Period 2 975 000 1 000 000 2 98 Years Question 8 Simple Rate of Return Method Annual incremental net operating income Initial investment Simple rate of return Simple rate of return 405 000 2 975 000 13 61 Should be reduced by any salvage from the sale of the old equipment Question 9 Discount Rate 16 instead of 14 Year s Cash Flow 14 Factor PV of Cash Flows Annual net cash inflow 1 5 1 000 000 3 433 3 433 000 Annual net cash inflow 1 5 1 000 000 3 274 3 274 000 Year s Cash Flow 16 Factor PV of Cash Flows A higher discount rate results in a lower NPV Question 10 Salvage Value If the equipment had a salvage value of 300 000 at the end of five years would you expect the project payback period to be a higher b lower c the same d Cannot be determined Salvage Value If the equipment had a salvage value of 300 000 at the end of five years would you expect the project payback period to be a higher b lower c the same d Cannot be determined The salvage value at the end of the five years is irrelevant to the payback calculation Question 11 Net Present Value If the equipment had a salvage value of 300 000 at the end of five years would you expect the NPV to be a higher b lower c the same d Cannot be determined Net Present Value If the equipment had a salvage value of 300 000 at the end of five years would you expect the NPV to be a higher b lower c the same d Cannot be determined NPV Salvage Value 300 000 Year s Cash Flow 14 Factor PV of Cash Flows Annual net cash inflow Salvage Value Net Present Value 1 5 5 1 000 000 300 000 3 433 0 519 3 433 000 155 700 3 588 700 Question 12 Simple Rate of Return If the equipment had a salvage value of 300 000 at the end of five years would you expect its simple rate of return to be a higher b lower c the same d Cannot be determined Simple Rate of Return If the equipment had a salvage value of 300 000 at the end of five years would you expect its simple rate of return to be a higher b lower c the same d Cannot be determined increase from 13 61 to 17 38 The simple rate of return will Simple Rate of return Initial Cost of equipment 2 975 000 Less Salvage value 300 000 Depreciable base 2 675 000 5 years Annual depreciation 535 000 Prior depreciation 595 000 60 000 Since annual depreciation will be lower by 60 000 per year net operating income will be 465 000 60 000 higher Simple Rate of Return Method Annual incremental net operating income Initial investment Simple rate of return Simple rate of return 465 000 2 675 000 17 38 Initial investment 2 975 000 300 000 2 675 000 Reduced by any salvage from the sale of the old equipment Questions 13 15 Variable expense ratio Assume a post audit was done and the variable expense ratio turned out to be 45 instead of 37 what would be the project s actual Net present value Payback period Simple rate of return 45 Variable expense ratio Pre Audit Post Audit Sales Variable expenses Contribution Margin Fixed Expense Depreciation Net operating income 2 735 000 1 000 000 1 735 000 735 000 595 000 405 000 2 735 000 1 230 750 1 504 250 735 000 595 000 174 250 Present value of the annual net cash inflows Annual net cash inflows Net operating income Add Noncash deduction for depreciation Annual net cash inflow 174 250 595 000 769 250 Annual net cash inflow 1 5 769 000 3 433 2 640 835 Year s Cash Flow 14 Factor PV of Cash Flows Rounded from 2 640 835 25 Project s Net Present Value Purchase of equipment 2 975 000 Now Years 1 5 Sales Variable expenses Out of pocket costs Total cash flows Discount factor Present value 2 975 000 1 000 2 975 000 2 735 000 1 230 750 735 000 769 250 3 433 2 640 835 Net present value 2 640 835 2 975 000 334 165 Payback Period Year s Cash Flow 14 Factor PV of Cash Annual net cash inflow 1 5 769 250 3 433 2 640 835 Year Investment Cash Inflow Unrecovered Investment 2 975 000 1 2 3 4 5 769 250 769 250 769 250 769 250 769 250 Payback Period 3 667 250 769 …
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