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    capital budgeting problems finance management accounting payback net present value accounting rate of return

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    421 views3 pages

    Capital Budgeting

    Uploaded by

    Anonymous LC5kFdtc
    capital budgeting problems finance management accounting payback net present value accounting rate of return

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as docx, pdf, or txt
    of 3

    CAPITAL BUDGETING

    Problem 1
    Grimmett Company is considering purchasing a machine that would cost $403,200 and have a useful
    life of 9 years. The machine would reduce cash operating costs by $74,667 per year. The machine
    would have a salvage value of $60,480 at the end of the project.

    Required:
    a. Compute the payback period for the machine.
    b. Compute the simple rate of return for the machine.

    Problem 2
    Corin Corporation is considering the purchase of a machine that would cost $420,000 and would last
    for 8 years. At the end of 8 years, the machine would have a salvage value of $97,000. The machine
    would reduce labor and other costs by $76,000 per year. The company requires a minimum pretax
    return of 16% on all investment projects.

    Present value factors Single sum Ordinary annuity


    16%, 1 period 0.8621 0.8621
    16%, 8 periods 0.3050 4.3436

    Required: Determine the net present value of the project.

    Problem 3
    Ursus, Inc., is considering a project that would have a ten-year life and would require a $1,000,000
    investment in equipment. At the end of ten years, the project would terminate and the equipment would
    have no salvage value. The project would provide net operating income each year as follows:

    All of these items, except for depreciation of $100,000 a year, represent cash flows. The depreciation
    is included in the fixed expenses. The company's required rate of return is 12%.

    Present value factors Single sum Ordinary annuity


    12%, 10 periods 0.32197 5.65022

    Required:
    a. Compute the project's net present value.
    b. Compute the project's internal rate of return to the nearest whole percent.
    c. Compute the project's payback period.
    d. Compute the project's simple rate of return.
    a. The payback period is computed as follows:

    Payback period = Investment required Net annual cash flow


    = $403,200 $74,667 = 5.40 years

    In this case the salvage value plays no part in the payback period since all of the investment is recovered
    before the end of the project.

    b. The simple rate of return is computed as follows:

    Simple rate of return = Annual incremental net operating income Initial investment = $36,587 $403,200 =
    9.07%
    a. Since depreciation is the only noncash item on the income statement, the annual net cash flow can be
    computed by adding back depreciation to net operating income.

    b. The formula for computing the factor of the internal rate of return (IRR) is:
    Investment required Annual net cash inflow = Factor of the IRR
    To the nearest whole percent, the internal rate of return is 27%.

    c. The formula for the payback period is:


    Investment required Annual net cash inflow = Payback period
    $1,000,000 $300,000 = 3.33 years

    d. The formula for the simple rate of return is:


    Net operating income Initial investment = Simple rate of return
    $200,000 $1,000,000 = 20.0%

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