Exercise 1

 

Emerald Bay Furniture Company’s managers have gathered all of the capital investment proposals for the year, and they are ready to make their final selections.  The following proposals and related rate-of-return amounts were received during the period:

 

Project	Capital Investment	Rate of Return
AB	$450,000	19%
CD	500,000	28%
EF	654,000	12%
GH	800,000	32%
IJ	320,000	23%
KL	240,000	18%
MN	180,000	16%
OP	400,000	26%
QR	560,000	14%
ST	1,200,000	22%
UV	1,600,000	20%

 

 

 

Assume that the company’s minimum rate of return is 15 percent of the $5,000,000 is available for capital investments during the year.

 

1.  List the acceptable capital investment proposals in the order of probability.

2. Which proposals should be selected for this year?  Why?

 

Exercise 9

 

Eco Wet, Inc., a manufacturer of gears for lawn sprinklers, is thinking about adding a new fully automated machine.  This machine can produce gears that the company now produces on its third shift.  The machine has an estimated useful life of ten years and will cost $500,000.  The residual value of the new machine is $50,000.  Gross cash revenue from the machine will be about $420,000 per year, and related operating expenses, including depreciation, should total $400,000.  Depreciation is estimated to be $80,000 annually.  The payback period should be five years or less.  Use the payback period method to determine whether the company should invest in the new machine.  Show the computations that support your answer.

 

Exercise 12

 

Assume the same facts for Exercise 11 for Sound Perfection, Inc. Management decided that the only capital investments the yield at least a 25 percent return will be accepted.  Using the accounting rate-of-return method, decide whether the company should invest in the machine.  Show the computations that support your method.

 

(Exercise 11: Sound Perfection, Inc., a manufacturer of stereo speakers, is thinking about adding a new machine.  This machine can produce speaker parts that the company now buys from outsiders.  The machine has an estimated useful life of 14 years and will cost $450,000.  The residual value of the new machine is $50,000. Gross cash revenue from the machine will be about $300,000 per year, and related cash expenses should total $210,000.  Depreciation is estimated to be $30,000 annually.  Sound Perfection’s management has decided that only capital investments that yield at least a 20 percent return will be accepted.  Using the accounting rate-of-return method, decide whether the company should invest in the machine.  Show the computations that support your decision.)

 

Problem 4

 

Edge Company’s production vice president believes keeping up-to-date with technological changes that makes the company successful and feels that a machine introduced recently would fill an important need.  The machine has an estimated useful life of four years, a purchase price of $250,000, and a residual value of $25,000.  The company controller has estimated average annual net income of $11,250 and the following cash flows for the new machine:

 

Year	Cash Inflows	Cash Outflows	Net Cash Flows
1	$325,000	250,000	$75,000
2	320,000	250,000	70,000
3	315,000	250,000	65,000
4	310,000	250,000	60,000

 

 

 

 

 

 

 

The company uses a 12 percent minimum rate of return and a three-year payback period for capital investment evaluation purposes.

 

REQUIRED

 

1.  Analyze the data about the machine.  Use the following evaluation approaches in your analysis:

 

1. The net present value method (Round to the nearest dollar.)

2. The accounting rate-of-return method. (Round percentage to one decimal place.)

3. The payback period method (Round to one decimal place.)

 

1.  Summarize the information generated in requirement 1 and make a recommendation.

 

Problem 5

 

City Sights, Ltd., operates a tour and sightseeing business.  Its trademark is the use of trolley buses.  Each vehicle has its own identity and is specially made for the company.  Gridlock, the oldest bus, was purchased 15 years ago and has 5 years of its estimated useful life remaining.  The company paid $250,000 for Gridlock, and the business could be sold today for $20,000.  Gridlock is expected to generate average annual net cash inflows of $25,000 for the remainder of its estimated useful life.

 

                Management wants to replace Gridlock with a modern looking vehicle called Phantom.  Phantom has a purchase price of $140,000 and an estimated useful life of 20 years.  Net cash inflows for Phantom are projected to be $40,000 per year.

 

                Assume that (1) all cash flows occur at year end, (2) each vehicle’s residual value equals 10 percent of its purchase price, and (3) the minimum rate of return is 10 percent.

 

REQUIRED

 

1.  Compute the present value of future cash flows from Gridlock.

2. Compute the net present value of cash flows if Phantom were purchased.

3. Show City Sights keep Gridlock or purchase Phantom?