Problem 13-11

1. The project profitability index is computed as follows:

Net Present Value Investment Required Project Profitability index

Project (a) (b) (a)÷ (b)

A $44,323 $160,000 0.28

B $42,000 $135,000 0.31

C $35,000 $100,000 0.35

D $38,136 :$175,000 0.22

2. a., b., and c

Net Present Value Project Profitability Index Internal Rate of Return

First preference………. A C D

Second preference….. B B C

Third preference…….. C A A

Fourth preference…… D D B

Exercise 13-8

1. Computation of the annual cash inflow associated with the new electronic games:
Net operating income………………………………………….. $40,000
Add noncash deduction for depreciation…………….. $35,000
Annual net cash inflow………………………………………… $75,000

The payback computation would be:

Investment required
Payback period =
Annual net cash inflow
$ 300,000
= = 4 years
$ 75,000 per year

Yes, the games would be purchased. The payback period is less than the maximum 5 years
required by the company.

2. The simple rate of return would be:

Annual incremental net income

Simple rate of return =
Initial investment
$ 40,000
¿ =13.3 %
$ 300.000

Yes, the games would be purchased. The 13.3% return exceeds 12%.
 Exercise 13-7

Project A:

Now 1 2 3 4 5 6

Purchased of equipment…… $(100,000)

Annual cash inflows………….. $21,000 $21,000 $21,000 $21,000 $21,000 $21,000

Salvage value……………………. ________ _______ _______ ______ ______ ______ 8,000

Total cash flows (a)………….. $(100,000) $21,000 $21,000 $21,000 $21,000 $21,000 $29,000

Discount factor (14%) (b)…. 1,000 0.877 0.769 0.675 0.592 0.519 0.456

Present value (a)x(b)……….. $(100,000) $18,417 $16,149 $14,175 $12,432 $10,899 $13,224

Net present value……………. $(12,417)

Project B:

Now 1 2 3 4 5 6

Working capital invested…… $(100,000)

Annual cash inflows………….. $16,000 $16,000 $16,000 $16,000 $16,000 $16,000

Working capital released….. ________ _______ ______ ______ ______ _______ 100,000

Total cash flows (a)………….. $(100,000) $16,000 $16,000 $16,000 $16,000 $16,000 $116,000

Discount factor (14%) (b)…. 1,000 0.877 0.769 0.675 0.592 0.519 0.456

Present value (a)x(b)……….. $(100,000) $14,032 $12,304 $10,800 $9,472 $8,304 $52,896

Net present value……………. $7,808

The $100,000 should be invested in Project B rather than Project A. Project B has a positive net present
value whereas Project A has a negative net present value.
Exercise 13-6

This is a cost reducing project, so the simple rate of return would be computed as follows:

Operating cost of old machine…………………………………….. $ 30,000

Less operating cost of new machine……………………………. 12,000

Less annual depreciation of the new machine

($120,000÷ 10 years)………………………………………………… 12,000

Annual incremental net operating income…………………. $ 6,000

Cost of the new machine…………………………………………… $ 120,000

Scrap value of old machine……………………………………….. 40,000

Initial investment………………………………………………………. $ 80,000

Annual incremental net income

Simple rate of return =
Initial investment

$ 6,000
= = 7.5%
$ 80,000

Exercise 13-5

1.The project profitability index for each proposal is:

Net Present Value Investment Required Project Profitability index

Proposal Number (a) (b) (a)÷(b)

A $36,000 $90,000 0.40

B $38,000 $100,000 0.38

C $35,000 $70,000 0.50

D $40,000 $120,000 0.33

2. The ranking is:

Proposal Number Project Profitability index

C 0.50

A 0.40

B 0.38

D 0.33

Note that proposal D has the highest net present value, but it ranks lowest in terms of the project
profitability index.
 Exercise 13-3

1.Annual savings in part-time help………………………………….. $3,800

Added contribution margin from expanded sales

(1,000 dozen x $ 1.20 per dozen…………………………………… 1,200

Annual cash inflows……………………………………………………… $5,000

Invewstment required
2. :tor of the internal rate of return =
Annual cash inflow
$ 18,600
= =3.720
$ 5,000
Looking in Exhibit 13B-2, a factor of 3.720 falls closest to the 16% rate of return.

3. The cash flows will not be even over the six-year life of the machine because of the extra $9,125
Inflow in the sixth year. Therefore, the above approach cannot be used to compute the internal
rate of return in this situation. Using trial-and-error or some other method, the internal rate of
22%.

Now 1 2 3 4 5 6

Purchase of machine…….. $ (18,600)

Reduced part-time help… $ 3,800 $ 3,800 $ 3,800 $ 3,800 $ 3,800 $ 3,800

Added contribution margin. 1,200 1,200 1,200 1,200 1,200 1,200

Salvage value……………………. ________ _______ _______ ______ ______ ______ 9,125

Total cash flows (a)………….. $ (18,600) $5,000 $5,000 $5,000 $5,000 $5,000 $14,125

Discount factor (14%) (b)…. 1,000 0.820 0.672 0.551 0.451 0.370 0.303

Present value (a)x(b)……….. $ (18,600) $18,417 $16,149 $14,175 $12,432 $10,899 $13,224

Net present value……………. $ 0

Exercise 13-4

The equipment’s net present value without considering the intangible benefits would be:

Amount of 20% Present Value

Item Year(s) Cash Flows Factor of Cash Flows

Cost of the equipment…. Now $(2,500,000) 1,000 $(2,500,000)

Annual cost savings……… 1-15 $400,000 4.675 1,870,000

Net present value………… $ (630,000)

The annual value of the intangible benefits would have to be great enough to offset a $ 630,000
negative present value for the equipment. This annual value can be computed as follows:

$ 630,000
Required increase in present value factor for 15 years = =¿ $134,759
4.675
Exercise 13-2

1.

Now 1 2 3 4 5

Purchase of machine…….. $ (27,000)

Reduced operating cost.… _________ $ 7,000 $ 7,000 $ 7,000 $ 7,000 $ 7,000

Total cash flows (a)………….. $ (27,000) $ 7,000 $ 7,000 $ 7,000 $ 7,000 $ 7,000

Discount factor (12%) (b)…. 1,000 0.893 0.797 0.712 0.636 0.567

Present value (a)x(b)……….. $ (27,000) $6,251 $5,579 $4,984 $4,452 $3,969

Net present value……………. $ (1,765)

Note: The annual reduction in operating costs can also be converted to its present value using the
discount factor of 3,605 as shown in Exhibit 13B-2 in Appendix 13B.

2.

Item Cash Flow Yeas Total Cash Flows

Annual cost savings. $7,000 5 $35,000

Initial Investment….. $(27,000) 1 (27,000)

Net cash flow………… $ 8,000

Exercise 13-1

1. The payback period is determined as follows:

Year Investment Cash Inflow Unrecovered Investment

1 $15,000 $1,000 $14,000

2 $8,000 $2,000 $20,000

3 $2,000 $17,500

4 $4,000 $13,500

5 $5,000 $8,500

6 $6,000 $2,500

7 $5,000 $0

8 $4,000 $0
9 $3,000 $0

10 $2,000 $0

The investment in the project is fully recovered the 7 th year. To be more exact, the payback period is
approximately 6.5 years.

2. Because the investment is recovered prior to the last year, the amount of the cash inflow in the
last year has no effect on the payback period.