JOHN RYAN JINGCO

Capital Budgeting Seatwork

A. The following data are given for Alright Aluminum Company:

Initial cost of proposed equipment $75,000
Estimated useful life 7 years
Estimated annual savings in cash operating expenses $18,000
Predicted residual value at the end of the useful life $ 3,000
Cost of capital 12%

Compute the following:

1. Payback period

Payback period =$75,000/ 18,000= 4.167 years

2. Present value of estimated annual savings

$12,000 X PV factor of an annuity of $1 at 12% for 7 years = $18,OOO X 4.564 = $82,152

3. Present value of estimated residual value

$3,000 x PV factor of $1= $3,000 X 0.452 = $1,356

4. Total present value of estimated cash inflows

Total PV = $82,152 + $1,3516 = $83,508

5. Net present value (NPV)

NPV = PV -I = $83,508 -$75,000 = $8,508

6. Internal rate of return (IRR)

Determining NPV at 12% = $(8412)

NPV at 7% = $943

Therefore IRR
= R1 + NPV1(R2-R1)
NPV1 - NPV2 = 12% +- $(8412)(7%-12%)
-$8412-943 = 12% - 4.54%
IRR = 7.46%

B. The Rango Company is considering a capital investment for which the initial outlay is
$20,000. Net annual cash inflows (before taxes) are predicted to be $4,000 for 10 years.
Straight-line depreciation is to be used, with an estimated salvage value of zero. Ignoring
income taxes, compute the items listed below.

7. Payback period

Payback period = $20,000/$4,000= 5 years

8. Accounting rate of return (ARR)

Depreciation = $20,000/10 years= $2,000/year

Accounting rate of return = ($4,000-$2,000)/$20,000= 0.10 = 10%

9. Net present value (NPV), assuming a cost of capital (before tax) of 12 percent

Net present value (NPV) = PV of cash inflows [discounted at the cost of capital (12%)] -Initial
investment
= $4,000 X (PV Factor) -$20,000 = $4,000(5.650) -$20,000 = $2,600

C.Trovato Corporation is considering a project that would require an investment of $48,000. No

other cash outflows would be involved. The present value of the cash inflows would be $51,840.
10. The profitability index of the project is closest to:

Project Q

Investment required ($48,000)

Present value of cash inflows 51,840

Net present value $3,840

Project profitability index (NPV / Investment =0.08

required)

D.Dumora Corporation is considering an investment project that will require an initial investment
of $9,400 and will generate the following net cash inflows in each of the five years of its useful
life:
Year 1 Year 2 Year 3 Year 4 Year 5
Net cash inflows........ $1,000 $2,000 $4,000 $6,000 $5,000
Dumora’s discount rate is 16%.
11. Dumora's payback period for this investment project is closest to:

Amount Remaining Balance

Initial investment $9,400

Year 1 cash inflow $1,000 $8,400

Year 2 cash inflow $2,000 $6,400

Year 3 cash inflow $4,000 $2,400

Year 4: $2,400 ÷ $6,000 = 0.4

12. Dumora's net present value for this investment project is closest to:

year(s) amount 16% factor PV

Cost 1 $1,000 0.862 $862

savings−Year 1

Cost 2 $2,000 0.743 1,486

savings−Year 2

Cost 3 $4,000 0.641 2,564

savings−Year 3

Cost 4 $6,000 0.552 3,312

savings−Year 4

Cost 5 $5,000 0.476 2,380

savings−Year 5

Initial investment Now ($9,400) 1.000 ( 9,400)

Net present $1,204

value

E.Hazard Company is considering the acquisition of a machine that costs $375,000. The
machine is expected to have a useful life of 6 years, a negligible residual value, an annual cash
flow of $150,000, and annual operating income of $87,500.
13. What is the estimated cash payback period for the machine?

Payback Period = Initial Investment/Annual Cash Inflows = 375000/150000 = 2.5

2.5 years
F. The management of Nebraska Corporation is considering the purchase of a new machine
costing $490,000. The company's desired rate of return is 10%. The present value factors for $1
at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621,
respectively. In addition to the foregoing information, use the following data in determining the
acceptability in this situation:

Year Income from Operations Net Cash Flow

1 $100,000 $180,000

2 40,000 120,000

3 40,000 100,000

4 10,000 90,000

5 10,000 120,000
14. The payback period is
Payback Period = Initial Investment/Annual Cash Inflows
Annual Cash Inflow = (180000+120000+100000+90000+120000)/5 = $122,000

Payback Period = $490,000/$122,000=4.016

4years

15. The average rate of return is

16%

16. The net present value is

Year Cashflows Present value factor Discounted Cash

flows

1 $180,000 0.909 $163,620

2 $120,000 0.826 $99,120

3 $100,000 0.751 $75,100

4 $90,000 0.683 $61,470

5 $120,000 0.621 $74,520

Present value of cash inflows $473,830

Present Value of cash outflows $490,000
Net present value is ($16,170)