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Exam 16: Planning for Capital Investments

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Question 81

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Shenandoah Springs Company is considering two investment opportunities whose cash flows are provided below: $\begin{array} { | l | r | r | } \hline \text { Year } & \text { Investment } \mathrm { A } & \text { lnvestment B } \\\hline 0 & ( \$ 15,000 ) & ( \$ 9,000 ) \\\hline 1 & 5,000 & 5,000 \\\hline 2 & 5,000 & 4,000 \\\hline 3 & 5,000 & 3,000 \\\hline 4 & 4,000 & 1,000 \\\hline\end{array}$ The company's hurdle rate is 12%. What is the present value index of Investment B? (Do not round your PV factors and intermediate calculations.)

A) 1.01
B) 1.16
C) 0.86
D) None of these answers is correct.

E) A) and B)
F) A) and D)

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Question 82

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Paul Company is considering purchasing a capital investment that is expected to provide annual cash inflows of $12,000 per year for 3 years. Assuming that the required rate of return is 10%, what is the present value of these cash inflows? (Do not round PV factors and intermediate calculations. Round your final answer to the nearest dollar.)

A) $9,016
B) $28,822
C) $29,842
D) $27,047

E) C) and D)
F) B) and C)

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Question 83

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Cash inflows from a capital investment may include the terminal value of capital assets and increases in revenues.

Ashley projects that she can get $100,000 cash per year for 5 years on a real estate investment project. If Ashley wants to earn a rate of return of 12%, what is the maximum that she should pay for the investment? (rounded to the nearest dollar)

The time value of money concept recognizes the fact that the present value of a dollar to be received in the future is worth more than a dollar.

The future value of $1 table should be used to discount lump sum cash flows expected to occur in the future.

Depreciation on a capital investment (such as equipment) has the effect of decreasing the amount of income taxes that the company owning the asset must pay.

Which method for evaluating capital investment proposals reduces the present value of cash outflows from the present value of cash inflows?

Joan Osborne is evaluating a potential capital investment. She has calculated the net present value using a minimum rate of return of 10%. Using this rate, the net present value is negative. What does this tell her about the rate of return expected for the project?

Janelle Bates has just inherited $250,000 from her uncle's estate. She is considering opening a small sewing and fabric shop. She would need to purchase inventory costing $50,000. Janelle plans to rent a shop in a local shopping center for $12,000 per year. Fixtures, display equipment, and furniture will cost $18,000 and will be depreciated $3,000 per year for 5 years to its expected salvage value of $3,000. Operating costs will amount to $25,000 per year. Janelle estimates her revenues from sales and sewing services will total $65,000. Because Janelle believes she can earn a 10% return by investing in mutual funds, she does not want to start the business unless she can earn at least this rate. Ignore income taxes. Required: 1) Prepare a schedule of expected cash flows for the proposed investment by completing the table provided below. In column 1 enter a brief description of the cash flow. In column 2 indicate whether the cash flow is an inflow (I) or an outflow (O). In column 3 enter the years in which the cash flow will occur. For example, if the cash flow occurs immediately enter a 0. If the cash flow occurs each year enter 1-5, etc. In column 4 enter the cash flow amount. $\begin{array}{|l|c|c|c|}\hline \text { Item Description } & \text { Inflow/Outflow } & \text { Years } & \text { Amount } \\\hline(\mathrm{Col} \text { 1) } & (\mathrm{Col} 2) & \text { (Col 3) } & \text { (Col 4) } \\\hline\\\hline\\\hline\\\hline\\\hline\\\hline\\\hline\end{array}$ 2) What is the initial outlay for this capital investment (the amount of the cash flow at time = 0)? 3) What is the amount of the annual net cash flow for this capital investment? 4) What is the net present value of the proposed venture? Should Janelle proceed?

The payback method shows how long will be required to recover the cost of an investment in a capital asset.

Indicate whether each of the following statements is true or false. 1. The payback method does not take the time value of money into account. 2. The unadjusted rate of return indicates the length of time required to recover the initial cost of an investment. 3. The payback period can only be calculated for capital investments that are expected to provide equal annual cash inflows over their useful lives. 4. Generally, investments with shorter payback periods are preferred. 5. Use of the payback method to analyze capital investments is the best way of identifying the projects that will make the greatest contribution to a company's profits.

A capital investment decision is essentially a decision to exchange current cash outflows for future cash inflows.

Sources of cash inflows from capital investments include incremental expenses and installation costs.