Chapter 24: Q2DQ (page 1083)
What is capital budgeting?
Capital budgeting is analyzing alternative long-term investments such as the purchase of machines or buildings.
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Retsa Company is considering an investment in technology to improve its operations. The investment will require an initial outlay of \(800,000 and will yield the following expected cash flows. Management requires investments to have a payback period of two years, and it requires a 10% return on its investments.
Period Cash Flow
1 . . . . . . . . . . . . \)450,000
2 . . . . . . . . . . . . 400,000
3 . . . . . . . . . . . . 350,000
4 . . . . . . . . . . . . 300,000
Required
1. Determine the payback period for this investment. (Round the answer to one decimal.)
2. Determine the break-even time for this investment. (Round the answer to one decimal.)
3. Determine the net present value for this investment.
Analysis Component
4. Should management invest in this project? Explain.
5. Compare your answers for parts 1 through 4 with those for Problem 24-5B. What are the causes of the differences in results and your conclusions?
Samsung’s annual report includes information about its debt and interest rates. Its annual report reveals that Samsung recently issued bonds with an interest rate of 4.1%. Required Explain how Samsung would use that 4.1% rate to evaluate its investments in capital projects.
Following is information on two alternative investments being considered by Tiger Co. The company requires a 4% return from its investments.
Project X1 Project X2
Initial investment . . . . . . . . . . . . . . . . . . . . . . . . . \((80,000) \)(120,000)
Expected net cash flows in year:
1........................ 25,000 60,000
2........................ 35,500 50,000
3........................ 60,500 40,000
Compute each project’s (a) net present value and
(b) profitability index. (Round present value calculations to the nearest dollar and round the profitability index to two decimal places.) If the company can choose only one project, which should it choose? Explain.
Refer to the information in Exercise 24-5. Assume the company requires a 10% rate of return on its investments. Compute the net present value of each potential investment. (Round to the nearest dollar.)
Heels, a shoe manufacturer, is evaluating the costs and benefits of new equipment that would custom fit each pair of athletic shoes. The customer would have his or her foot scanned by digital computer equipment; this information would be used to cut the raw materials to provide the customer a perfect fit. The new equipment costs \(90,000 and is expected to generate an additional \)35,000 in cash flows for five years. A bank will make a \(90,000 loan to the company at a 10% interest rate for this equipment’s purchase. Use the following table to determine the break-even time for this equipment. (Round the present value of cash flows to the nearest dollar.)
Present Value Present Value Cumulative Present Value
Year Cash Flows* of 1 at 10% of Cash Flows of Cash Flows
0 \)(90,000) 1.0000
1 35,000 0.9091
2 35,000 0.8264
3 35,000 0.7513
4 35,000 0.6830
5 35,000 0.6209
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