Chapter 26: 1RQ (page 1463)
Explain the difference between capital assets, capital investments, and capital budgeting.
Capital assets, capital investments, and capital budgeting are associated with maintaining and utilizing the funds and other resources for the most profitable outcomes.
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How is payback calculated with unequal net cash inflows?
Splash Nation is considering purchasing a water park in Atlanta, Georgia, for \(1,910,000. The new facility will generate annual net cash inflows of \)483,000 foreight years. Engineers estimate that the facility will remain useful for eight years andhave no residual value. The company uses straight-line depreciation, and its stockholdersdemand an annual return of 10% on investments of this nature.
Requirements
1. Compute the payback, the ARR, the NPV, the IRR, and the profitability index ofthis investment.
2. Recommend whether the company should invest in this project.
Refer to Short Exercise S26-4. Assume the expansion has no residual value. What is the project’s NPV (round to nearest dollar)? Is the investment attractive? Why or why not?
Use the Present Value of \(1 table (Appendix A, Table A-1) to determine the present value of \)1 received one year from now. Assume a 8% interest rate. Use the same table to find the present value of \(1 received two years from now. Continue this process for a total of five years. Round to three decimal places.
Requirements
1. What is the total present value of the cash flows received over the five-year period?
2. Could you characterize this stream of cash flows as an annuity? Why or why not?
3. Use the Present Value of Ordinary Annuity of \)1 table (Appendix A, Table A-2) to determine the present value of the same stream of cash flows. Compare your results to your answer to Requirement 1.
4. Explain your findings.
Question: Using the payback and accounting rate of return methods to make capital investment decisions
Consider how Hunter Valley Snow Park Lodge could use capital budgeting to decide whether the \(11,000,000 Snow Park Lodge expansion would be a good investment. Assume Hunter Valley’s managers developed the following estimates concerning the expansion:
Number of additional skiers per day 121 skiers Average number of days per year that weather conditions allow skiing at Hunter Valley 142 days Useful life of expansion (in years) 7 years Average cash spent by each skier per day \) 241 Average variable cost of serving each skier per day 83 Cost of expansion 11,000,000 Discount rate 10% |
Assume that Hunter Valley uses the straight-line depreciation method and expects the lodge expansion to have a residual value of $600,000 at the end of its seven-year life.
Requirements
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