Chapter 26: Q12RQ (page 1464)
What is the accounting rate of return?
Answer
ARR is calculated using accrual accounting rather than net cash inflows.
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Henry Co. is considering acquiring a manufacturing plant. The purchase price is \(1,200,000. The owners believe the plant will generate net cash inflows of \)325,000 annually. It will have to be replaced in six years. Use the payback method to determine whether Henry should purchase this plant. Round to one decimal place.
Calculate the present value of the following future cash flows, rounding all calculations to the nearest dollar.
11. \(5,000 received in three years with interest of 10%
12. \)5,000 received in each of the following three years with interest of 10%
13. Payments of \(2,000, \)3,000, and $4,000 received in years 1, 2, and 3, respectively, with interest of 7%
Suppose Hunter Valley is deciding whether to purchase new accounting software. The payback for the $30,050 software package is two years, and the software’s expected life is three years. Hunter Valley’s required rate of return for this type of project is 10.0%. Assuming equal yearly cash flows, what are the expected annual net cash savings from the new software?
Use the NPV method to determine whether Hawkins Products should invest in the
following projects:
• Project A: Costs \(285,000 and offers seven annual net cash inflows of \)55,000. Hawkins Products requires an annual return of 14% on investments of this nature.
• Project B: Costs \(395,000 and offers 10 annual net cash inflows of \)77,000. Hawkins Products demands an annual return of 12% on investments of this nature.
Requirements
1. What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
2. What is the maximum acceptable price to pay for each project?
3. What is the profitability index of each project? Round to two decimal places.
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.
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