Chapter 26: Q17RQ (page 1464)
How does compound interest differ from simple interest?
Answer
Simple interest is calculated on principle only whereas compound interest is calculated on both the principal and the previously accrued interest.
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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?
Using NPV to make capital investment decisions Holmes Industries is deciding whether to automate one phase of its production process. The manufacturing equipment has a six-year life and will cost \(910,000.
Year 1 \) 262,000 Year 2 254,000 Year 3 222,000 Year 4 215,000 Year 5 200,000 Year 6 175,000 |
Requirements
Holmes could refurbish the equipment at the end of six years for \(104,000. The refurbished equipment could be used one more year, providing \)77,000 of net cash inflows in year 7. Additionally, the refurbished equipment would have a $55,000 residual value at the end of year 7. Should Holmes invest in the equipment and refurbish it after six years? (Hint: In addition to your answer to Requirement 1, discount the additional cash outflow and inflows back to the present value.)
Question: Defining capital investment terms
Fill in each statement with the appropriate capital investment analysis method:
Payback, ARR, NPV, or IRR. Some statements may have more than one answer.
You are planning for a very early retirement. You would like to retire at age 40 and have enough money saved to be able to withdraw \(215,000 per year for the next 40 years (based on family history, you think you will live to age 80). You plan to save by making 10 equal annual installments (from age 30 to age 40) into a fairly risky investment fund that you expect will earn 10% per year. You will leave the money in this fund until it is completely depleted when you are 80 years old.
Requirements
1. How much money must you accumulate by retirement to make your plan work? (Hint:Find the present value of the \)215,000 withdrawals.)
2. How does this amount compare to the total amount you will withdraw from the investment during retirement? How can these numbers be so different?
How is IRR calculated with unequal net cash inflows?
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