Chapter 26: Q3RQ (page 1463)
What is capital rationing?
Method of awarding capital in most profitable way among the different project is called capital rationing.
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Using ARR to make capital investment decisions Refer to the Henry Hardware information in Exercise E26-20. Assume the project has no residual value. Compute the ARR for the investment. Round to two places.
Henry Hardware is adding a new product line that will require an investment of \(1,512,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of \)310,000 the first year, \(270,000 the second year, and \)240,000 each year thereafter for eight years.
Water City is considering purchasing a water park in Omaha, Nebraska, for \(1,920,000. The new facility will generate annual net cash inflows of \)472,000 for eight years. Engineers estimate that the facility will remain useful for eight years and have no residual value. The company uses straight-line depreciation, and its stockholders demand an annual return of 12% on investments of this nature.
Requirements
1. Compute the payback, the ARR, the NPV, the IRR, and the profitability index of this investment.
2. Recommend whether the company should invest in this project.
Lockwood Company is considering a capital investment in machinery:
Initial investment $ 600,000
Residual value 50,000
Expected annual net cash inflows 100,000
Expected useful life 8 years
Required rate of return 12%
8. Calculate the payback.
9. Calculate the ARR. Round the percentage to two decimal places.
10. Based on your answers to the above questions, should Lockwood invest in the machinery?
Congratulations! You have won a state lottery. The state lottery offers you the following (after-tax) payout options:
Option #1: \(12,000,000 after five years Option #2: \)2,150,000 per year for five years Option #3: $10,000,000 after three years |
Assuming you can earn 6% on your funds, which option would you prefer?
Explain the difference between capital assets, capital investments, and capital budgeting.
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