Chapter 26: Q5RQ (page 1463)
List some common cash inflows from capital investments.
Investment, cash operating cost savings, and any future residual.
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Explain the difference between the present value factor tables—Present Value of \(1 and Present Value of Ordinary Annuity of \)1.
How can spreadsheet software, such as Excel, help with sensitivity analysis?
Outlining the capital budgeting process Review the following activities of the capital budgeting process: a. Budget capital investments. b. Project investments’ cash flows. c. Perform post-audits. d. Make investments. e. Use feedback to reassess investments already made. f. Identify potential capital investments. g. Screen/analyze investments using one or more of the methods discussed. Place the activities in sequential order as they occur in the capital budgeting process.
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
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?
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