Chapter 26: Q7RQ (page 1463)
What is the payback method of analyzing capital investments?
The payback method computes the time it takes to recoup the cost of the initial investment in net cash inflows.
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Henry Co. is considering acquiring a manufacturing plant. The purchase price is
Using IRR to make capital investment decisions
Refer to the data regarding Hawkins Products in Exercise E26-25. Compute the IRR of each project, and use this information to identify the better investment.
Hayes Company is considering two capital investments. Both investments have an initial cost of
Year | Plan Alpha | Plan Beta |
1 | \( 1,700,000 | \) 1,700,000 |
2 | 1,700,000 | 2,300,000 |
3 | 1,700,000 | 2,900,000 |
4 | 1,700,000 | 2,300,000 |
5 | 1,700,000 | 1,700,000 |
6 | 1,700,000 | 1,600,000 |
7 | 1,700,000 | 1,200,000 |
8 | 1,700,000 | 800,000 |
9 | 1,700,000 | 400,000 |
10 | 1,700,000 | 2,100,000 |
Total | \( 17,000,000 | \) 17,000,000 |
Requirements
Use Excel to compute the NPV and IRR of the two plans. Which plan, if any, should the company pursue?
Explain the relationship between NPV and IRR. Based on this relationship and the company’s required rate of return, are your answers as expected in Requirement 1? Why or why not?
After further negotiating, the company can now invest with an initial cost of $9,500,000 for both plans. Recalculate the NPV and IRR. Which plan, if any, should the company pursue?
Howard Company operates a chain of sandwich shops. The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of
Requirements
1. Compute the payback, the ARR, the NPV, and the profitability index of these two plans.
2. What are the strengths and weaknesses of these capital budgeting methods?
3. Which expansion plan should Howard Company choose? Why?
4. Estimate Plan A’s IRR. How does the IRR compare with the company’s required rate of return?
Hamilton Company is considering two capital investments. Both investments have an initial cost of
Year | Plan Alpha | Plan Beta |
1 | \(1,600,000 | \)1,600,000 |
2 | \(1,600,000 | 2,200,000 |
3 | \)1,600,000 | 2,800,000 |
4 | \(1,600,000 | 2,200,000 |
5 | \)1,600,000 | 1,600,000 |
6 | \(1,600,000 | 1,500,000 |
7 | \)1,600,000 | 1,300,000 |
8 | \(1,600,000 | 1,100,000 |
9 | \)1,600,000 | 900,000 |
10 | \(1,600,000 | 800,000 |
Total | \)16,000,000 | \(16,000,000 |
Requirements
1. Use Excel to compute the NPV and IRR of the two plans. Which plan, if any, should the company pursue?
2. Explain the relationship between NPV and IRR. Based on this relationship and the company’s required rate of return, are your answers as expected in Requirement 1? Why or why not?
3. After further negotiating, the company can now invest with an initial cost of \)6,500,000. Recalculate the NPV and IRR. Which plan, if any, should the company pursue?
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