Chapter 26: Q8RQ (page 1463)
How is payback calculated with equal net cash inflows?
Answer
The payback period calculates by dividing by keeping the original investment amount in the numerator and the annual cash flow in the denominator.
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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.
Hicks Company is considering an investment opportunity with the following expected net cash inflows: Year 1, \(235,000; Year 2, \)195,000; Year 3, \(125,000. The company uses a discount rate of 6%, and the initial investment is \)365,000. Calculate the NPV of the investment. Should the company invest in the project? Why or why not?
Splash Nation is considering purchasing a water park in Atlanta, Georgia, for \(1,910,000. The new facility will generate annual net cash inflows of \)483,000 foreight years. Engineers estimate that the facility will remain useful for eight years andhave no residual value. The company uses straight-line depreciation, and its stockholdersdemand an annual return of 10% on investments of this nature.
Requirements
1. Compute the payback, the ARR, the NPV, the IRR, and the profitability index ofthis investment.
2. Recommend whether the company should invest in this project.
Your grandfather would like to share some of his fortune with you. He offers to give you money under one of the following scenarios (you get to choose):
1. \(7,250 per year at the end of each of the next eight years
2. \)49,650 (lump sum) now
3. $98,650 (lump sum) eight years from now
Requirements
1. Calculate the present value of each scenario using an 8% discount rate. Which scenario yields the highest present value? Round to nearest whole dollar.
2. Would your preference change if you used a 10% discount rate?
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
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