Chapter 26: Q9RQ (page 1463)
How is payback calculated with unequal net cash inflows?
Answer
Payback Period = Initial Investment / Net Cash Flow per period
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S26-2 Using payback to make capital investment decisions
Carter Company is considering three investment opportunities with the following payback periods:
Project A | Project B | Project C | |
Payback period | 2.7 years | 6.4 years | 3.8 years |
Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being equal.
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?
What are post-audits? When are they conducted?
Why are net present value and internal rate of return considered discounted cash flow methods?
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 \(8,500,000. Expected annual net cash inflows are \)1,600,000 for 10 years, with zero residual value at the end of 10 years. Under Plan B, Howard Company would open three larger shops at a cost of \(8,100,000. This plan is expected to generate net cash inflows of \)1,000,000 per year for 10 years, which is the estimated useful life of the properties. Estimated residual value for Plan B is $990,000. Howard Company uses straight-line depreciation and requires an annual return of 6%.
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?
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