Chapter 13

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University of Guelph *

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Finance

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Feb 20, 2024

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Capital Budgeting Decisions Exercise 13-1 1. Item Year(s) Cash Flow Present Value of Cash Flows* Annual cost savings ............... 1-5 $25,000 $99,825 Initial investment. . Now $(80,000 ) (80,000 ) Net present value. $19,825 *Calculated using NPV formula in Microsoft Excel and an 8% required return. PV for cashflows year 1-5 Year 1: 25,000 x 0.926 = 23,150 Year 2: 25,000 x 0.857 = 21,425 Exercise 13-3 1. The solar panel’s net present value without considering the intangible benefits would be: Item Year(s ) Amount of Cash Flows Present Value of Cash Flows* Cost of the equipment .............. Now $(2,000,00 0) $(2,000,000) Annual cash savings. 1-15 $200,000 1,521,000

Net present value ...... $(479,000 ) *Calculated using NPV formula in Microsoft Excel and a 10% required return. 2. The annual value of the intangible benefits would have to be large enough to offset the $478,784 negative present value for the equipment. Using the PMT formula in Microsoft Excel, the required increase in annual cash flows to offset the negative NPV of $478,784 is approximately $62,948. In other words, the goodwill created among customers from investing in solar panels would need to generate an incremental contribution margin of nearly $63,000 ignoring taxes. Exercise 13-5 1. The payback period is determined as follows: Year Investme nt Cash Inflow Unrecovered Investment 1 $15,000 $1,000 $14,000 2 $12,500 $2,000 $24,500 3 $2,500 $22,000 4 $4,000 $18,000 5 $5,000 $13,000 6 $6,000 $7,000 7 $5,000 $2,000 8 $4,000 $0 9 $3,000 $0 10 $2,000 $0

The investment in the project is fully recovered in the 7th year. To be more exact, the payback period is approximately 6.5 years. 2. Since the investment is recovered prior to the last year, the amount of the cash inflow in the last year has no effect on the payback period. Exercise 13-7 Item Year(s ) Amount of Cash Flows Present Value of Cash Flows* Project Alpha: Investment required .............. Now $(30,000) $(30,000) Annual cash inflows ................ 1-10 $8,000 53,681 Net present value. $ 23,681 Project Beta: Investment ........... Now $(30,000) $(30,000) Cash inflow ........... 10 $120,000 55,583 Net present value. $ 25,583 *Calculated using NPV formula in Microsoft Excel and an 8% required return. Project B should be selected since it provides a higher net present value. Exercise 13-11 1. The payback period would be: Payback period = Investment required Net annualcashinflow 4.2 years = $ 210,000 $ 50,000 Yes, the boat would be purchased, since the 4.2-year payback period is less than the company’s maximum 5-year payback period.

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Exercise 13-15 1. Computation of the annual cash inflow associated with the new go-cart track: Operating income ................................ $73,000 Add: Noncash deduction for depreciation ...................................... 63,000 Net annual cash inflow ........................ $136,000 The payback computation would be: Payback period = Investment required Net annualcashinflow = $ 680,000 $ 136,000 = 5 Yes, the go-cart track meets the requirement. The payback period is less than the maximum 6 years required.