Pedro's Plumbing uses an interest rate of 20% to evaluate new invest- ment projects. The company is considering a new in-store security system for its Carlton Place branch. The system is budgeted to cost $654,900. The cost will be depreciated over its expected useful life of five years. The new system should increase cash flows by reducing stock shrinkage by $200,000 per year for five years. Because the project is considered to be low risk, it has been suggested that it be evaluated using an interest rate of 14%, not 20%. Required (a) Calculate the net present value at the normal rate of 20%. (b) Calculate the net present value at the low risk rate of 14%. (c) What would happen if the project were to be evaluated at a rate of 16%?

Pedro's Plumbing uses an interest rate of 20% to evaluate new invest- ment projects. The company is considering a new in-store security system for its Carlton Place branch. The system is budgeted to cost $654,900. The cost will be depreciated over its expected useful life of five years. The new system should increase cash flows by reducing stock shrinkage by $200,000 per year for five years. Because the project is considered to be low risk, it has been suggested that it be evaluated using an interest rate of 14%, not 20%. Required (a) Calculate the net present value at the normal rate of 20%. (b) Calculate the net present value at the low risk rate of 14%. (c) What would happen if the project were to be evaluated at a rate of 16%?

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Concept explainers

Cash Flow Statement Analysis

A company's cash flow is the movement of its cash inflows and cash outflows. A cash flow statement is prepared to determine changes in an organization's cash position. A cash flow statement shows how much money was generated and spent on the business during the fiscal year. The cash flow analysis is a method of analyzing an organization's investing, financing, and operating activities. A cash flow statement reveals an organization's liquidity and solvency, as well as its ability to change cash flows in the future. It eliminates the other effects of accounting methods by improving the comparability of different organizations' operational performance.

Question

13. Pedro's Plumbing uses an interest rate of 20% to evaluate new invest-
ment projects. The company is considering a new in-store security system
for its Carlton Place branch. The system is budgeted to cost $654,900.
The cost will be depreciated over its expected useful life of five years. The
new system should increase cash flows by reducing stock shrinkage by
$200,000 per year for five years. Because the project is considered to be
low risk, it has been suggested that it be evaluated using an interest rate
of 14%, not 20%.
Required
(a) Calculate the net present value at the normal rate of 20%.
(b) Calculate the net present value at the low risk rate of 14%.
(c)
What would happen if the project were to be evaluated at a rate of
16%?

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