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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Question
Evaluating Alternative Investments
Use the present and future value tables provided in this week’s reading to solve the situations depicted below:
1. Bob’s Music Store is doing well in the area. He has some excess cash in the bank account and is looking at different alternatives that might bring more return than the meager rate his bank is offering. He currently receives 2% interest from his bank, which we will use to determine the net present value of each alternative. He has narrowed it down to two options:
Alternative A: The first option is to upgrade and customize his computer system. The cost will be $3,000. He expects to save $1,800 per year in labor costs as a result of the additional automation. He also believes he will be able to sell any computer hardware for $500 at the end of the 3-year horizon he is looking at before having to upgrade once again.
Alternative B: The second option is to expand his current inventory by offering a new line of guitars. The initial outlay of the expansion is $8,000. He expects current annual sales of $80,000 to increase by 5% per year. In addition, he will have to pay $500 to renovate his current sales floor to accommodate the additional inventory. He is using the same 3-year horizon as in the first option.
What is the net present value of each alternative?
2. Margo of Margo’s Curios is looking for ways to increase her sales and, hopefully, her net income. She is considering two alternatives which she believes will result in increased business. Her current investments earn 4% and she plans to use a 4-year horizon to determine the best approach.
Option A: Her first option is to increase her current advertising expense of $1,800 per year by 15%. As a result, she expects her annual sales of $25,000 to increase by 2% and her annual labor cost of $4,800 to also increase by 2%.
Option B: Her second option is to pay for a new website design. It will cost $300 up front and $300 per year in maintenance. She expects this to increase her annual sales by 2% per year.
Calculate the net present value of each alternative.
Round answers to the nearest whole dollar.
1. Alternative A NPV________ Alternative B NPV___________
2. Option A NPV ___________ Option B NPV ___________
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