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1. Suny Brockportcns ACC 202 Chapter 12
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ACC 202 CHAPTER 12Planning for capital investments
Brief Exercises
BE 158
DiamondCompanyisconsideringinvestinginnew equipmentthatwill cost$1,400,000 witha 10-year
useful life.The newequipmentisexpectedtoproduce annual netincome of $90,000 overits useful life.
Depreciationexpense,usingthe straight-line rate,is$140,000 peryear.
Instructions
Compute the cashpayback period.
BE 159
Madeline Companyisproposingtospend$200,000 to purchase a machine that will provide annualcash
flowsof $38,000. The appropriate presentvalue factorfor10 periodsis5.65.
Instructions
Compute the proposedinvestment’snetpresentvalueandindicate whetherthe investmentshouldbe
made by Madeline Company.

2. BE 160
LakeFrontCompanyisconsideringinvestinginanew dockthat will cost$560,000. The companyexpects
to use the dock for 5 years,afterwhichit will be soldfor$300,000. LakeFrontanticipatesannual cash
flowsof $110,000 resultingfromthe new dock.The company’sborrowingrate is8%,while itscostof
capital is10%.
Instructions
Calculate the netpresentvalue of the dockandindicate whetherLakeFrontshouldmake the
investment.
BE 161
Mobil Companyhas hiredaconsultantto propose away to increase the company’srevenues.The
consultanthasevaluatedtwomutuallyexclusive projectswiththe followinginformationprovidedfor
each project:
ProjectTurtle ProjectSnake
Capital investment $1,105,000 $625,000
Annual cashflows 180,000 105,000
Estimateduseful life 10 years 10 years
Mobil Companyusesa discountrate of 9% to evaluate bothprojects.
Instructions
(a) Calculate the netpresentvalue of bothprojects.
(b) Calculate the profitabilityindex foreachproject.
(c) WhichprojectshouldMobil accept?
(c) ProjectSnake hasa lowernetpresentvalue thanProjectTurtle,butbecause of itslowercapital
investment,ithasa higherprofitabilityindex.Basedonitsprofitabilityindex,ProjectSnake shouldbe
accepted.

3. Ex. 162
CarlsonBottlingCorporationisconsideringthe purchase of anew bottlingmachine. The machine would
cost $300,000 and has an estimateduseful lifeof 8 yearswithzerosalvage value.Management
estimatesthatthe newbottlingmachine will providenetannual cashflowsof $52,500. Management
alsobelievesthatthe newbottlingmachinewillsave the companymoneybecauseitisexpectedtobe
more reliable thanothermachines,andthuswill reducedowntime.How muchwouldthe reductionin
downtime have tobe worthinorder forthe projectto be acceptable?Assumeadiscountrate of 9%
Ex. 163
StantonCompanyisperformingapost-auditof a projectcompletedone yearago.The initial estimates
were thatthe projectwouldcost$490,000, wouldhave a useful life of 9years,zerosalvage value,and
wouldresultinnetannual cashflowsof $90,000 peryear.Now that the investmenthasbeenin
operationfor1 year,revisedfiguresindicate thatitactuallycost$510,000, will have a useful lifeof 11
years,and will produce netannual cashflowsof $77,000 peryear.Evaluate the successof the project.
Assume adiscountrate of 10%
.
BE 164
Mint Companyiscontemplatinganinvestmentcosting$135,000. The investmentwillhave alife of 8
yearswithno salvage value andwill produce annual cashflowsof $25,305.
Instructions
What isthe approximate internal rate of returnassociatedwiththisinvestment?
BE 165
SaltCompanyisconsideringinvestinginanew facilitytoextractand produce salt.The facilitywill
increase revenuesby$220,000, butit will alsoincrease annual expensesby$160,000. The facilitywill
cost $980,000 to build,anditwill have a$20,000 salvage value atthe endof itsuseful life.
Instructions

4. Calculate the annual rate of return onthisfacility.
Exercises
Ex. 166
Corn Doggy,Inc. producesandsellscorndogs.The corn dogs are dippedbyhand.AustinBeagle,
productionmanager,isconsideringpurchasingamachine thatwill make the corndogs.Austinhas
shoppedformachinesandfoundthatthe machine he wantswill cost$215,000. Inaddition,Austin
estimatesthatthe newmachine will increase the company’sannual netcashinflowsby$33,000. The
machine will have a12-yearuseful life andnosalvage value.
Instructions
(a) Calculate the cashpayback period.
(b) Calculate the machine’sinternal rate of return.
(c) Calculate the machine’snetpresentvalue usingadiscountrate of 10%.
(d) AssumingCornDoggy,Inc.’scost of capital is10%, isthe investmentacceptable?Whyorwhy
not?
Ex. 167
CepedaManufacturingCompanyisconsideringthree new projects,eachrequiringanequipment
investmentof $22,000. Each projectwill lastfor3 years andproduce the followingcashinflows.
Year AA BB CC
1 $ 7,000$ 9,500$11,000
2 9,000 9,500 10,000
3 15,000 9,500 9,000
Total $31,000 $28,500 $30,000

5. The equipment'ssalvage value iszero.Cepedausesstraight-line depreciation.Cepedawill notaccept
any projectwitha paybackperiodover2 years.Cepeda'sminimumrequiredrate of returnis12%.
Instructions
(a) Compute eachproject'spaybackperiod,indicatingthe mostdesirable projectandthe least
desirable projectusingthismethod.(Roundtotwodecimals.)
Ex. 167 (Cont.)
(b) Compute the netpresentvalue of eachproject.Doesyourevaluationchange?(Roundto nearest
dollar.)
Ex. 168
GantnerCompanyisconsideringacapital investmentof $300,000 in additional productive facilities.The
newmachineryisexpectedtohave a useful lifeof 5 yearswithnosalvage value.Depreciationis
computedbythe straight-linemethod.Duringthe life of the investment,annual netincomeandcash
inflowsare expectedtobe $27,000 and $87,000, respectively.Gantnerhasa12% cost of capital rate,
whichisthe minimumacceptable rate of returnonthe investment.
Instructions
(Roundto twodecimals.)
(a) Compute (1) the annual rate of returnand (2) the cash paybackperiodonthe proposedcapital
expenditure.
(b) Usingthe discountedcashflowtechnique,compute the netpresentvalue.
Ex. 169

6. Top GrowthFarms, a farmingcooperative,isconsideringpurchasingatractor for$551,500. The machine
has a 10-year life andan estimatedsalvagevalue of $36,000. Deliverycostsandset-upchargeswill be
$12,100 and$400, respectively.TopGrowthusesstraight-linedepreciation.
Top Growthestimatesthatthe tractor will be usedfive timesaweekwiththe average charge tothe
individualfarmersof $400. Fuel is$50 for eachuse of the tractor. The presentvalue of an annuityof 1
for 10 yearsat 9% is 6.418.
Instructions
For the new tractor, compute the:
(a) cash paybackperiod.
(b) netpresentvalue.
(c) annual rate of return.
Ex. 170
Tom Bat became a baseball enthusiastata veryearlyage.All of hisbaseball experience hasprovided
himvaluable knowledge of the sport,andhe is thinkingaboutgoingintothe battingcage business.He
estimatesthe constructionof astate-of-the-artbuildingandthe purchase of necessaryequipmentwill
cost $840,000. Boththe facilityandthe equipmentwill be depreciatedover12 yearsusingthe straight-
line methodandare expectedtohave zerosalvage values.Hisrequiredrate of returnis9% (present
value factorof 7.1607). Estimatedannual netincome andcashflowsare as follows:
Revenue $350,500
Less:
Utilitycost 40,000
Supplies 8,000
Labor 141,000
Depreciation 70,000
Other 38,500 297,500
Netincome $ 53,000

7. Instructions
For thisinvestment,calculate:
(a) The net presentvalue.
(b) The internal rate of return.
(c) The cash payback period.
Ex. 171
Mimi Companyisconsideringacapital investmentof $275,000 in new equipment.The equipmentis
expectedtohave a5-year useful lifewithnosalvage value.Depreciationiscomputedbythe straight-line
method. Duringthe life of the investment,annual netincomeandcashinflowsare expectedtobe
$25,000 and$80,000, respectively.Mimi'sminimumrequiredrate of returnis10%. The presentvalue of
1 for5 periodsat10% is .621 and the presentvalue of anannuityof 1 for5 periodsat10% is3.791.
Instructions
Compute eachof the following:
(a) cash paybackperiod.
(b) netpresentvalue.
(c) annual rate of return.
Ex. 172
SavannaCompanyisconsideringtwocapital investmentproposals.Relevantdataoneachprojectare as
follows:
ProjectRed ProjectBlue
Capital investment $440,000 $640,000
Annual netincome 25,000 60,000
Estimateduseful life 8 years 8 years

8. Depreciationiscomputedbythe straight-line methodwithnosalvage value.Savannarequiresan8%
rate of returnon all newinvestments.The presentvalue of 1for 8 periodsat8% is .540 and the present
value of an annuityof 1 for8 periodsis5.747.
Instructions
(a) Compute the cashpayback periodforeachproject.
(b) Compute the netpresentvalue foreachproject.
(c) Compute the annual rate of returnforeach project.
(d) WhichprojectshouldSavannaselect?
Ex. 173
Yappy Companyisconsideringacapital investmentof $320,000 in additional equipment.The new
equipmentisexpectedtohave a useful life of 8yearswithno salvage value. Depreciationiscomputed
by the straight-linemethod. Duringthe life of the investment,annual netincomeandcashinflowsare
expectedtobe $22,000 and $62,000, respectively.Yappyrequiresa10% returnon all new investments.
PresentValue of anAnnuityof 1
Period 8% 9% 10% 11% 12% 15%
8 5.747 5.535 5.335 5.146 4.968 4.487
Instructions
(a) Compute eachof the following:
1. Cash paybackperiod.
2. Netpresentvalue.
3. Profitabilityindex.
4 Internal rate of return.

9. 5. Annual rate of return.
(b) Indicate whetherthe investmentshouldbe acceptedorrejected.
Ex. 174
Laramie Service Centerjustpurchasedanautomobilehoistfor$16,900. The hoisthas a 5-year life and
an estimatedsalvage value of $1,250. Installationcostswere $3,770, and freight chargeswere $960.
Laramie usesstraight-line depreciation.
The newhoistwill be usedtoreplace mufflersandtiresonautomobiles.Laramie estimatesthatthe new
hoistwill enablehismechanicstoreplace fourextramufflersperweek.Eachmufflersells for$85
installed.The costof a muffleris$46, and the laborcost to install amuffleris$13.
Instructions
(a) Compute the paybackperiodforthe new hoist.
(b) Compute the annual rate of returnforthe new hoist.(Roundtoone decimal.)
Ex. 175
Sophie’sPetShopisconsideringthe purchase of anew deliveryvan.Sophie Smith,ownerof the shop,
has compiledthe followingestimatesintryingtodeterminewhetherthe deliveryvanshouldbe
purchased:
Cost of the van $35,000
Annual netcash flows 6,000
Salvage value 4,000
Estimateduseful life 8 years
Cost of capital 10%
Presentvalue of anannuityof 1 5.335

10. Presentvalue of 1 .467
Sophie'sassistantmanageristryingtoconvince Sophie thatthe vanhas otherbenefitsthatshe hasn't
consideredinthe initialestimates.These additional benefits,includingthe free advertisingthe store's
name paintedonthe van's doorswill provide,are expectedtoincrease netcashflowsby$500 each
year.
Instructions
(a) Calculate the netpresentvalue of the van,basedonthe initial estimates.Shouldthe vanbe
purchased?
(b) Calculate the netpresentvalue,incorporatingthe additional benefitssuggestedbythe assistant
manager.Shouldthe vanbe purchased?
(c) Determine howmuchthe additionalbenefitswouldhave tobe worthinorderfor the van tobe
purchased.
Ex. 176
VistaCompanyisconsideringtwonewprojects,eachrequiringanequipmentinvestmentof $97,000.
Each projectwill lastforthree yearsand produce the followingcashinflows:
Year Cool Hot
1 $ 38,000 $ 42,000
2 43,000 42,000
3 48,000 42,000
$129,000 $126,000
The equipmentwill have nosalvage value atthe endof itsthree-yearlife.VistaCompanyusesstraight-
line depreciationandrequiresaminimum rate of returnof 12%.

11. Presentvalue dataare as follows:
PresentValue of 1 PresentValue of anAnnuityof 1
Period 12% Period 12%
1 .893 1 .893
2 .797 2 1.690
3 .712 3 2.402
Instructions
(a) Compute the netpresentvalue of eachproject.
(b) Compute the profitabilityindexof eachproject.
(c) Whichprojectshouldbe selected? Why?
Ex. 177
KSU Corp. isconsideringpurchasingone of twonew diagnosticmachines. Eithermachine wouldmake it
possible forthe companytobidon jobsthat itcurrentlyisn'tequippedtodo.Estimatesregardingeach
machine are providedbelow.
Machine A Machine B
Original cost $106,000 $ 175,000
Estimatedlife 8 years 8 years
Salvage value -0- -0-
Estimatedannual cashinflows $30,000 $45,000
Estimatedannual cashoutflows$10,000 $15,000

12. Instructions
Calculate the netpresentvalue andprofitabilityindex of eachmachine.Assume a9% discountrate.
Whichmachine shouldbe purchased?
Ex. 178
SantanaCompanyis consideringinvestinginaprojectthat will cost$151,000 and have no salvage value
at the endof its5-year life.Itisestimatedthatthe projectwill generate annual cashinflowsof $40,000
each year.The companyrequiresa9% rate of returnand usesthe followingcompoundinteresttable:
PresentValue of anAnnuityof 1
Period 6% 8% 9% 10% 11% 12%
15%
5 4.212 3.993 3.890 3.791 3.696 3.605 3.352
Instructions
(a) Compute (1) the netpresentvalue and(2) the profitabilityindexof the project.
(b) Compute the internal rate of returnonthis project.
(c) ShouldSantanainvestinthisproject?
Ans:N/A,LO: 3,5,7, Bloom:E,Difficulty:Medium, Min:10,AACSB:Analytic,AICPA BB:Resource
Management,AICPA FN:RiskAnalysis,AICPA PC:ProblemSolving/DecisionMaking,IMA: Quantitative
Methods
Ex. 179
JohnsonCompanyisconsideringpurchasingone of twonew machines.The followingestimatesare
available foreachmachine:

13. Machine 1 Machine 2
Initial cost $152,000 $169,000
Annual cashinflows 50,000 60,000
Annual cashoutflows 15,000 20,000
Estimateduseful life 6 years 6 years
The company's minimumrequiredrate of returnis9%.
PresentValue of anAnnuityof 1
Period 8% 9% 10% 11% 12% 15%
6 4.623 4.486 4.355 4.231 4.111 3.784
Instructions
(a) Compute the (1) netpresentvalue,(2) profitabilityindex,and(3) internal rate of returnforeach
machine.
(b) Whichmachine shouldbe purchased?
Ex. 180
PlatoonCompanyisperformingapost-auditof aprojectthat wasestimatedtocost$420,000, have a
useful lifeof 6 yearswitha zerosalvage value,andresultinnetcashinflowsof $100,000 per year.After
the investmentwasinoperationforayear,revisedfiguresindicate thatitactuallycost$470,000, will
have a 9-year useful life,andwillproduce netcashinflowsof $77,000. The presentvalue of anannuity
of 1 for 6 yearsat 10% is4.355 and for9 yearsis 5.759.
Instructions
Determine whetherthe projectshouldhave beenacceptedbasedon(a) the original estimatesandthen
on (b) the actual amounts.

14. Ex. 181
ShillingCorp.isthinkingaboutopeningabaseball campinFlorida.Inorderto start the camp, the
companywouldneedtopurchase land,buildfive baseball fields,andadormitory-type sleepingand
diningfacilitytohouse 100 players.Eachyear the camp wouldbe runfor 10 sessionsof 1 weekeach.
The company wouldhire collegebaseball playersascoaches.The campattendeeswouldbe baseball
playersage 12-18. PropertyvaluesinFloridahave enjoyedasteadyincrease invalue.Itis expectedthat
afterusingthe facilityfor20 years,Shillingcansell the propertyformore thanit wasoriginally
purchasedfor.The followingamountshave beenestimated:
Cost of land $ 630,000
Cost to builddormanddiningfacility 2,100,000
Annual cashinflowsassuming100playersand10 weeks2,520,000
Annual cashoutflows 2,260,000
Estimateduseful life 20 years
Salvage value 4,400,000
Discountrate 10%
Presentvalue of anannuityof 1 8.514
Presentvalue of 1 .149
Ex. 181 (Cont.)
Instructions
(a) Calculate the netpresentvalue of the project.
(b) To gauge the sensitivityof the projecttothese estimates,assume thatif only80 campersattend
each week,revenueswillbe $2,085,000 and expenseswill be $1,865,000. What is the net presentvalue
usingthese alternative estimates? Discussyourfindings.
(c) Assumingthe original facts,whatisthe netpresentvalue if the projectisactuallyriskierthan
firstassumed,anda 12% discountrate ismore appropriate? The presentvalue of 1 at 12% is.104 and
the presentvalue of anannuityof 1 is7.469.

15. Ex. 182
Ace Corporationrecentlypurchasedanew machine foritsfactoryoperationsata cost of $950,000. The
investmentisexpectedtogenerate $250,000 inannual cash flowsfora periodof five years.The
requiredrate of returnis8%. The newmachine isexpectedtohave zerosalvage value atthe endof the
five-yearperiod.
Instructions
Calculate the internal rate of return.(Table 4from AppendixCisneeded.)
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