Chapter Eight Exercise 1 1. Basic present value calculations Calculate the present value of the following cash flows, rounding to the nearest dollar:
Chapter Eight Exercise 1
- Basic present value calculations
Calculate the present value of the following cash flows, rounding to the nearest dollar:
- A single cash inflow of $12,000 in 5 years, discounted at a 12% rate of return.
- An annual receipt of $16,000 over the next 12 years, discounted at a 14% rate of return.
- A single receipt of $15,000 at the end of Year 1 followed by a single receipt of $10,000 at the end of Year 3. The company has a 10% rate of return.
- An annual receipt of $8,000 for 3 years followed by a single receipt of $10,000 at the end of Year 4. The company has a 16% rate of return.
Chapter Eight Exercise 3
- Straightforward net present value calculations
Contempo Inc. is considering the acquisition of some new labor-saving equipment. Management estimates that the equipment will cost $42,000 and will produce the following savings in cash operating costs during the next 5 years: Year 1, $15,000; Year 2, $13,000; Year 3, $10,000; Year 4, $10,000; and Year 5, $6,000. The company uses the net present value method to analyze investments and desires a minimum rate of return of 12%.
- Compute the net present value of the proposed investment. Ignore income taxes and round to the nearest dollar.
- Considering the time value of money , should Contempo acquire the new equipment? Why?
Chapter Eight Problem 3
- Straightforward net present value and payback
computations
The Calgary Eskimos play in the Canadian Hockey League. Although the Eskimos will soon be moving to a modern arena, management is studying the possibility of expanding the team’s present facility to accommodate increased crowds. A $2.4 million expansion is planned that has a $200,000 residual value and will be depreciated by the straight-line method over four seasons. Information about the expansion follows:
| Number of seats | Occupancy rate | Ticket price | ||||
| Class 1 seats | 2,500 | 80% | $6 | |||
| Class 2 seats | 2,000 | 60 | 4 |
- The team will play 50 home games each season. Total added operating costs per game (ushers, cleanup, and depreciation) are expected to average $11,800. All such costs, except depreciation, require cash outlays.
- Instructions
- By using the net present value method and a 16% desired rate of return, determine whether the expansion should be undertaken.
- In addition to the cash flows presented here, what other cash flows might change if the Eskimos add on to the arena?
Chapter Eight Problem 4
- Equipment replacement decision
Columbia Enterprises is studying the replacement of some equipment that originally cost $74,000. The equipment is expected to provide 6 more years of service if $8,700 of major repairs are performed in 2 years. Annual cash operating costs total $27,200. Columbia can sell the equipment now for $36,000; the estimated residual value in 6 years is $5,000.
New equipment is available that will reduce annual cash operating costs to $21,000. The equipment costs $103,000, has a service life of 6 years, and has an estimated residual value of $13,000. Company sales will total $430,000 per year with either the existing or the new equipment.
Columbia has a minimum desired return of 12% and depreciates all equipment by the straight-line method.
Instructions
- By using the net present value method, determine whether
Columbia should keep its present equipment or acquire the new equipment. Round
all calculations to the nearest dollar, and ignore income taxes.
- Columbia’s management believes that the time value of money should be considered in all long-term decisions. Briefly discuss the rationale that underlies management’s belief.
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