1. Capital Investment Decisions
Chapter 26
Capital Investment Decisions
Demonstration Problems
© 2016 Dr. Keith D. Moon

2. E26-19
Rapp Hardware is adding a new product line that will require an investment of $1,418,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of $310,000 the first year, $290,000 the second year, and $250,000 each year thereafter for eight years. Compute the payback period. Round to one decimal place.
© 2016 Dr. Keith D. Moon

3. E26-19 Net Cash Outflows Net Cash Inflows Year Amount Invested Annual
Accumulated
$ 1,418,000 1
$ 310,000
$ 310,000 2 3 4 5 6 7 8 9 10
© 2016 Dr. Keith D. Moon

4. E26-19 Net Cash Outflows Net Cash Inflows Year Amount Invested Annual
Accumulated
$ 1,418,000 1
$ 310,000
$ 310,000 2
290,000
600,000 3 4 5 6 7 8 9 10
© 2016 Dr. Keith D. Moon

5. E26-19 Net Cash Outflows Net Cash Inflows Year Amount Invested Annual
Accumulated
$ 1,418,000 1
$ 310,000
$ 310,000 2
290,000
600,000 3
250,000
850,000 4 5 6 7 8 9 10
© 2016 Dr. Keith D. Moon

6. E26-19 Net Cash Outflows Net Cash Inflows Year Amount Invested Annual
Accumulated
$ 1,418,000 1
$ 310,000
$ 310,000 2
290,000
600,000 3
250,000
850,000 4
1,100,000 5 6 7 8 9 10
© 2016 Dr. Keith D. Moon

7. E26-19 Net Cash Outflows Net Cash Inflows Year Amount Invested Annual
Accumulated
$ 1,418,000 1
$ 310,000
$ 310,000 2
290,000
600,000 3
250,000
850,000 4
1,100,000 5
1,350,000 6 7 8 9 10
© 2016 Dr. Keith D. Moon

8. E26-19 Net Cash Outflows Net Cash Inflows Year Amount Invested Annual
Accumulated
$ 1,418,000 1
$ 310,000
$ 310,000 2
290,000
600,000 3
250,000
850,000 4
1,100,000 5
1,350,000 6
1,600,000 7 8 9 10
© 2016 Dr. Keith D. Moon

9. E26-19 Net Cash Outflows Net Cash Inflows Year Amount Invested Annual
Accumulated
$ 1,418,000 1
$ 310,000
$ 310,000 2
290,000
600,000 3
250,000
850,000 4
1,100,000 5
1,350,000 6
1,600,000 7
1,850,000 8 9 10
© 2016 Dr. Keith D. Moon

10. E26-19 Net Cash Outflows Net Cash Inflows Year Amount Invested Annual
Accumulated
$ 1,418,000 1
$ 310,000
$ 310,000 2
290,000
600,000 3
250,000
850,000 4
1,100,000 5
1,350,000 6
1,600,000 7
1,850,000 8
2,100,000 9 10
© 2016 Dr. Keith D. Moon

11. E26-19 Net Cash Outflows Net Cash Inflows Year Amount Invested Annual
Accumulated
$ 1,418,000 1
$ 310,000
$ 310,000 2
290,000
600,000 3
250,000
850,000 4
1,100,000 5
1,350,000 6
1,600,000 7
1,850,000 8
2,100,000 9
2,350,000 10
© 2016 Dr. Keith D. Moon

12. E26-19 Net Cash Outflows Net Cash Inflows Year Amount Invested Annual
Accumulated
$ 1,418,000 1
$ 310,000
$ 310,000 2
290,000
600,000 3
250,000
850,000 4
1,100,000 5
1,350,000 6
1,600,000 7
1,850,000 8
2,100,000 9
2,350,000 10
2,600,000
© 2016 Dr. Keith D. Moon

13. Amount needed to complete inflows at the end of Year 5
recovery in Year 6 =
Amount invested −
Accumulated net cash
inflows at the end of Year 5
© 2016 Dr. Keith D. Moon

14. Amount needed to complete inflows at the end of Year 5
recovery in Year 6 =
Amount invested −
Accumulated net cash
inflows at the end of Year 5
$1,418,000
$1,350,000
© 2016 Dr. Keith D. Moon

15. Amount needed to complete inflows at the end of Year 5
recovery in Year 6 =
Amount invested −
Accumulated net cash
inflows at the end of Year 5
$1,418,000
$1,350,000
$68,000
© 2016 Dr. Keith D. Moon

16. Amount needed to complete recovery in year 6
Payback =
5 years +
Amount needed to complete recovery in year 6
Net cash inflow in year 6
© 2016 Dr. Keith D. Moon

17. Amount needed to complete recovery in year 6
Payback =
5 years +
Amount needed to complete recovery in year 6
Net cash inflow in year 6
$68,000
$250,000
© 2016 Dr. Keith D. Moon

18. Amount needed to complete recovery in year 6
Payback =
5 years +
Amount needed to complete recovery in year 6
Net cash inflow in year 6
$68,000
$250,000
0.3 years
© 2016 Dr. Keith D. Moon

19. Amount needed to complete recovery in year 6
Payback =
5 years +
Amount needed to complete recovery in year 6
Net cash inflow in year 6
$68,000
$250,000
0.3 years
5.3 years
© 2016 Dr. Keith D. Moon

20. E26-24
Use the NPV method to determine whether Juda Products should invest in the following projects:
Project A: Costs $290,000 and offers seven annual net cash inflows of $57,000. Juda Products requires an annual return of 14% on investments of this nature.
Project B: Costs $395,000 and offers 10 annual net cash inflows of $70,000. Juda Products demands an annual return of 12% on investments of this nature.
Requirements
What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
What is the maximum acceptable price to pay for each project?
What is the profitability index of each project? Round to two decimal places.
© 2016 Dr. Keith D. Moon

21. E26-24
Requirement 1: What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
Net
Cash
Inflow
Annuity PV Factor
Present
Value
Years
(i = 14%, n = 7)
(i = 12%, n = 10)
Project A:
© 2016 Dr. Keith D. Moon

22. E26-24
Requirement 1: What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
Net
Cash
Inflow
Annuity PV Factor
Present
Value
Years
(i = 14%, n = 7)
(i = 12%, n = 10)
Project A:
1 – 7
Present value of annuity
$ 57,000
× 4.288
$ 244,416
© 2016 Dr. Keith D. Moon

23. E26-24
Requirement 1: What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
Net
Cash
Inflow
Annuity PV Factor
Present
Value
Years
(i = 14%, n = 7)
(i = 12%, n = 10)
Project A:
1 – 7
Present value of annuity
$ 57,000
× 4.288
$ 244,416
Initial investment
(290,000)
© 2016 Dr. Keith D. Moon

24. E26-24
Requirement 1: What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
Net
Cash
Inflow
Annuity PV Factor
Present
Value
Years
(i = 14%, n = 7)
(i = 12%, n = 10)
Project A:
1 – 7
Present value of annuity
$ 57,000
× 4.288
$ 244,416
Initial investment
(290,000)
Net present value of the project
$ 45,584
© 2016 Dr. Keith D. Moon

25. E26-24
Requirement 1: What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
Net
Cash
Inflow
Annuity PV Factor
Present
Value
Years
(i = 14%, n = 7)
(i = 12%, n = 10)
Project A:
1 – 7
Present value of annuity
$ 57,000
× 4.288
$ 244,416
Initial investment
(290,000)
Net present value of the project
$ 45,584
Project B:
© 2016 Dr. Keith D. Moon

26. E26-24
Requirement 1: What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
Net
Cash
Inflow
Annuity PV Factor
Present
Value
Years
(i = 14%, n = 7)
(i = 12%, n = 10)
Project A:
1 – 7
Present value of annuity
$ 57,000
× 4.288
$ 244,416
Initial investment
(290,000)
Net present value of the project
$ 45,584
Project B:
1 – 10
$ 70,000 ×
5.650
$ 395,500
© 2016 Dr. Keith D. Moon

27. E26-24
Requirement 1: What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
Net
Cash
Inflow
Annuity PV Factor
Present
Value
Years
(i = 14%, n = 7)
(i = 12%, n = 10)
Project A:
1 – 7
Present value of annuity
$ 57,000
× 4.288
$ 244,416
Initial investment
(290,000)
Net present value of the project
$ 45,584
Project B:
1 – 10
$ 70,000 ×
5.650
$ 395,500
(395,000)
© 2016 Dr. Keith D. Moon

28. E26-24
Requirement 1: What is the NPV of each project? Assume neither project has a residual value. Round to two decimal places.
Net
Cash
Inflow
Annuity PV Factor
Present
Value
Years
(i = 14%, n = 7)
(i = 12%, n = 10)
Project A:
1 – 7
Present value of annuity
$ 57,000
× 4.288
$ 244,416
Initial investment
(290,000)
Net present value of the project
$ 45,584
Project B:
1 – 10
$ 70,000 ×
5.650
$ 395,500
(395,000)
$ (500)
© 2016 Dr. Keith D. Moon

29. E26-24
Requirement 2: What is the maximum acceptable price to pay for each project?
© 2016 Dr. Keith D. Moon

30. E26-24
Requirement 2: What is the maximum acceptable price to pay for each project?
The maximum acceptable price to pay is $244,416 for Project A and $395,500 for project B (the total present value of net cash inflows from each project, calculated in Requirement 1).
© 2016 Dr. Keith D. Moon

31. Present value of net cash inflows
Requirement 3: What is the profitability index of each project? Round to two decimal places.
Present value of net cash inflows
Initial investment =
Profitability Index
© 2016 Dr. Keith D. Moon

32. Present value of net cash inflows
Requirement 3: What is the profitability index of each project? Round to two decimal places.
Present value of net cash inflows
Initial investment =
Profitability Index
Project A
$ 244,416
$ 290,000
0.84 (rounded)
© 2016 Dr. Keith D. Moon

33. Present value of net cash inflows
Requirement 3: What is the profitability index of each project? Round to two decimal places.
Present value of net cash inflows
Initial investment =
Profitability Index
Project A
$ 244,416
$ 290,000
0.84 (rounded)
Project B
$ 395,500
$ 395,000
1.00 (rounded)
© 2016 Dr. Keith D. Moon

34. Present value of net cash inflows
Requirement 3: What is the profitability index of each project? Round to two decimal places.
Present value of net cash inflows
Initial investment =
Profitability Index
Project A
$ 244,416
$ 290,000
0.84 (rounded)
Project B
$ 395,500
$ 395,000
1.00 (rounded)
© 2016 Dr. Keith D. Moon