Concept explainers
Using payback, APR,
Learning Objectives 2,4
- Plan A 1.39 profitability index; Plan B $(187,580) NPV
Howard Company operates a chain of sandwich shops. The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of $8,500,000. Expected annual net
Requirements
- Compute the payback, the ARR, the NPV, and the profitability index of these two plans.
- What are the strengths and weaknesses of these capital budgeting methods?
- Which expansion plan should Howard Company choose? Why?
- Estimate Plan A's IRR. How does the IRR compare with the company's required
rate of return ?
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Chapter 26 Solutions
Horngren's Accounting (12th Edition)
- Your company is planning to purchase a new log splitter for is lawn and garden business. The new splitter has an initial investment of $180,000. It is expected to generate $25,000 of annual cash flows, provide incremental cash revenues of $150,000, and incur incremental cash expenses of $100,000 annually. What is the payback period and accounting rate of return (ARR)?arrow_forwardA bookstore is planning to purchase an automated inventory/remote marketing system, which includes an upgrade to a more sophisticated cash register system. The package has an initial investment cost of $360,000. It is expected to generate $144,000 of annual cash flows, reduce costs and provide incremental cash revenues of $326,000, and incur incremental cash expenses of $200,000 annually. What is the payback period and accounting rate of return (ARR)?arrow_forwardUsing Excel for capital budgeting calculations Download an Excel template for this problem online in MyAccountingLab or at http://www.pearsonhighered.com/Horngren. Glacier Creek Textiles is planning to purchase new manufacturing equipment. The equipment has an acquisition cost of $100,000, an estimated useful life of five years and no residual value. The company uses a 12% rate of return to evaluate capital projects. The cash flows for the five years are: Requirements Compute the accounting rate of return. Compute the net present value of the investment using Excel’s PV function. Compute the net present value of the investment using Excel’s NPV function. Compute the profitability index, rounded to two decimal places. Compute the internal rate of return of the investment using Excel’s IRR function. Display to two decimal places, but do not round.arrow_forward
- K Mc Graw Hill You are asked to evaluate the following two projects for the Norton corporation. Use a discount rate of 13 percent. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. Project X (Videotapes of the Weather Report) ($18,000 Investment) Year Cash Flow 1 $ 9,000 2 7,000 8,000 7,600 3 4 Profitability index Project Y (Slow-Motion Replays of Commercials) ($38,000 Investment) Cash Flow $ 19,000 12,000 13,000 15,000 a. Calculate the profitability index for project X. Note: Do not round intermediate calculations and round your answer to 2 decimal places. Year 1 2 3 4 Profitability index b. Calculate the profitability index for project Y. Note: Do not round intermediate calculations and round your answer to 2 decimal places. c. Which project would you select based on the profitability index? O Project X Project Y Project Yarrow_forwardYou were approached with the task of assessing three supposedly value-enhancing investment opportunities your company is considering. The cash flows for each are listed below. Assume that all three projects are equally risky and have a discount rate of 6.00% per year. Time Project A Project B Project C 01234 -$250 -$1,200 -$1,800 $50 $300 $750 $50 $500 $350 $50 $600 $750 $50 $1,000 $450 Infinity $50 Calculate the payback period for project "B". Note: Report your answer in years rounded to two decimal places. If it is impossible to compute the answer, report 0.00 as your response.arrow_forwardYou have four independant projects to consider investing in to improve your companies facilities. Their details are given in the following table: Answers entered using text are case sensitive! Alternative A B C D Cash Flows at the end of each year 1 2 -$100,000 $25,000 $25,000 -$120,000 5,000 10,000 -$90,000 50,000 50,000 -$90,000 0 0 0 3 $25,000 20,000 10,000 0 4 $25,000 40,000 0 0 5 $25,000 80,000 0 1,000,000 Using a MARR of 8%, which, if any of the above projects will your company undertake (Perform all calculations using 5 significant figures and round your answer to one decimal place)?arrow_forward
- 10:17 W W n s26-3 S26-4 Using the payback and accounting rate of return methods to make capital investment decisions Learning Objective 2 ::: Consider how Hunter Valley Snow Park Lodge could use capital budgeting to decide whether the $11,000,000 Snow Park Lodge expansion would be a good investment. Assume Hunter Valley's managers developed the following estimates concerning the expansion: Number of additional skiers per day Average number of days per year that weather conditions allow skiing at Hunter Valley Useful life of expansion (in years) Average cash spent by each skier per day Average variable cost of serving each skier per day Cost of expansion C 056ll 70% QAA 1465/ 1480 | b 121 skiers 142 days 7 years $ 241 83 11,000,000 ||| 0 < Xarrow_forwardToby Amberville’s Manhattan Café, Inc., is considering investment in two alternative capital budgeting projects. Project A is an investment of $75,000 to replace working but obsolete refrigeration equipment. Project B is an investment of $150,000 to expand dining roomfacilities.Relevant cash flowdata forthe two projects over their expected two-year lives are: Project A year 1 year 2 probability cash flow probability cash flow 0.18 0 $ 0.08 0 $ 0.64 50,000 $ 0.084 50,000 0.18 100,000 0.08 100,00 Project B year 1 year 2 probability cash flow probability cash flow 0.50 0 $ 0.125 0 $ 0.50 200,000 0.75 100,000 0.125 200,000 A. Calculate the expected value, standard deviation, and coefficient of variation for cash flows from each project. B. Calculate the risk-adjusted NPV for each project using a 15% cost of capital for the riskier project and a 12% cost of capital for the less risky one. Which project is preferred…arrow_forward(Learning Objective 5: Differentiate financing with debt vs. equity) OrchardMedical Goods is embarking on a massive expansion. Assume the plans call for opening20 new stores during the next two years. Each store is scheduled to be 30% larger than thecompany’s existing locations, offering more items of inventory and with more elaborate displays. Management estimates that company operations will provide $1.0 million of the cashneeded for expansion. Orchard Medical must raise the remaining $4.75 million from outsiders.The board of directors is considering obtaining the $4.75 million either by borrowing at 4%or by issuing an additional 200,000 shares of common stock. This year the company has earned$5 million before interest and taxes and has 200,000 shares of $1-par common stock outstanding. The market price of the company’s stock is $23.75 per share. Assume that income beforeinterest and taxes is expected to grow by 30% each year for the next two years. The company’smarginal income tax…arrow_forward
- i will 5 upvotes urgent A firm wants to sponsor a new engineering lab at a local university. This requires $4.0M to construct the lab, $1.5M to equip it, and $750,000 every 6 years for new equipment. What is the required endowment if the university will earn 8% interest on the funds?arrow_forwardQuestion Content Area There are two projects under consideration by the Rainbow factory. Each of the projects will require an initial investment of $35,000 and is expected to generate the following cash flows: First Year Second Year Third Year Total Alpha Project $31,500 $22,500 $5,000 $59,000 Beta Project 7,000 23,000 28,000 58,000 (Click here to see present value and future value tables) A. If the discount rate is 12%, compute the NPV of each project. Round your present value factor to three decimal places and final answer to answer to 2 decimal places. Alpha Project $fill in the blank 1 Beta Project $fill in the blank 2 B. Which project should be recommended. .Please round off anwsers. Thank youarrow_forwardQuestion 2: Evaluating investment projects You are planning to invest $30,000 in research & development (R&D). This investment will generate cost savings of $21,000 in year 1 and $15,000 in year 2. After 2 years, the salvage value is zero. The cost of capital is 25% a year. a) Compute the net present value. NPV = $ Should you invest? OYES ONO b) Following a government stimulus program, the cost of capital decreased to 10% a year. Compute the net present value at the new cost of capital. NPV = $ Should you invest now? OYES ONO c) The economy is at full employment and is beginning to overheat (i.e., total demand exceeds the available capacity, which leads to rapid price increases). Firms' investment activity increases total demand and contributes to economic overheating. To prevent high inflation, the Federal Reserve chairman wants to reduce firms' investment activity. The Federal Reserve can control the cost of capital in the economy by adjusting its benchmark interest rate. To reduce…arrow_forward
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