TITLE
Exam Preparation Exercises
SECTION
Cash Flow Analysis
QUESTION1 PV Cash Payments
Ohio Buckeye Company
purchased a tract of land on which a $60,000
payment is due each year for the next 5 years. What is the present
value of this stream of cash payments when the discount rate is 10%?
NOTE: For the Present Value Tables, see Appendix 13B of your e-book.
The present value factor for an annuity for 5 years at a 10% rate
is 3.791.
ANSWER 1
$60,000 * 3.791 = $227,460
QUESTION 2 Profitability Index
Capital State University is
evaluating the two investment proposals
given below.
Investment Proposal A B
Investment Required $(200,000) $(100,000)
Present value of cash inflows 250,000 130,000
Net present value 50,000 30,000
Life of the project 7 years 5 years
Ignore the impact of income taxes in your calculation.
Based on the project profitability index for each investment proposal,
which investment proposal should be undertaken and what is its
project profitability index?
ANSWER 2
To get the profitability
index you divide the net present value by the required investment amount.
Project A - 50000 / 200000 = 0.25
Project B - 30000 / 100000 = 0.3
Project B should be undertaken as it has a higher profitability index.
QUESTION 3 Net
Present Value
You are the CFO of Keller Inc., a
distributor of outdoor swimming pool
Products. Keller Inc. is evaluating purchasing a $25,000 machine that would
reduce pool installation operating costs by $4,000 per year. At the end of the
machine’s 10-year useful life, it will have no scrap value. Keller has a
required
rate of return of 12%. Ignore the impact of income taxes in your calculation.
Determine the net present value of the investment in the machine.
ANSWER 3
12% PV
Factor = 5.650
4,000 (Pool Cost) x 5650 (12% PV Factor) = 22600
Present Value 22,600 - Initial cost 25,000 = -2400
QUESTION 4 C2 IRR
Ohio Golf
Course Inc. is considering the purchase of a specialized riding lawn
mower to use in mowing the golf greens on the course. Currently, the greens
are mowed using a hand-pushed mower. The specialized riding mower will cost
$14,125 and have a useful life of 10 years. It will have no scrap value. The
specialized riding mower will cut the greens faster than the hand-pushed mower,
resulting in labor expense savings of $2,500 per year. Ignore the impact of
income taxes in your calculation.
Determine the internal rate of return on the specialized riding mower.
ANSWER 4
IRR = 14,125 / 2,500
IRR = 5.65
IRR = 12%
QUESTION 5 Payback Period
The
management of Ohio Microbrew is considering an investment in a high-quality
bottling machine with the following cash flows.
Year 1 Investment $30,000
Year 2 Investment $10,000
Year 1 Cash Inflow $4,000
Year 2 Cash Inflow $8,000
Year 3 Cash Inflow $10,000
Year 4 Cash Inflow $14,000
Year 5 Cash Inflow $12,000
Year 6 Cash Inflow $10,000
Year 7 Cash Inflow $8,000
Year 8 Cash Inflow $4,000
Ignore the impact of income taxes in your calculation.
What is the payback period in years and months for the potential investment?
ANSWER 5
Payback
Period = 4 years and 4 months
Year 5 $12,000 / 12 months = $1,000 per month * 4 = $4,000 to recover the total
amount
Year / Investment / Cash
Inflow / Unrecovered investment
1 $30,000 $4,000 (26,000)
2 10,000 8,000 (28,000)
3 10,000 (18,000)
4 14,000 (4,000)
5 12,000
8,000
QUESTION 6 Value of Required
Intangible Benefits
Buckeye Distributors, Inc. is contemplating the purchase of
automated equipment
that would save $50,000 each year in inventory and direct labor costs. The
equipment costs $500,000 and is expected to have a 10-year useful life with no
salvage value. The company requires a minimum 12% rate of return on all
equipment purchases. This automated equipment would provide valuable intangible
benefits such as higher quality products and production flexibility that are
difficult
to measure. Ignore the impact of income taxes in your calculation.
What dollar value per year would the intangible benefits have to be worth in
order to
make the equipment an acceptable investment?
ANSWER 6 Investment Costs....... -$500,000 * 1 = ($500,000)
Savings........ $50,000 * 5.65 $282,500
........................................................ ($217,500)
Intangible Benefits $217,500 / 5.65 = $38,496 (The intangible benefits would
need to be worth at least $38,496 in order to make the equipment an acceptable
investment.)
QUESTION 7 Simple Rate of Return
Delaware
Processing Co. makes electronic equipment for satellites. The company
is contemplating purchasing equipment for an additional satellite equipment
line.
The additional equipment line would increase revenue by $100,000. Incremental
operating expenses would be $50,000. The equipment would cost $200,000 and
have an 8-year life with no salvage value. Ignore the impact of income taxes in
your calculation.
Calculate the simple rate of return percentage for this potential investment.
ANSWER7
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Annual incremental
revenues |
$100,000
|
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Annual incremental
operating expenses |
$50,000
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Annual depreciation
(200,000 - 0) / 8 |
$25,000
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Annual incremental expenses |
$75,000
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Annual incremental net
operating income |
$25,000
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|
Simple rate of return |
$25,000 / $200,000 = 12.50% |
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