Accounting 225 Quiz Section #16

Chapter 13 Class Exercises Solution

1. The following data concern an investment project:

The working capital will be released for use elsewhere at the conclusion of the project. Compute
the project's net present value.

2. Bradley Company's required rate of return is 14%. The company has an opportunity to be the
exclusive distributor of a very popular consumer item. No new equipment would be needed, but
the company would have to use one-fourth of the space in a warehouse it owns. The warehouse
cost $200,000 new. The warehouse is currently half-empty and there are no other plans to use the
empty space. In addition, the company would have to invest $100,000 in working capital to carry
inventories and accounts receivable for the new product line. The company would have the
distributorship for only 5 years. The distributorship would generate a $17,000 annual net cash
inflow.
What is the net present value of the project at a discount rate of 14 per cent? Should the project
be accepted?

Yes, the distributorship should be accepted since the project has a positive net present value.

Accounting 225 Quiz Section #16

Chapter 13 Class Exercises Solution
3. Monson Company is considering three investment opportunities with cash flows as described
below:

Compute the net present value of each project assuming Monson Company uses a 12% discount
rate.

Accounting 225 Quiz Section #16

Chapter 13 Class Exercises Solution
4. Tranter, Inc., is considering a project that would have a ten-year life and would require a
$1,200,000 investment in equipment. At the end of ten years, the project would terminate and the
equipment would have no salvage value. The project would provide net operating income each
year as follows:

All of the above items, except for depreciation, represent cash flows. The company's required
rate of return is 12%.
a) Compute the project's net present value.
Because depreciation is the only noncash item on the income statement, the annual net cash flow
can be computed by adding back depreciation to net operating income.

b) Compute the project's internal rate of return to the nearest whole percent.
The formula for computing the factor of the internal rate of return (IRR) is:
Factor of the IRR = Investment required Annual net cash inflow
$1,200,000 $300,000 = 4.00 Factor
To the nearest whole percent, the internal rate of return is 21%

Accounting 225 Quiz Section #16

Chapter 13 Class Exercises Solution
5. The Wisbley Company is contemplating the purchase of a helicopter for its executives to use
in their business trips. This helicopter could be either purchased or leased from the manufacturer.
The useful life of the helicopter is four years. Data concerning these two alternatives follow:

If the helicopter is leased, it would be returned to the manufacturer in four years. Wisbley's
required rate of return is 22%.
a) What would be the present value of all the cash outflows for rental payments, if the
helicopter is leased?
Present value = ($250,000) x 2.494 = ($623,500)

b) What would be the present value of the cash outflows for repairs, assuming the helicopter is
purchased?
Present value = ($6,000 x 0.672) + ($8,000 x 0.551) =$4,032 + $4,408 = $8,440

c) What would be the present value of the salvage value of the helicopter, if the helicopter is
purchased?
Present value = $270,000 x 0.451 = $121,770

d) What is the incremental net present value in favor of leasing rather than purchasing (rounded
off to the nearest hundred dollars)?
The net present value of the cash outflows under the leasing alternative is $623,500 ($250,000 x
2.494). The net present value of the cash outflows under the purchase alternative is $811,610
{$24,940 ($10,000 x 2.494) + $8,440 [($6,000 x 0.672) + ($8,000 x 0.551)] - $121,770
($270,000 x 0.451) + $900,000}. The leasing alternative's net present value of cash outflows is
less than purchase alternative's net present value of cash outflows by $188,110 ($623,500 vs.
$811,610).

Accounting 225 Quiz Section #16

Chapter 13 Class Exercises Solution
6. Bill Anders retires in 8 years. He has $650,000 to invest and is considering a franchise for a
fast-food outlet. He would have to purchase equipment costing $500,000 to equip the outlet and
invest an additional $150,000 for inventories and other working capital needs. Other outlets in
the fast-food chain have an annual net cash inflow of about $160,000. Mr. Anders would close
the outlet in 8 years. He estimates that the equipment could be sold at that time for about 10% of
its original cost. Mr. Anders' required rate of return is 16%.
What is the investment's net present value when the discount rate is 16 percent? Is this an
acceptable investment?

Yes, the outlet is an acceptable investment because its net present value is positive.