CHAPTER NINE HOMEWORK HINTS:

Exercise 9-2
9-2.
Identifying cash flows
(LO 1) Mighty Vita produces a wide range of herbal supplements sold nationwide through
independent distributors. In response to an increasing demand for its products, the company is
considering the purchase of a new packaging machine to replace the seven-year-old machine
currently in use. The new machine will cost $160,000, and installation will require an additional
$15,000. The machine has a useful life of 10 years and is expected to have a salvage value of
$8,000 at that time. The variable cost to operate the new machine is $10 per carton compared to
the current machine's variable cost of $10.10 per carton, and Mighty Vita expects to pack
250,000 cartons each year. If the new machine is purchased, Mighty Vita will avoid a required
$10,000 overhaul of the current machine in four years. The current machine has a market value
of $14,000.
Required
Identify the amount and timing of all cash flows related to the acquisition of the new packaging
machine.
Exercise 9.2 Solution:
Cash Flow Timing Amount
Purchase price Year 0 ($160,000)
Installation Year 0 (15,000)
Salvage of old equipment Year 0 14,000
Salvage of new equipment Year 10 8,000
Variable cost savings (250,000 × .1) Years 1-10 25,000
Avoided overhaul 4 10,000

Exercise 9-9
Net present value
(LO 3) Larry's Lawn Service needs to purchase a new lawnmower costing $7,756 to replace an
old lawnmower that cannot be repaired. The new lawnmower is expected to have a useful life of
four years, with no salvage value at the end of that period.
Required
(a)
If Larry's required rate of return is 11%, what level of annual cash savings must the lawnmower
generate to be considered an acceptable investment under the net present value method?
(b)
If Larry's required rate of return is 14%, what level of annual cash savings must the lawnmower
generate to be considered an acceptable investment under the net present value method?

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Exercise 9.9 Solution:

a. For the lawnmower to be acceptable using the net present value method, the net present
value must be greater than or equal to zero. Let x equal the present value of the annual
cash savings:

(x × PVA4, 11%) - $7,756= $0

x × 3.1024 = $7,756
x = $2,500

b.
(x × PVA4, 14%) - $7,756= $0
x × 2.9137 = $7,756
x = $2,662

Exercise 9-12 Davis Video in problem

Internal rate of return (IRR) = net initial investment
Annual savings

= 413,515 – 5,304
40,400 + 25,500

= 408,211
65,900

= 6.1944 (PVA factor) expected to last 12 yr

Should accept because the NPV is higher than the hurdle rate

Exercise 9.16
Payback period with uneven cash flows
(LO 5) The Seago Company is planning to purchase $500,000 of equipment with an estimated
seven-year life and no estimated salvage value. The company has projected the following annual
cash flows for the investment.
Year Projected Cash Flows
1 $200,000
2 150,000
3 100,000
4 60,000
5 60,000
6 40,000
7 40,000

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 Year Projected Cash Flows
Total $650,000
Required
(a)
Calculate the payback period for the proposed equipment purchase. Assume that all cash flows
occur evenly throughout the year.
(b)
If Seago requires a payback period of three years or less, should the company make this
investment?

Exercise 9.16 solution:

a.
Year Annual Cash Flows Cumulative Cash Flows
1 $200,000 $200,000
2 150,000 350,000
3 100,000 450,000 $500,000
4 60,000 510,000
5 60,000 570,000 payback
6 40,000 610,000
7 40,000 650,000
Total $650,000

The payback period is between years 3 & 4. At the end of year 3, $50,000 ($500,000 -
$450,000) more cash is needed for the investment to be paid back completely. In year
$50,000
4, $6,000 is received evenly throughout the year, so it will take 10 months ( ×
$60,000
12) to recoup the remaining $50,000. Therefore, the payback period is 3 years and 10
months.

b. Seago should not accept this project based on payback period, since the payback period
of 3 years and 10 months is greater than the required 3 year payback period.

Exercise 9.18 Davis Video in problem

a) Accounting rate of return = operating income
Net investment

= 33,100 – 840 – (102,800 / 4 yr) = 6,560

b) 6,560 / 102,800 = .0638

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c) Increase