Concept explainers
Keller Construction is considering two new investments. Project E calls for the purchase of earthmoving equipment. Project H represents an investment in a hydraulic lift. Keller wishes to use a
a. Determine the net present value of the projects based on a zero percent discount rate.
b. Determine the net present value of the projects based on a 9 percent discount rate.
c. The
d. If the two projects are not mutually exclusive, what would your acceptance or rejection decision be if the cost of capital (discount rate) is 8 percent? (Use the net present value profile for your decision; no actual numbers are necessary.)
e. If the two projects are mutually exclusive (the selection of one precludes the selection of the other), what would be your decision if the cost of capital is (1) 6 percent, (2) 13 percent, (3) 18 percent? Once again, use the net present value profile for your answer.
a.
To calculate: The NPV of the projects by using zero discount rate for Keller Construction Company.
Introduction:
Net present value (NPV):
It is the difference between the PV (present value) of cash inflows and the PV of cash outflows. It is used in capital budgeting and planning of investment to assess the benefits and losses of any project or investment.
Answer to Problem 23P
The NPV of the project E is $8,000 and project H is $5,000 based on zero discount rate for Keller Construction Company.
Explanation of Solution
The calculation of NPV of project E:
The calculation of NPV of project H:
Working Notes:
The calculation of inflows for project E:
The calculation of inflows for project H:
b.
To calculate: The NPV of the projects by using 9% discount rate for Keller Construction Company.
Introduction:
Net present value (NPV):
It is the difference between the PV (present value) of cash inflows and the PV of cash outflows. It is used in capital budgeting and planning of investment to assess the benefits and losses of any project or investment.
Present value (PV):
The current value of an investment or an asset is termed as its present value. It is calculated by discounting the future value of the investment or asset.
Answer to Problem 23P
The calculation of PV of inflows for Project E at 9%:
The calculation of PV of inflows for Project H at 9%:
Thus, the NPV of project E is $2,127 and project H is $1,976.
Explanation of Solution
The calculation of NPV of project E:
The calculation of NPV of project H:
The formulae used for the calculation of PV of inflows for Project E:
The formulae used for the calculation of PV of inflows for Project E:
c.
To plot: The graph for the NPV of the project according to the Fig. 12-3 for the Keller Construction Company.
Introduction:
Internal rate of return (IRR):
A method of capital budgeting that is used to measure the profitability of potential projects or investments. It is a discount that makes the NPV equals to zero for a specific project.
Answer to Problem 23P
The graph for the NPV of the project according to the Fig. 12-3 for the Keller Construction Company:
Explanation of Solution
Calculation of IRR:
Working Note:
The formulae used in the calculation of IRR:
d.
To determine: The decision regarding the acceptance or the rejection of the projects, if the projects are mutually exclusive and discount rate of the cost of capital is 8% for the Keller Construction Company.
Introduction:
Net present value (NPV):
It is the difference between the PV (present value) of cash inflows and the PV of cash outflows. It is used in capital budgeting and planning of investment to assess the benefits and losses of any project or investment.
Present value (PV):
The current value of an investment or an asset is termed as its present value. It is calculated by discounting the future value of the investment or asset.
Answer to Problem 23P
The calculation of PV of project E and project H at 8%:
The NPV of project E is $2,681 and project H is $2,277. Thus, the NPV of project E is higher than the project H. Therefore, project E must be accepted as it is more profitable than the project H.
Explanation of Solution
The calculation of NPV of project E:
The calculation of NPV of project H:
The formulae used in the calculation of PV of project E and H at 8% are shown below:
e.
To determine: The decision regarding the acceptance or rejection of the projects, if the projects are mutually exclusive and discount rates of cost of capital are 6%, 13%, and 18% for the Keller Construction Company.
Introduction:
Net present value (NPV):
It is the difference between the PV (present value) of cash inflows and the PV of cash outflows. It is used in capital budgeting and planning of investment to assess the benefits and losses of any project or investment.
Present value (PV):
The current value of an investment or an asset is termed as its present value. It is calculated by discounting the future value of the investment or asset.
Answer to Problem 23P
The calculation of PV of project E and project H at 6%:
The NPV of project E is $3,855 and project H is $2,903. Thus, the NPV of project E is higher than the project H, So, project E must be accepted at 6% discount rate as it is superior to the project H.
The calculation of PV of project E and project H at 13%:
The NPV of project E is $108 and project H is $847. Thus, the NPV of project H is higher than the project E, So, project H must be accepted at 13% discount rate as it is superior to the project E.
The calculation of PV of project E and project H at 18%:
The NPV of project E is ($2,035) and project H is ($415). Thus, both projects must be rejected at 18% discount rate as NPV of both projects are negative.
Explanation of Solution
The calculation of NPV of project E at 6%:
The calculation of NPV of project H at 6%:
The calculation of NPV of project E at 13%:
The calculation of NPV of project H at 13%:
The calculation of NPV of project E at 18%:
The calculation of NPV of project H at 18%:
The formulae used in the calculation of PV of project E and H at 6% are shown below:
The formulae used in the calculation of PV of project E and H at 13% are shown below:
The formulae used in the calculation of PV of project E and H at 18% are shown below:
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Chapter 12 Solutions
Loose Leaf for Foundations of Financial Management Format: Loose-leaf
- Use the information provided to answer the questions Calculate the Accounting Rate of Return (on average investment) of Project B (expressed to twodecimal places).Calculate the Net Present Value of each project (with amounts rounded off to the nearest Rand). Use your answers from previous question to recommend the project that should be chosen. Motivateyour choice.arrow_forwardIf Fuzzy Button Clothing Company's managers select projects based on the MIRR criterion, they should this independent project. Which of the following statements best describes the difference between the IRR method and the MIRR method? O The IRR method uses the present value of the initial investment to calculate the IRR. The MIRR method uses the terminal value of the initial investment to calculate the MIRR. O The IRR method uses only cash inflows to calculate the IRR. The MIRR method uses both cash inflows and cash outflows to calculate the MIRR. O The IRR method assumes that cash flows are reinvested at a rate of return equal to the IRR. The MIRR method assumes that cash flows are reinvested at a rate of return equal to the cost of capital.arrow_forwardWhich of the following statements is true? The internal rate of return is the rate of return of an investment project over its useful life. When the net cash inflow is the same every year for a project after the initial investment, the internal rate of return of a project can be determined by dividing the initial investment required in the project by the annual net cash inflow. This computation yields a factor that can be looked up in a table of present values of annuities to find the internal rate of return. Multiple Choice Only statement I is true. Only statement II is true. Both statements are true.arrow_forward
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- Yokam Company is considering two alternative projects. Project 1 requires an initial investment of $400,000 and has a present value of cash flows of $1,100,000. Project 2 requires an initial investment of $4,000,000 and has a present value of cash flows of $6,000,000. 1. Compute the profitability index for each project. 2. Based on the profitability index, which project should the company prefer? Complete this question by entering your answers in the tabs below. Required 1 Required 2 Compute the profitability index for each project. Project 1 Project 2 Choose Numerator: Profitability Index T 7 Choose Denominator: 4 of 5 180 # Next > G Oarrow_forwardYokam Company is considering two alternative projects. Project 1 requires an initial investment of $470,000 and has a present value of all its cash flows of $2,350,000. Project 2 requires an initial investment of $5,000,000 and has a present value of all its cash flows of $6,000,000. (a) Compute the profitability index for each project. (b) Based on the profitability index, which project should the company select? Complete this question by entering your answers in the tabs below. Required A Required B Compute the profitability index for each project. Profitability Index Numerator: Denominator: Profitability Index = Profitability index Project 1 Project 2arrow_forwardPayback, Accounting Rate of Return, Present Value, Net PresentValue, Internal Rate of ReturnAll scenarios are independent of all other scenarios. Assume that all cash flows are after-tax cashflows.a. Kambry Day is considering investing in one of the following two projects. Either projectwill require an investment of $20,000. The expected cash flows for the two projects follow.Assume that each project is depreciable b. Wilma Golding is retiring and has the option to take her retirement as a lump sum of$450,000 or to receive $30,000 per year for 20 years. Wilma’s required rate of return is6%.c. David Booth is interested in investing in some tools and equipment so that he can doindependent drywalling. The cost of the tools and equipment is $30,000. He estimatesthat the return from owning his own equipment will be $9,000 per year. The tools andequipment will last 6 years.d. Patsy Folson is evaluating what appears to be an attractive opportunity. She is currentlythe owner of a small…arrow_forward
- Principles of Accounting Volume 2AccountingISBN:9781947172609Author:OpenStaxPublisher:OpenStax College