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    Watertown Paper Corporation is considering adding a machine that would cost $900,000, have a six year life, and provide annual cash inflows of $400,000 and outflows of $190,000. The cash payback period is calculated to be 4.3 years. The net present value is calculated to be $42,043 using a 9% discount rate, so the project should be accepted. The internal rate of return is calculated to be between 10-11%, which exceeds the required 9% rate of return, so the project should be accepted.

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    ch12 2

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    2K views3 pages
    Watertown Paper Corporation is considering adding a machine that would cost $900,000, have a six year life, and provide annual cash inflows of $400,000 and outflows of $190,000. The cash payback period is calculated to be 4.3 years. The net present value is calculated to be $42,043 using a 9% discount rate, so the project should be accepted. The internal rate of return is calculated to be between 10-11%, which exceeds the required 9% rate of return, so the project should be accepted.

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    Watertown Paper Corporation is considering adding a machine that would cost $900,000, have a six year life, and provide annual cash inflows of $400,000 and outflows of $190,000. The cash payback period is calculated to be 4.3 years. The net present value is calculated to be $42,043 using a 9% discount rate, so the project should be accepted. The internal rate of return is calculated to be between 10-11%, which exceeds the required 9% rate of return, so the project should be accepted.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    2K views3 pages

    ch12 2

    Uploaded by

    ghsoub777
    Watertown Paper Corporation is considering adding a machine that would cost $900,000, have a six year life, and provide annual cash inflows of $400,000 and outflows of $190,000. The cash payback period is calculated to be 4.3 years. The net present value is calculated to be $42,043 using a 9% discount rate, so the project should be accepted. The internal rate of return is calculated to be between 10-11%, which exceeds the required 9% rate of return, so the project should be accepted.

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    © All Rights Reserved
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    of 3

    Chapter 12

    >

    DO IT!

    Cash Payback
    Period

    Action Plan

    Watertown Paper Corporation is considering adding another machine for the manufacture
    of corrugated cardboard. The machine would cost $900,000. It would have an estimated
    life of six years and no salvage value. The company estimates that annual cash inflows
    would increase by $400,000 and that annual cash outflows would increase by $190,000.
    Compute the cash payback period.

    Solution

    Annual cash inflows 2


    Annual cash outflows 5
    Net annual cash flow.
    Cash payback
    period 5 Cost of
    capital investment/Net
    annual cash flow.

    >

    Estimated annual cash inflows


    Estimated annual cash outflows

    $400,000
    190,000

    Net annual cash flow

    $210,000

    Cash payback period 5 $900,000/$210,000 5 4.3 years.


    Related exercise material: BE12-1 and

    DO IT!

    12-1.

    DO IT!

    Net Present Value

    Watertown Paper Corporation is considering adding another machine for the manufacture
    of corrugated cardboard. The machine would cost $900,000. It would have an estimated
    life of six years and no salvage value. The company estimates that annual cash inflows
    would increase by $400,000 and that annual cash outflows would increase by $190,000.
    Management has a required rate of return of 9%. Calculate the net present value on this
    project and discuss whether it should be accepted.

    Solution
    Action Plan

    Estimated annual cash


    inflows 2 Estimated
    annual cash outflows 5
    Net annual cash flow.
    Use the NPV technique
    to calculate the difference
    between net cash
    flows and the initial
    investment.
    Accept the project if
    the net present value is
    positive.

    Estimated annual cash inflows


    Estimated annual cash outflows

    $400,000
    190,000

    Net annual cash flow

    $210,000

    Present value of net annual cash flows


    Capital investment

    Cash Flow

    9% Discount
    Factor

    Present
    Value

    $210,000

    4.48592a

    $942,043
    900,000

    Net present value

    $ 42,043

    Table 4, Appendix A, 9%, six years

    Since the net present value is greater than zero, Watertown should accept the project.
    Related exercise material: BE12-2, BE12-3, E12-1, E12-2, E12-3, and

    DO IT!

    12-2.

    D-1

    D-2

    >

    DO IT!

    DO IT!

    Internal Rate
    of Return
    Action Plan

    Estimated annual cash


    inflows 2 Estimated
    annual cash outflows 5
    Net annual cash flow.
    Capital investment/Net
    annual cash flows 5
    Internal rate of return
    factor.
    Look up the factor in
    the present value of an
    annuity table to find
    the internal rate of
    return.
    Accept the project if
    the internal rate of
    return is equal to or
    greater than the
    required rate of return.

    >

    Watertown Paper Corporation is considering adding another machine for the manufacture
    of corrugated cardboard. The machine would cost $900,000. It would have an estimated
    life of six years and no salvage value. The company estimates that annual cash inflows
    would increase by $400,000 and that annual cash outflows would increase by $190,000.
    Management has a required rate of return of 9%. Calculate the internal rate of return on
    this project and discuss whether it should be accepted.

    Solution
    Estimated annual cash inflows
    Estimated annual cash outflows

    $400,000
    190,000

    Net annual cash flow

    $210,000

    $900,000/210,000 5 4.285714. Using Table 4 of Appendix A and the factors that correspond with the six-payment row, 4.285714 is between the factors for 10% and 11%.
    Since the project has an internal rate that is greater than 10% and the required rate of
    return is only 9%, the project should be accepted.
    Related exercise material: BE12-7, BE12-8, E12-5, E12-6, E12-7, and

    DO IT!

    12-3.

    DO IT!

    Annual Rate of
    Return

    Watertown Paper Corporation is considering adding another machine for the manufacture
    of corrugated cardboard. The machine would cost $900,000. It would have an estimated
    life of six years and no salvage value. The company estimates that annual revenues would
    increase by $400,000 and that annual expenses excluding depreciation would increase by
    $190,000. It uses the straight-line method to compute depreciation expense. Management
    has a required rate of return of 9%. Compute the annual rate of return.

    Solution
    Action Plan

    Expected annual net


    income 5 Annual
    revenues 2 Annual
    expenses (including
    depreciation expense).
    Annual rate of
    return 5 Expected
    annual net income/
    Average investment.
    Average investment 5
    (Original investment 1
    Value at end of useful
    life)/2.

    Revenues
    Less:
    Expenses (excluding depreciation)
    Depreciation ($900,000/6 years)

    $400,000
    $190,000
    150,000

    Annual net income

    340,000
    $ 60,000

    Average investment 5 ($900,000 1 0)/2 5 $450,000.


    Annual rate of return 5 $60,000/$450,000 5 13.3%.
    Since the annual rate of return (13.33%) is greater than Watertowns required rate of
    return (9%), the proposed project is acceptable.
    Related exercise material: BE12-9, E12-8, E12-9, E12-10, E12-11, and

    DO IT!

    12-4.

    >

    Comprehensive

    DO IT!

    Cornfield Company is considering a long-term capital investment project in laser equipment.


    This will require an investment of $280,000, and it will have a useful life of five years. Annual
    net income is expected to be $16,000 a year. Depreciation is computed by the straight-line
    method with no salvage value. The companys cost of capital is 10%. (Hint: Assume cash
    flows can be computed by adding back depreciation expense.)

    Instructions
    (Round all computations to two decimal places.)
    (a) Compute the cash payback period for the project. (Round to two decimals.)
    (b) Compute the net present value for the project. (Round to nearest dollar.)
    (c) Compute the annual rate of return for the project.

    Action Plan

    (d) Should the project be accepted? Why?

    Calculate the time it

    Solution to Comprehensive DO IT!

    will take to pay back the


    investment: cost of the
    investment divided by
    net annual cash flows.
    When calculating NPV,
    remember that net
    annual cash flow equals
    annual net income plus
    annual depreciation
    expense.
    Be careful to use the
    correct discount factor
    in using the net present
    value method.
    Calculate the annual
    rate of return: expected
    annual net income
    divided by average
    investment.

    >

    DO IT!

    (a) $280,000 4 $72,000 ($16,000 1 $56,000) 5 3.89 years


    (b)
    Present Value
    at 10%
    Discount factor for five payments
    Present value of net cash flows:
    $72,000 3 3.79079
    Capital investment
    Negative net present value

    3.79079
    $272,937
    280,000
    $ (7,063)

    (c) $16,000 4 $140,000 ($280,000 4 2) 5 11.4%


    (d) The annual rate of return of 11.4% is good. However, the cash payback period is
    78% of the projects useful life, and net present value is negative. The recommendation is to reject the project.

    REVIEW

    DO IT! 12-1 Wallowa Company is considering a long-term investment project called ZIP. Compute the cash payback
    ZIP will require an investment of $120,000. It will have a useful life of four years and no period for an investment.
    salvage value. Annual cash inflows would increase by $80,000, and annual cash outflows (LO 2), AP
    would increase by $40,000. Compute the cash payback period.
    DO IT! 12-2 Wallowa Company is considering a long-term investment project called ZIP. Calculate net present value
    ZIP will require an investment of $120,000. It will have a useful life of four years and no of an investment.
    salvage value. Annual cash inflows would increase by $80,000, and annual cash outflows (LO 3), AN
    would increase by $40,000. The companys required rate of return is 12%. Calculate the net
    present value on this project and discuss whether it should be accepted.
    DO IT! 12-3 Wallowa Company is considering a long-term investment project called ZIP.

    Calculate internal rate of

    ZIP will require an investment of $120,000. It will have a useful life of four years and no return.
    salvage value. Annual cash inflows would increase by $80,000, and annual cash outflows (LO 7), AN
    would increase by $40,000. The companys required rate of return is 12%. Calculate the
    internal rate of return on this project and discuss whether it should be accepted.
    DO IT! 12-4 Wallowa Company is considering a long-term investment project called ZIP. Calculate annual rate of
    ZIP will require an investment of $120,000. It will have a useful life of four years and no return.
    salvage value. Annual revenues would increase by $80,000, and annual expenses (exclud- (LO 8), AP
    ing depreciation) would increase by $40,000. Wallowa uses the straight-line method to
    compute depreciation expense. The companys required rate of return is 12%. Compute
    the annual rate of return.

    D-3

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