Lockwood Company is considering a capital investment in machinery:
Initial investment $ 600,000
Residual value 50,000
Expected annual net cash inflows 100,000
Expected useful life 8 years
Required rate of return 12%
8. Calculate the payback.
9. Calculate the ARR. Round the percentage to two decimal places.
10. Based on your answers to the above questions, should Lockwood invest in the machinery?
8. The payback of the company is 6 Years.
9. Average annual operating income of the company is 9.62%.
10. No, the company should not invest in the machinery.
Total net cash inflows during operating life of the asset (a*8)
Less: Total depreciation during operating life of the asset (Cost − Residual Value) (b)
Total operating income during operating life (c= a-b)
Divide by: Asset’s operating life in years (d)
Average annual operating income from asset (c/d)
The required rate of return estimated by the company is 12% and the company should not approve an investment if it is less than estimated percentage. The computed percentage is 9.62% that is lower than the estimated percentage and thus the company should not proceed with investment.
S26-2 Using payback to make capital investment decisions
Carter Company is considering three investment opportunities with the following payback periods:
Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being equal.
Match the following business activities to the steps in capital budgeting process.
Steps in the capital budgeting process:
a. Develop strategies
1. A manager evaluates progress one year into the project.
2. Employees submit suggestions for new investments.
3. The company builds a new factory.
4. Top management attends a retreat to set long-term goals.
5. Proposed investments are analyzed.
6. Proposed investments are ranked.
7. New equipment is purchased.
Henderson Manufacturing, Inc. has a manufacturing machine that needs attention. The company is considering two options. Option 1 is to refurbish the current machineat a cost of $1,200,000. If refurbished, Henderson expects the machine to last anothereight years and then have no residual value. Option 2 is to replace the machine at acost of $4,600,000. A new machine would last 10 years and have no residual value.Henderson expects the following net cash inflows from the two options:
YearRefurbish CurrentPurchase New
1 $ 350,000 $ 3,780,000
2 340,000 510,000
3 270,000 440,000
4 200,000 370,000
5 130,000 300,000
6 130,000 300,000
7 130,000 300,000
8 130,000 300,000
Total $ 1,680,000 $ 6,900,000
Henderson uses straight-line depreciation and requires an annual return of 10%.
1. Compute the payback, the ARR, the NPV, and the profitability index of these twooptions.
2. Which option should Henderson choose? Why?
94% of StudySmarter users get better grades.Sign up for free