Cornell Company is considering a project with an initial investment of $596,500 that is expected to produce cash inflows of $125,000 for nine years. Cornell’s required rate of return is 12%.
14. What is the NPV of the project?
15. What is the IRR of the project?
16. Is this an acceptable project for Cornell?
14. The NPV of the company is $69.531.25.
15. The Annuity factor is 4.772, @15% for 9 years. So the IRR of the project is 15%.
16. This project should be accepted by the company.
Net Cash Inflow
Annuity PV Factor
(i = 12%, n = 9)
Present value of annuity (a)
Initial investment (b)
Net present value (a-b)
The NPV of the company is greater than zero and the IRR is greater than required rate of return. Thus the company should accept the project.
Hill Company operates a chain of sandwich shops. The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of$8,700,000. Expected annual net cash inflows are $1,550,000 for 10 years, with zeroresidual value at the end of 10 years. Under Plan B, Hill Company would open threelarger shops at a cost of $8,340,000. This plan is expected to generate net cash inflowsof $990,000 per year for 10 years, the estimated useful life of the properties. Estimatedresidual value for Plan B is $1,200,000. Hill Company uses straight-line depreciationand requires an annual return of 10%.
1. Compute the payback, the ARR, the NPV, and the profitability index of thesetwo plans.
2. What are the strengths and weaknesses of these capital budgeting methods?
3. Which expansion plan should Hill Company choose? Why?
4. Estimate Plan A’s IRR. How does the IRR compare with the company’s requiredrate of return?
Calculate the present value of the following future cash flows, rounding all calculations to the nearest dollar.
11. $5,000 received in three years with interest of 10%
12. $5,000 received in each of the following three years with interest of 10%
13. Payments of $2,000, $3,000, and $4,000 received in years 1, 2, and 3, respectively, with interest of 7%
Using ARR to make capital investment decisions Refer to the Henry Hardware information in Exercise E26-20. Assume the project has no residual value. Compute the ARR for the investment. Round to two places.
Henry Hardware is adding a new product line that will require an investment of $1,512,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of $310,000 the first year, $270,000 the second year, and $240,000 each year thereafter for eight years.
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