W6 Assignment Application Problems 6 Page 539 Brief Exercise

W6 Assignment Application Problems 6page 539 Brief Exercises 12-1, 12-4, 12-5, 12-6

Rihanna Company is considering purchasing new equipment for $450,000. It is expected that the equipment will produce net annual cash flows of $60,000 over its 10-year useful life. Annual depreciation will be $45,000. Compute the cash payback period.

Caine Bottling Corporation is considering the purchase of a new bottling machine. The machine would cost $200,000 and has an estimated useful life of 8 years with zero salvage value. Management estimates that the new bottling machine will provide net annual cash flows of $34,000. Management also believes that the new bottling machine will save the company money because it is expected to be more reliable than other machines, and thus will reduce downtime. How much would the reduction in downtime have to be worth in order for the project to be acceptable? Assume a discount rate of 9%. (Hint: Calculate the net present value.)

McKnight Company is considering two different, mutually exclusive capital expenditure proposals. Project A will cost $400,000, has an expected useful life of 10 years, a salvage value of zero, and is expected to increase net annual cash flows by $70,000. Project B will cost $310,000, has an expected useful life of 10 years, a salvage value of zero, and is expected to increase net annual cash flows by $55,000. A discount rate of 9% is appropriate for both projects. Compute the net present value and profitability index of each project. Which project should be accepted?

Quillen Company is performing a post-audit of a project completed one year ago. The initial estimates were that the project would cost $250,000, would have a useful life of 9 years, zero salvage value, and would result in net annual cash flows of $46,000 per year. Now that the investment has been in operation for 1 year, revised figures indicate that it actually cost $260,000, will have a total useful life of 11 years, and will produce net annual cash flows of $39,000 per year. Evaluate the success of the project. Assume a discount rate of 10%.

Bruno Corporation is involved in the business of injection molding of plastics. It is considering the purchase of a new computer-aided design and manufacturing machine for $430,000. The company believes that with this new machine it will improve productivity and increase quality, resulting in an increase in net annual cash flows of $101,000 for the next 6 years. Management requires a 10% rate of return on all new investments. Instructions: Calculate the internal rate of return on this new machine. Should the investment be accepted?

Paper For Above instruction

Investment appraisals are crucial for organizations aiming to allocate capital efficiently and ensure sustainable growth. This essay explores several key investment decision-making tools and analyses through practical case studies, focusing on payback periods, net present value (NPV), profitability index, and internal rate of return (IRR). Emphasis is placed on understanding how these metrics inform managerial decisions, especially when considering capital expenditures with varying lifespans, cash flows, and risk profiles.

Cash Payback Period and Its Implications

The payback period measures how long it takes for an investment to recover its initial cost through cash inflows, serving as a simple indicator of liquidity risk. Rihanna Company's equipment costing $450,000 is expected to generate $60,000 annually over 10 years, with annual depreciation of $45,000. To compute the payback period, we consider the cash inflow of $60,000 per year, ignoring depreciation since it is a non-cash expense. Dividing the initial investment by annual cash flows yields:

Payback Period = $450,000 / $60,000 = 7.5 years.

This indicates that Rihanna Company would recover its initial investment in 7.5 years, which is within the equipment's 10-year lifespan, making it an acceptable investment from a liquidity perspective. However, this metric doesn't account for the time value of money or residual value, which are addressed by other criteria such as NPV and IRR.

Evaluating Investment Alternatives Using NPV and the Profitability Index

In assessing capital projects, NPV considers the time value of money by discounting future cash inflows at an appropriate rate. For Caine Bottling's machine costing $200,000 with an 8-year lifespan and annual cash flows of $34,000, the NPV is calculated using a discount rate of 9%. The present value of annuities formula facilitates this computation, providing insight into whether the project adds value.

Similarly, McKnight Company's two projects, A and B, are evaluated by calculating their NPVs and profitability indexes. Project A, with a higher initial investment and cash flows, likely yields a higher NPV, but the profitability index (NPV divided by initial cost) provides a relative measure of efficiency. The project with the higher profitability index should be accepted, aligning with capital rationing principles.

Residual Value and Performance Evaluation

Quillen Company's post-audit demonstrates the importance of comparing actual versus estimated performance, considering the revised costs, lifespan, and cash flows. The project's success hinges on whether the adjusted cash flows sufficiently cover the actual costs and whether the NPV remains positive at the discount rate of 10%. A decreased cash flow relative to initial estimates could signal a need for strategic adjustments or improved project management.

Internal Rate of Return and Investment Acceptance

The IRR is the discount rate that equates the present value of future cash inflows with the initial investment. Bruno Corporation's project, with a cost of $430,000 and annual cash inflows of $101,000 over six years, requires IRR calculation to determine profitability. If the IRR exceeds the company's required rate of 10%, the project is deemed acceptable. The IRR can be computed using financial calculators or software, and for this case, it exceeds 10%, indicating an attractive investment opportunity.

Conclusion

Effective capital budgeting hinges on applying multiple evaluation tools to provide a comprehensive view of investment risk and return. The payback period offers a quick risk assessment, whereas NPV and IRR incorporate strategic value and profitability. Organizations must balance these metrics with qualitative considerations, such as strategic fit and operational risks, to make informed decisions that support long-term success.

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