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BUSI 320 Dev Shell: BUSI 320-SummerB01 Connect Homework 6

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Score: 42.66 out of 48 points (88.88%) 1. award: 1 out of 1.00 point Assume a corporation has earnings before depreciation and taxes of $111,000, depreciation of $49,000, and that it has a 35 percent tax bracket. a. Compute its cash flow using the following format. (Input all answers as positive values.) Earnings before depreciation and taxes $ 111,000 Depreciation 49,000 Earnings before taxes $ 62,000 Taxes 21,700 Earnings after taxes $ 40,300 Depreciation 49,000 Cash flow $ 89,300 b. How much would cash flow be if there were only $11,000 in depreciation? All other factors are the same. Cash flow $ 76,000 c. How much cash flow is lost due to the reduced depreciation from $49,000 to $11,000? Cash flow lost $ 13,300 Worksheet Learning Objective: 12-02 Cash flow rather than earnings is used in the capital budgeting decision. Assume a corporation has earnings before depreciation and taxes of $111,000, depreciation of $49,000, and that it has a 35 percent tax bracket. a. Compute its cash flow using the following format. (Input all answers as positive values.) Earnings before depreciation and taxes $ 111,000 Depreciation 49,000 Earnings before taxes $ 62,000 ± .1% Taxes 21,700 ± .1% Earnings after taxes $ 40,300 ± .1% Depreciation 49,000 ± .1% Cash flow $ 89,300 ± .1% b. How much would cash flow be if there were only $11,000 in depreciation? All other factors are the same. Cash flow $ 76,000 ± .1% c. How much cash flow is lost due to the reduced depreciation from $49,000 to $11,000? 2. award: 1 out of 1.00 point Cash flow lost $ 13,300 ± .1% Explanation: a. Taxes = Tax rate × Earnings before taxes = .35 × $62,000 = $21,700 b. Earnings before depreciation and taxes $ 111,000 Depreciation 11,000 Earnings before taxes $ 100,000 Taxes @ .35 35,000 Earnings after taxes $ 65,000 Depreciation 11,000 Cash flow $ 76,000 c. Cash flow lost = $89,300 − 76,000 = $13,300 The Short-Line Railroad is considering a $115,000 investment in either of two companies. The cash flows are as follows: Year Electric Co. Water Works 1 $ 95,000 $ 10,000 2 10,000 10,000 3 10,000 95,000 4 – 10 10,000 10,000 a. Compute the payback period for both companies. (Round your answers to 1 decimal place.) Payback Period Electric Co. 3.0 years Water Works 3.0 years b. Which of the investments is superior from the information provided? Electric Co. rev: 04_16_2014_QC_48106 Worksheet Learning Objective: 12-03 The payback method considers the importance of liquidity, but fails to consider the time value of money. The Short-Line Railroad is considering a $115,000 investment in either of two companies. The cash flows are as follows: Year Electric Co. Water Works 1 $ 95,000 $ 10,000 2 10,000 10,000 3 10,000 95,000 4 – 10 10,000 10,000 a. Compute the payback period for both companies. (Round your answers to 1 decimal place.) Payback Period Electric Co. 3.0 ± 1% years Water Works 3.0 ± 1% years b. Which of the investments is superior from the information provided? Electric Co. rev: 04_16_2014_QC_48106 3. award: 1.72 out of 2.00 points Explanation: a. Electric Co.: Cash flows Amount yet to be Recovered Initial investment $115,000 Year 1 $ 95,000 20,000 Year 2 10,000 10,000 Year 3 10,000 0 Year 4 10,000 0 The initial investment is fully recovered in exactly 3 years. Water Works: Cash flows Amount yet to be Recovered Initial investment $115,000 Year 1 $ 10,000 105,000 Year 2 10,000 95,000 Year 3 95,000 0 Year 4 10,000 0 The initial investment is fully recovered in exactly 3 years. b. The Electric Co. is a superior investment because it produces a large cash inflow in the first year, while the large recovery for Water Works is not until the third year. The problem is that the payback method does not consider the time value of money. X-treme Vitamin Company is considering two investments, both of which cost $40,000. The cash flows are as follows: Year Project A Project B 1 $42,000 $38,000 2 22,000 21,000 3 10,000 15,000 Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. a-1. Calculate the payback period for Project A and Project B. (Round your answers to 2 decimal places.) Payback Period Project A 1.05 year(s) Project B 1.10 year(s) a-2. Which of the two projects should be chosen based on the payback method? Project A b-1. Calculate the net present value for Project A and Project B. Assume a cost of capital of 12 percent. (Do not round intermediate calculations and round your final answers to 2 decimal places.) Net Present Value Project A $ 22,160.00 Project B $ 21,351.00 b-2. Which of the two projects should be chosen based on the net present value method? Project A c. Should a firm normally have more confidence in the payback method or the net present value method? Net present value method Worksheet Learning Objective: 12-03 The payback method considers the importance of liquidity, but fails to consider the time value of money. Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. X-treme Vitamin Company is considering two investments, both of which cost $40,000. The cash flows are as follows: Year Project A Project B 1 $42,000 $38,000 2 22,000 21,000 3 10,000 15,000 Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods. a-1. Calculate the payback period for Project A and Project B. (Round your answers to 2 decimal places.) Payback Period Project A .95 ± .01 year(s) Project B 1.10 ± .01 year(s) a-2. Which of the two projects should be chosen based on the payback method? Project A b-1. Calculate the net present value for Project A and Project B. Assume a cost of capital of 12 percent. (Do not round intermediate calculations and round your final answers to 2 decimal places.) Net Present Value Project A $ 22,156.07 ± .1% Project B $ 21,346.35 ± .1% b-2. Which of the two projects should be chosen based on the net present value method? Project A c. Should a firm normally have more confidence in the payback method or the net present value method? Net present value method Explanation: a-1. Project A: Cash flows Amount yet to be Recovered Initial investment $ 40,000 Year 1 $ 42,000 0 Year 2 22,000 0 Year 3 10,000 0 The initial investment is fully recovered between Year 0 and Year 1. The partial year is computed as the amount that still needs to be recovered at the end of Year 0 divided by the Year 1 cash flow, so: Payback periodA = 0 + ($40,000 / $42,000) = .95 year(s) Project B: Cash flows Amount yet to be Recovered Initial investment $ 40,000 Year 1 $ 38,000 2,000 Year 2 21,000 0 Year 3 15,000 0 The initial investment is fully recovered between Year 1 and Year 2. The partial year is computed as the amount that still needs to be recovered at the end of Year 1 divided by the Year 2 cash flow, so: Payback periodB = 1 + ($2,000 / $21,000) = 1.10 year(s) a-2. Under the payback method, you should select Project A because of the shorter payback period. b-1. Net present valueA = −$40,000 + ($42,000 / 1.12) + ($22,000 / 1.122) + ($10,000 / 1.123) = $22,156.07 Net present valueB = −$40,000 + ($38,000 / 1.12) + ($21,000 / 1.122) + ($15,000 / 1.123) = $21,346.35 b-2. Under the net present value method, you should select Project A because of the higher net present value. c. A firm should normally have more confidence in the net present value method because it considers all of a project's cash flows and also the time value of money. Calculator Solution: b-1. Project A: Press the following keys: CF, 2nd, CLR WORK. Calculator displays CF0, enter 40,000 +|- key, press the Enter key. Press down arrow, enter 42,000 and press Enter. Press down arrow, enter 1 and press Enter. Press down arrow, enter 22,000 and press Enter. Press down arrow, enter 1 and press Enter. Press down arrow, enter 10,000 and press Enter. Press down arrow, enter 1 and press Enter. Press NPV; calculator shows I = 0; enter 12 and press Enter. Press down arrow; calculator shows NPV = 0. Press CPT; calculator shows NPV = 22,156.07. b-2. Project B: Press the following keys: CF, 2nd, CLR WORK. Calculator displays CF0, enter 40,000 +|- key, press Enter key Press down arrow, enter 38,000 and press Enter. Press down arrow, enter 1 and press Enter. Press down arrow, enter 21,000 and press Enter. Press down arrow, enter 1 and press Enter. Press down arrow, enter 15,000 and press Enter. Press down arrow, enter 1 and press Enter. Press NPV; calculator shows I = 0; enter 12 and press Enter. Press down arrow; calculator shows NPV = 0. Press CPT; calculator shows NPV = 21,346.35. Under the net present value method, you should select Project A because of the higher net present value. Appendix Solutions: Project A Year Cash Flow PVIF Present Value 1 $42,000 .893 $37,506 2 22,000 .797 17,534 3 10,000 .712 7,120 Present value of inflows $62,160 Present value of outflows 40,000 Net present value $22,160 Project B Year Cash Flow PVIF Present Value 1 $38,000 .893 $ 33,934 2 21,000 .797 16,737 3 15,000 .712 10,680 Present value of inflows $ 61,351 Present value of outflows 40,000 Net present value $ 21,351 4. award: 1 out of 1.00 point 5. award: 1 out of 1.00 point You buy a new piece of equipment for $25,456, and you receive a cash inflow of $3,400 per year for 13 years. Use Appendix D for an approximate answer but calculate your final answer using the financial calculator method. What is the internal rate of return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Internal rate of return 9.00 % Worksheet Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. You buy a new piece of equipment for $25,456, and you receive a cash inflow of $3,400 per year for 13 years. Use Appendix D for an approximate answer but calculate your final answer using the financial calculator method. What is the internal rate of return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Internal rate of return 9.00 ± 1% % Explanation: IRR is the interest rate that makes the NPV equal to zero. NPV = $0 = −$25,456 + $3,400 PVIFA (IRR, 13) The IRR must be calculated using a financial calculator, computer, a present value of annuity table, or trialand-error. Calculator Solution: Press the following keys: CF, 2nd, CLR WORK. Calculator displays CF0, enter 25,456 +|- key, press the Enter key. Press down arrow, enter 3,400, and press Enter. Press down arrow, enter 13, and press Enter. Press IRR; calculator shows IRR = 0. Press CPT; calculator shows IRR = 9.00. Answer: IRR = 9.00 % Appendix Solution: Appendix D: PVIFA = $25,456 / $3,400 = 7.487; For n = 13, we find 7.487 under the 9 percent column. IRR = 9% Home Security Systems is analyzing the purchase of manufacturing equipment that will cost $46,000. The annual cash inflows for the next three years will be: Year Cash Flow 1 $ 23,000 2 21,000 3 16,000 Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the financial calculator method. a. Determine the internal rate of return. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Internal rate of return 15.56 % b. With a cost of capital of 12 percent, should the equipment be purchased? Yes Worksheet Learning Objective: 12-04 The net present value and internal rate of return are generally the preferred methods of capital budgeting analysis. Home Security Systems is analyzing the purchase of manufacturing equipment that will cost $46,000. The annual cash inflows for the next three years will be: Year Cash Flow 1 $ 23,000 2 21,000 3 16,000 Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the financial calculator method. a. Determine the internal rate of return. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Internal rate of return 15.56 ± 1% % b. With a cost of capital of 12 percent, should the equipment be pu...
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