Chapter 14

Capital Budgeting Decisions

Exercise 14-1 (10 minutes)

1.

Item
Year(s)
Annual cost
savings..............
1-8
Initial investment.
Net present value.

Now

Cash
Flow

$7,000 4.968 $ 34,776

$(40,00
0) 1.000 (40,000)
$ (5,224)

2.
Cash
Flow

Item
Annual cost
savings..............

$7,000
$(40,00
0)

Initial investment.
Net cash flow........

Present
12% Value of
Facto
Cash
r
Flows

Years

Total
Cash
Flows

$ 56,000

(40,000)
$ 16,000

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Solutions Manual, Appendix 14C

Exercise 14-2 (30 minutes)

1. Annual savings in part-time help.....................
Added contribution margin from expanded
sales (1,000 dozen $1.20 per dozen)........
Annual cash inflows........................................

$3,800
1,200
$5,000

2. Factor of the internal

Investment required
=
rate of return
Annual cash inflow
=

$18,600
= 3.720
$5,000

Looking in Exhibit 14B-2, and scanning along the six-period

line, we can see that a factor of 3.720 falls closest to the 16%
rate of return.
3. The cash flows will not be even over the six-year life of the
machine because of the extra $9,125 inflow in the sixth year.
Therefore, the above approach cannot be used to compute the
internal rate of return in this situation. Using trial-and-error or
some other method, the internal rate of is 22%:

Item
Year(s)
Initial investment
Now
Annual cash
inflows..............
1-6
Salvage value.....
6
Net present value

Present
Amount
22%
Value of
of Cash Facto
Cash
Flows
r
Flows
$(18,600) 1.000 $(18,600)
$5,000 3.167
$9,125 0.303

15,835
2,765
$
0

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Managerial Accounting, 13th Edition

Exercise 14-3 (15 minutes)

The equipments net present value without considering the
intangible benefits would be:
20%
Present
Amount of Facto
Value of
Item
Year(s) Cash Flows
r
Cash Flows
Cost of the
$(2,500,000
equipment............
Now
) 1.000 $(2,500,000)
Annual cost savings.
1-15
$400,000 4.675
1,870,000
Net present value....
$ (630,000)
The annual value of the intangible benefits would have to be
great enough to offset a $630,000 negative present value for the
equipment. This annual value can be computed as follows:
Required increase in present value
$630,000
=
= $134,759
Factor for 15 years
4.675

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Solutions Manual, Appendix 14C

Exercise 14-4 (10 minutes)

1. The project profitability index for each proposal is:
Proposa
l
Number
A
B
C
D

Net Present
Value
(a)
$36,000
$38,000
$35,000
$40,000

Project
Investmen Profitability Index
t Required
(a) (b)
(b)
$90,000
0.40
$100,000
0.38
$70,000
0.50
$120,000
0.33

2. The ranking is:

Proposa
l
Number
C
A
B
D

Project
Profitability
Index
0.50
0.40
0.38
0.33

Note that proposal D has the highest net present value, but it
ranks lowest in terms of the project profitability index.

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4

Managerial Accounting, 13th Edition

Exercise 14-5 (10 minutes)

1. The payback period is determined as follows:
Investme
Year
nt
1
$15,000
2
$8,000
3
4
5
6
7
8
9
10

Cash
Inflow
$1,000
$2,000
$2,500
$4,000
$5,000
$6,000
$5,000
$4,000
$3,000
$2,000

Unrecovered
Investment
$14,000
$20,000
$17,500
$13,500
$8,500
$2,500
$0
$0
$0
$0

The investment in the project is fully recovered in the 7th year.

To be more exact, the payback period is approximately 6.5
years.
2. Because the investment is recovered prior to the last year, the
amount of the cash inflow in the last year has no effect on the
payback period.

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Solutions Manual, Appendix 14C

Exercise 14-6 (10 minutes)

This is a cost reduction project, so the simple rate of return would
be computed as follows:
Operating cost of old machine.............
Less operating cost of new machine....
Less annual depreciation on the new
machine ($120,000 10 years)........
Annual incremental net operating
income...............................................

$ 30,000
12,000

Cost of the new machine......................

Scrap value of old machine..................
Initial investment.................................

$120,000
40,000
$ 80,000

12,000
$ 6,000

Simple rate = Annual incremental net operating income

of return
Initial investment
=

$6,000
= 7.5%
$80,000

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Managerial Accounting, 13th Edition

Exercise 14-7 (15 minutes)

1. The payback period is:
Payback period =

Investment required
Annual net cash inflow

432,000
= 4.8 years
90,000

No, the equipment would not be purchased because the

payback period (4.8 years) exceeds the companys maximum
payback time (4.0 years).
2. The simple rate of return would be computed as follows:
Annual cost savings......................................
Less annual depreciation (432,000 12
years).........................................................
Annual incremental net operating income....
Simple rate of return =
=

90,000
36,000
54,000

Annual incremental net operating income

Initial investment
54,000
= 12.5%
432,000

No, the equipment would not be purchased because its 12.5%

rate of return is less than the companys 14% required rate of
return.

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Solutions Manual, Appendix 14C

Exercise 14-8 (10 minutes)

Amount
of Cash
Flows

Item
Year(s)
Project X:
Initial
investment......
Now
$(35,000)
Annual cash
inflow..............
1-10
$9,000
Net present
value...............
Project Y:
Initial
investment......
Single cash
inflow..............
Net present
value...............

Now
10

18%
Factor
1.000
4.494

Present
Value of
Cash
Flows
$(35,000)
40,446
$ 5,446

$(35,000)

1.000

$150,000

0.191

$(35,000)
28,650
$( 6,350)

Project X should be selected. Project Y does not provide the

required 18% return, as shown by its negative net present value.

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Managerial Accounting, 13th Edition

Exercise 14-9 (10 minutes)

Purchase of the
stock......................
Annual cash
dividends...............
Sale of the stock.......
Net present value.....

Year(s)

Amount
of Cash
Flows

Now

$(13,000)

1-3
3

$420
$16,000

14%
Facto
r

Present
Value of
Cash
Flows

1.000 $(13,000)
2.322
0.675

975
10,800
$ (1,225)

No, Kathy did not earn a 14% return on the Malti Company stock.
The negative net present value indicates that the rate of return on
the investment is less than the minimum required rate of return of
14%.

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Solutions Manual, Appendix 14C

Exercise 14-10 (15 minutes)

Item
Project A:
Cost of
equipment........
Annual cash
inflows..............
Salvage value of
the equipment. .
Net present value
Project B:
Working capital
investment.......
Annual cash
inflows..............
Working capital
released............
Net present value

Year(s)

Amount of
Cash
Inflows

14%
Present
Facto
Value of
r
Cash Flows

Now

$(100,000)

1.000 $(100,000)

1-6
6

Now
1-6
6

$21,000

3.889

$8,000

0.456

$(100,000)

81,669
3,648
$ (14,683)

1.000 $(100,000)

$16,000

3.889

62,224

$100,000

0.456

45,600
$
7,824

The $100,000 should be invested in Project B rather than in

Project A. Project B has a positive net present value whereas
Project A has a negative net present value.

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Managerial Accounting, 13th Edition

Exercise 14-11 (30 minutes)

1.

Amount
of Cash
Item
Year(s)
Flows
Initial investment. .
Now $(84,900)
Annual cash
inflows................
1-12 $15,000
Net present value.

Present
14%
Value of
Factor Cash Flows
1.000 $(84,900)
5.660

84,900
$
0

Yes, this is an acceptable investment because it provides

exactly the minimum required 14% rate of return.
2.

Factor of the internal = Investment in the project

rate of return
Annual net cash inflow
=

Cost of the new press

Annual cost savings

$217,500
= 7.250
$30,000

Looking in Exhibit 14B-2, and reading along the 18-period line,

we find that a factor of 7.250 represents an internal rate of
return of 12%. Since the required rate of return is 16%, the
investment is not acceptable.
3.

Factor of the internal = Investment in the project

rate of return
Annual net cash inflow
We know that the investment is $217,500, and we can
determine the factor for an internal rate of return of 16% by
looking in Exhibit 14B-2 along the 18-period line. This factor is
5.818. Using these figures in the formula, we get:
$217,500
= 5.818 (factor for 16% for 18 years)
Annual cash inflow
Therefore, the annual cash inflow would have to be: $217,500
5.818 = $37,384.
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Solutions Manual, Appendix 14C

11

Exercise 14-12 (15 minutes)

1. Computation of the annual cash inflow associated with the new
pinball machines:
Net operating income....................................
Add noncash deduction for depreciation.......
Annual net cash inflow..................................

$40,000
35,000
$75,000

The payback computation would be:

Payback period =
=

Investment required
Annual net cash inflow
$300,000
= 4.0 years
$75,000 per year

Yes, the pinball machines would be purchased. The payback

period is less than the maximum 5 years required by the
company.
2. The simple rate of return would be:
Simple rate = Annual incremental net income
of return
Initial investment
=

$40,000
= 13.3%
$300,000

Yes, the pinball machines would be purchased. The 13.3%

return exceeds 12%.

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12

Managerial Accounting, 13th Edition

Exercise 14-13 (30 minutes)

1. Factor of the internal
Investment required
=
rate of return
Annual net cash inflow
=

$130,400
= 5.216
$25,000

Looking in Exhibit 14B-2 and scanning along the 10-period line,

a factor of 5.216 represents an internal rate of return of 14%.
2.

Present
14%
Value of
Year(s Amount of Facto
Cash
Item
)
Cash Flows
r
Flows
$(130,400
Initial investment...... Now $(130,400) 1.000
)
Annual net cash
inflows.................... 1-10
$25,000 5.216 130,400
Net present value......
$
0
The reason for the zero net present value is that 14% (the
discount rate we have used) represents the machines internal
rate of return. The internal rate of return is the discount rate
that results in a zero net present value.

3. Factor of the internal

Investment required
=
rate of return
Annual net cash inflow
=

$130,400
= 5.796 (rounded)
$22,500

Looking in Exhibit 14B-2 and scanning along the 10-period line,

a factor of 5.796 falls closest to the factor for 11%. Thus, to the
nearest whole percent, the internal rate of return is 11%.

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Solutions Manual, Appendix 14C

13

Exercise 14-14 (10 minutes)

Factor of the internal= Investment in the project
rate of return
Annual net cash inflow
=

$106,700
= 5.335
$20,000

Looking in Exhibit 14B-2, and scanning down the 10% column, we

find that a factor of 5.335 equals 8 periods. Thus, the equipment
will have to be used for 8 years in order to yield a return of 10%.

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14

Managerial Accounting, 13th Edition

Exercise 14-15 (10 minutes)

Note: All present value factors in the computation below have
been taken from Exhibit 14B-1 in Appendix 14B, using a 12%
discount rate.
$104,95
0

Amount of the investment...................

Less present value of Year 1 and Year
2 cash inflows:
Year 1: $30,000 0.893.................... $26,790
Year 2: $40,000 0.797.................... 31,880 58,670
Present value of Year 3 cash inflow......
$ 46,280
Therefore, the expected cash inflow for Year 3 is:
$46,280 0.712 = $65,000.

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Solutions Manual, Appendix 14C

15