Assignment: Chapter 14 LO 3
1. Cornerstone Exercise 14-23
Net Present Value
Holland, Inc., has just completed development of a new cell phone. The new product is expected to produce annual revenues of $1,350,000. Producing the cell phone requires an investment in new equipment, costing $1,440,000. The cell phone has a projected life cycle of five years. After five years, the equipment can be sold for $180,000. Working capital is also expected to increase by $180,000, which Holland will recover by the end of the new product’s life cycle. Annual cash operating expenses are estimated at $810,000. The required rate of return is 8 percent.
1. Prepare a schedule of the projected annual cash flows.
2. Calculate the NPV using only discount factors from Exhibit 14B-1. Round present value calculations and your final answer to the nearest whole dollar.
2. Exercise 14-28
Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows.
a. Southward Manufacturing is considering the purchase of a new welding system. The cash benefits will be $400,000 per year. The system costs $2,250,000 and will last 10 years.
b. Kaylin Day is interested in investing in a women’s specialty shop. The cost of the investment is $180,000. She estimates that the return from owning her own shop will be $35,000 per year. She estimates that the shop will have a useful life of six years.
c. Goates Company calculated the NPV of a project and found it to be $21,300. The project’s life was estimated to be eight years. The required rate of return used for the NPV calculation was 10 percent. The project was expected to produce annual after-tax cash flows of $45,000.
1. Compute the NPV for Southward Manufacturing, assuming a discount rate of 12 percent. Round to the nearest dollar.
Should the company buy the new welding system?
2. Conceptual Connection: Assuming a required rate of return of 8 percent, calculate the NPV for Kaylin Day’s investment. Round to the nearest dollar.
Should she invest?
Calculate the NPV assuming the estimated return was $45,000 per year. Round to the nearest dollar.
Would this affect the decision? What does this tell you about your analysis?
3. What was the required investment for Goates Company’s project? Round to the nearest dollar.
3. Exercise 14-30
Follow the format shown in Exhibit 14B-1 and Exhibit 14B-2 as you complete the requirements below. You may use the attached spreadsheet to help you complete this activity, but you are not required to do so. You will find the spreadsheet by clicking on the link in the drop-down menu above.
Wilburton Hospital is investigating the possibility of investing in new dialysis equipment. Two local manufacturers of this equipment are being considered as sources of the equipment. After-tax cash inflows for the two competing projects are as follows:
Both projects require an initial investment of $700,000. In both cases, assume that the equipment has a life of five years with no salvage value.
1. Assuming a discount rate of 12 percent, compute the net present value of each piece of equipment.
2. A third option has surfaced for equipment purchased from an out-of-state supplier. The cost is also $700,000, but this equipment will produce even cash flows over its five-year life. What must the annual cash flow be for this equipment to be selected over the other two? Assume a 12 percent discount rate.