Fraser Company will need a new warehouse in eight years. The warehouse will cost $410,000 to build.

Exercise 13A-4 Basic Present Value Concepts [LO13-7]

Fraser Company will need a new warehouse in eight years. The warehouse will cost $410,000 to build.

Required:

What lump-sum amount should the company invest now to have the $410,000 available at the end of the eight-year period? Assume that the company can invest money at:

 

Explanation

From Exhibit 13B-1, the factor for 12% for 8 periods is 0.404. Therefore, the company must invest:

$410,000 × 0.404 = $165,640

From Exhibit 13B-1, the factor for 13% for 8 periods is 0.376. Therefore, the company must invest:

$410,000 × 0.376 = $154,160

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In seven years, when he is discharged from the Air Force, Steve wants to buy an $22,000 power boat

Exercise 13A-3 Basic Present Value Concepts [LO13-7]

In seven years, when he is discharged from the Air Force, Steve wants to buy an $22,000 power boat.

Required:

What lump-sum amount must Steve invest now to have the $22,000 at the end of seven years if he can invest money at: 

Explanation

From Exhibit 13B-1, the factor for 10% for 7 periods is 0.513. Therefore, the present value of the required investment is:

$22,000 × 0.513 = $11,286.

From Exhibit 13B-1, the factor for 12% for 7 periods is 0.452. Therefore, the present value of the required investment is:

$22,000 × 0.452 = $9,944.

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Julie has just retired. Her company’s retirement program has two options as to how retirement benefits can be received.

Julie has just retired. Her company’s retirement program has two options as to how retirement benefits can be received. Under the first option, Julie would receive a lump sum of $140,000 immediately as her full retirement benefit. Under the second option, she would receive $27,000 each year for 5 years plus a lump-sum payment of $59,000 at the end of the 5-year period.

Required:

1-a. Calculate the present value for the following assuming that the money can be invested at 12%.

1-b. If she can invest money at 12%, which option would you recommend that she accept?

Explanation

The present value of the first option is $140,000, since the entire amount would be received immediately.

The present value of the second option is:

Annual annuity: $27,000 × 3.605 (Exhibit 13B-2)	$	97,335
Lump-sum payment: $59,000 × 0.567 (Exhibit 13B-1)		33,453
Total present value	$	130,788

Thus, Julie should accept the first option, which has a much higher present value.

On the surface, the second option appears to be a better choice because it promises a total cash inflow of $194,000 over the 5-year period ($27,000 × 5 = $135,000; $135,000 + $59,000 = $194,000), whereas the first option promises a cash inflow of only $140,000. However, the cash inflows under the second option are spread out over 5 years, causing the present value to be far less.

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Exercise 13A-1 Basic Present Value Concepts [LO13-7]

Exercise 13A-1 Basic Present Value Concepts [LO13-7]

Annual cash inflows that will arise from two competing investment projects are given below:

Year	Investment A		Investment B
1	$	1,000	$	4,000
2		2,000		3,000
3		3,000		2,000
4		4,000		1,000
	$	10,000	$	10,000

The discount rate is 9%.

Required: 

Compute the present value of the cash inflows for each investment. Each investment opportunity will require the same initial investment.

 

Investment project B is best.

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Kathy Myers frequently purchases stocks and bonds, but she is uncertain how to determine the rate of return that she is earning.

Kathy Myers frequently purchases stocks and bonds, but she is uncertain how to determine the rate of return that she is earning. For example, three years ago she paid $19,000 for 930 shares of Malti Company’s common stock. She received a $735 cash dividend on the stock at the end of each year for three years. At the end of three years, she sold the stock for $22,000. Kathy would like to earn a return of at least 17% on all of her investments. She is not sure whether the Malti Company stock provided a 17% return and would like some help with the necessary computations.

Required:

1. Compute the net present value that Kathy earned on her investment in Malti Company stock. 

2. Did the Malti Company stock provide a 17% return?

Explanation

1.

	Now			Years 1-3		Year 3
Purchase of stock	$	(19,000	)
Annual cash dividend				$	735
Sale of stock						$	22,000
Total cash flows (a)	$	(19,000	)	$	735	$	22,000
Discount factor (17%) (b)		1.000			2.210		0.624
Present value (a) × (b)	$	(19,000	)	$	1,624	$	13,728
Net present value	$	(3,648	)

2.

No, Kathy did not earn a 17% 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 17%.

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