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111.
Medium
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(Ignore income taxes in this problem.) General Manufacturing Company
consists of several divisions, one of which is the Transportation Division.
The company has decided to dispose of this division since it no longer fits
the company's long-term strategy. An offer of $9,000,000 has been received
from a prospective buyer. If General retained the division, the company would
operate the division for only nine years, after which the division would no
longer be needed and would be sold for $600,000. If the company retains the
division, an immediate investment of $500,000 would need to be made to update
equipment to current standards. Annual net operating cash flows would be
$1,805,000 if the division is retained. The company’s discount rate is 12%.
Required:
Using the net present value method, determine whether General
Manufacturing should accept or reject the offer made by the potential buyer.
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Answer:
12% Present
Year Explanation Amount Factor Valueo
0
Investment to update assets $
(500,000) 1.000 $ (500,000)
1-9 Annual cash inflows ....... 1,805,000 5.328
9,617,040
9
Selling price for
the division ............
600,000 0.361 216,600
Net present value ......... $9,333,640
The sales price of $9,000,000 is less than the present value of the
cash flows resulting from retaining the division. General thus should not
accept the offer.
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112.
Medium
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(Ignore income taxes in this problem.) Mark Stevens is considering
opening a hobby and craft store. He would need $100,000 to equip the business
and another $40,000 for inventories and other working capital needs. Rent on
the building used by the business will be $24,000 per year. Mark estimates
that the annual cash inflow from the business will amount to $90,000. In addition
to building rent, annual cash outflow for operating costs will amount to
$30,000. Mark plans to operate the business for only six years. He estimates
that the equipment and furnishings could be sold at that time for 10% of
their original cost. Mark uses a discount rate of 16%.
Required:
Would you advise Mark to make this investment? Use the net present
value method.
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Answer:
16% Present
Description Years Amount
Factor Value
o
Equipment ........... 0
($100,000) 1.000 ($100,000)
Working capital ..... 0
($ 40,000) 1.000 ($ 40,000)
Building rent ....... 1-6
($ 24,000) 3.685 ($ 88,440)
Net annual cash
inflow ............ 1-6 $ 60,000 3.685
$221,100
Salvage value,
equipment ......... 6 $ 10,000 0.410
$ 4,100
Release of working
capital ........... 6 $ 40,000 0.410
$ 16,400
Net present value $ 13,160
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113.
Medium
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(Ignore income taxes in this problem.) Vernon Company has been offered
a 7-year contract to supply a part for the military. After careful study, the
company has developed the following estimated data relating to the contract:
Cost of equipment needed ............................. $300,000
Working capital needed ............................... $ 50,000
Annual cash receipts from the delivery of parts,
less cash operating costs
.......................... $ 70,000
Salvage value of equipment at termination of
the contract
....................................... $
5,000
It is not expected that the contract would be extended beyond the
initial contract period. The company's discount rate is 10%.
Required:
Use the net present value method to determine if the contract should be
accepted. Round all computations to the nearest dollar.
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Answer:
10% Present
Description Years Amount Factor Value
o
Equipment ........... 0
($300,000) 1.000 ($300,000)
Working capital ..... 0
($ 50,000) 1.000 ($ 50,000)
Net annual cash
inflow ............ 1-7 $ 70,000 4.868
$340,760
Salvage value,
equipment ......... 7 $
5,000 0.513 $
2,565
Release of working
capital
........... 7 $ 50,000 0.513
$ 25,650
Net present value $ 18,975
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114.
Hard
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(Ignore income taxes in this problem.) AB Company is considering the
purchase of a machine that promises to reduce operating costs by the same
amount for every year of its 6-year useful life. The machine will cost
$83,150 and has no salvage value. The machine has a 20% internal rate of
return.
Required:
What is the annual cost savings promised by the machine?
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Answer:
Investment required ÷ Net
annual cash inflow =
Factor of the internal
rate of return
$83,150 ÷ Net annual
cash inflow = 3.326
$83,150 ÷ 3.326 = Net
annual cash inflow
=
$25,000
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115.
Easy
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(Ignore income taxes in this problem.) Ferris Company has an old
machine that is fully depreciated but has a current salvage value of $5,000.
The company wants to purchase a new machine that would cost $60,000 and have
a 5-year useful life and zero salvage value. Expected changes in annual
revenues and expenses if the new machine is purchased are:
Increased revenues ............... $63,000
Increased expenses:
Salary of additional
operator .. $20,000
Supplies
....................... 9,000
Depreciation ................... 12,000
Maintenance
.................... 4,000 45,000
Increased net income
.............. $18,000
Required:
a. Compute the payback period on the new equipment.
b. Compute the simple rate of return on the new equipment.
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Answer:
a. Investment required ÷ Net annual cash
inflow = Payback period
$60,000 - $5,000) ÷ ($18,000 + $12,000) = 1.83 years (rounded)
b. Incremental net income ÷ Investment =
Simple rate of return
$18,000 ÷ $55,000 = 32.7%
(rounded)
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