Problem 1: Unifying Concepts: Net Present Value and Internal Rate of Return Methods
Julie Kowalis, an investment analyst, wants to know if her investments during the past four years have earned at least a 12% return. Four years ago, she had the following investments:
a. She purchased a small building for $50,000 and rented space in it. She received rental income of $8,000 for each of the four years and then sold the building this year for $55,000.
b. She purchased a small refreshment stand near the city park for $25,000. Annual income from the stand was $5,000 for each of the four years. She sold the stand for $20,000 this year.
c. She purchased an antique car for $5,000 four years ago. She sold it this year to a collector for $7,000.
Required:
1. Using the net present value method, determine whether or not each investment earned at least 12%.
2. Did the investments as a whole earn at least 12%? Explain.
Problem 2:
Unifying Concepts: Payback and Internal Rate of Return
The management of Kitchen Shop is thinking of buying a new drill press to aid in adapting parts for different machines. The press is expected to save Kitchen Shop $8,000 per year in costs. However, Kitchen Shop has an old punch machine that isn't worth anything on the market and that will probably last indefinitely. The new press will last 12 years and will cost $41,595.
(Ignore income tax effects.)
Required:
1. Compute the payback period of the new machine.
2. Compute the internal rate of return.
3. Interpretive Question: What uncertainties are involved in this decision? Discuss how they might be dealt with.