1. Basic present value calculations
Calculate the present value of the following cash flows, rounding to the nearest dollar:
a. A single cash inflow of $12,000 in 5 years, discounted at a 12% rate of return.
b. An annual receipt of $16,000 over the next 12 years, discounted at a 14% rate of return.
c.A single receipt of $15,000 at the end of Year 1 followed by a single receipt of $10,000 at the end of Year 3. The company has a 10% rate ofreturn.
d.An annual receipt of $8,000 for 3 years followed by a single receipt of $10,000 at the end of Year 4. The company has a 16% rate of return.
3. Straightforward net present value calculations
Contempo Inc. is considering the acquisition of some new labor-saving equipment. Management estimates that the equipment will cost$42,000 and will produce the following savings in cash operating costs during the next 5 years: Year 1, $15,000; Year 2, $13,000; Year 3,$10,000; Year 4, $10,000; and Year 5, $6,000. The company uses the net present value method to analyze investments and desires a minimumrate of return of 12%.
a. Compute the net present value of the proposed investment. Ignore income taxes and round to the nearest dollar.
b. Considering the time value of money , should Contempo acquire the new equipment? Why?
Problem 3 and 4
1. Straightforward net present value and payback computations
The Calgary Eskimos play in the Canadian Hockey League. Although the Eskimos will soon be moving to a modern arena, management isstudying the possibility of expanding the team's present facility to accommodate increased crowds. A $2.4 million expansion is planned that hasa $200,000 residual value and will be depreciated by the straight-line method over four seasons. Information about the expansion follows:
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Number of seats
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Occupancy rate
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Ticket price
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Class 1 seats
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2,500
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80%
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$6
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Class 2 seats
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2,000
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60
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4
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2. The team will play 50 home games each season. Total added operating costs per game (ushers, cleanup, and depreciation) are expected toaverage $11,800. All such costs, except depreciation, require cash outlays.
3. Instructions
a. By using the net present value method and a 16% desired rate of return, determine whether the expansion should be undertaken.
b. In addition to the cash flows presented here, what other cash flows might change if the Eskimos add on to the arena?
4. Equipment replacement decision
Columbia Enterprises is studying the replacement of some equipment that originally cost $74,000. The equipment is expected to provide 6more years of service if $8,700 of major repairs are performed in 2 years. Annual cash operating costs total $27,200. Columbia can sell theequipment now for $36,000; the estimated residual value in 6 years is $5,000.
New equipment is available that will reduce annual cash operating costs to $21,000. The equipment costs $103,000, has a service life of 6years, and has an estimated residual value of $13,000. Company sales will total $430,000 per year with either the existing or the newequipment.
Columbia has a minimum desired return of 12% and depreciates all equipment by the straight-line method.
Instructions
a. By using the net present value method, determine whether Columbia should keep its present equipment or acquire the new equipment.Round all calculations to the nearest dollar, and ignore income taxes.
b. Columbia's management believes that the time value of money should be considered in all long-term decisions. Briefly discuss therationale that underlies management's belief.