Problem 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 of return.
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.
Problem 2. 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 minimum rate 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. Straightforward net present value and payback computations
STL Entertainment is considering the acquisition of a sightseeing boat for summer tours along the Mississippi River. The following information is available:
Cost of boat $500,000
Service life 10 summer seasons
Disposal value at the end of 10 seasons $100,000
Capacity per trip 300 passengers
Fixed operating costs per season $160,000
(including straight-line depreciation)
Variable operating costs per trip $1,000
Ticket price $5 per passenger
All operating costs, except depreciation, require cash outlays. On the basis ofsimilar operations in other areas of the country, management anticipates that eachtrip will be sold out and that 120,000 passengers will be carried each season. Ignore income taxes.
Instructions
By using the net present value method, determine whether STL Entertainmentshould acquire the boat. Assume a 14% desired return on all investments; round calculations to the nearest dollar.
Problem 4. Equipment replacement decision
Columbia Enterprises is studying the replacement of some equipment that originally cost $74,000. The equipment is expected to provide 6 more years of service if $8,700 of major repairs are performed in 2 years. Annual cash operating costs total $27,200. Columbia can sell the equipment 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 6 years, and has an estimated residual value of $13,000. Company sales will total $430,000 per year with either the existing or the new equipment.
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 the rationale that underlies management's belief.
Attachment:- Guidance Report.xlsx