To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 13 CAPITAL INVESTMENT DECISIONS QUESTIONS FOR WRITING AND DISCUSSION Independent projects are such that the acceptance of one does not preclude the acceptance of another With mutually exclusive projects, acceptance of one precludes the acceptance of others 11 If NPV > 0, then the investment is acceptable If NPV < 0, then the investment should be rejected 12 Disagree Only if the funds received each period from the investment are reinvested to earn the IRR will the IRR be the actual rate of return 13 Postaudits help managers determine if resources are being used wisely Additional resources or corrective action may be needed Postaudits also serve to encourage managers to make good capital investment decisions They also provide feedback that may help improve future decisions 14 NPV signals which investment maximizes firm value; IRR may provide misleading signals IRR may be popular because it provides the correct signal most of the time and managers are accustomed to working with rates of return 15 The accounting rate of return is the average income divided by original or average investment ARR = $100,000/$300,000 = 33.33% Often, investments must be made in assets that not directly produce revenues In this case, choosing the asset with the least cost (as measured by NPV) makes sense 16 Agree Essentially, net present value is a measure of the return in excess of the investment and its cost of capital NPV analysis is only as good as the accuracy of the cash flows If projections of cash flows are not accurate, then incorrect investment decisions may be made 17 The quality and reliability of the cash flow projections are directly related to the assumptions and methods used for forecasting If the assumptions and methods are faulty, then the forecasts will be wrong, and incorrect decisions may be made 18 The principal tax implications that should be considered in Year are gains and losses on the sale of existing assets 19 The MACRS method provides more shielding effect in earlier years than the straightline method does As a consequence, the present value of the shielding benefit is greater for the MACRS method The timing and quantity of cash flows determine the present value of a project The present value is critical for assessing whether a project is acceptable or not By ignoring the time value of money, good projects can be rejected and bad projects accepted The payback period is the time required to recover the initial investment Payback = $80,000/$30,000 = 2.67 years (a) A measure of risk Roughly, projects with shorter paybacks are less risky (b) Obsolescence If the risk of obsolescence is high, firms will want to recover funds quickly (c) Self-interest Managers want quick paybacks so that short-run performance measures are affected positively, enhancing chances for bonuses and promotion Also, this method is easy to calculate NPV measures the increase in firm value from a project The cost of capital is the cost of investment funds and is usually viewed as the weighted average of the costs of funds from all sources It should serve as the discount rate for calculating net present value or the benchmark for IRR analysis 10 For NPV, the required rate of return is the discount rate For IRR, the required rate of return is the benchmark against which the IRR is compared to determine whether an investment is acceptable or not 425 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 20 21 to maintain or increase market share are examples of intangible benefits Reduction in support labor in such areas as scheduling and stores are indirect benefits The half-year convention assumes that an asset is in service for only a half year in the year of acquisition Thus, only half of the first year’s depreciation can be claimed, regardless of the date on which use of the asset actually began It increases the length of time depreciation is recognized by one year over the indicated class life 22 Intangible and indirect benefits are of much greater importance in the advanced manufacturing environment Greater quality, more reliability, improved delivery, and the ability 426 Sensitivity analysis changes the assumptions on which the capital investment analysis is based Even with sound assumptions, there is still the element of uncertainty No one can predict the future with certainty By changing the assumptions, managers can gain insight into the effects of uncertain future events To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com EXERCISES 13–1 10 11 12 13 14 15 16 17 18 19 20 a e c a d e c b d e b c a e c a e b e c 13–2 Payback period = $200,000/$60,000 = 3.33 years Payback period: $125,000 1.0 year 175,000 1.0 year 200,000 0.8 year $500,000 2.8 years Investment = annual cash flow × payback period = $120,000 × = $360,000 Annual cash flow = Investment/payback period = $250,000/2.5 = $100,000 per year 427 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–3 Initial investment (Average depreciation = 300,000): Accounting rate of return = Average accounting income/Investment = ($2,500,000 – $2,000,000 - $300,000)/$1,500,000 = 13.3% Accounting rate of return (ARR): Project A: ARR = ($12,800 – $4,000)/$20,000 = 44% Project B: ARR = ($7,600 – $2,000)/$20,000 = 18% Project A should be chosen ARR = Average Net Income/Average Investment 0.25 = $100,000/Average Investment Average Investment = $100,000/0.25 = $400,000 Thus, Investment = × $400,000 = $800,000 ARR = Average Net Income/Investment 0.50 = Average Net Income/$200,000 Average Net Income = 0.50 × $200,000 = $100,000 13–4 NPV = P – I = (5.650 × $240,000) – $1,360,000 = $(4,000) The system should not be purchased NPV = P – I = (4.623 × $9,000) – $30,000 = $11,607 Yes, he should make the investment 428 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com NPV = P - I I = P – NPV I = 4.355 × $10,000 - $3,550 = $40,000 13–5 P = CF(df) = I for the IRR, thus, df = Investment/Annual cash flow = $1,563,500/$500,000 = 3.127 For five years and a discount factor of 3.127, the IRR is 18% P = CF(df) = I for the IRR, thus, df = $521,600/$100,000 = 5.216 For ten years, and a discount factor of 5.216, IRR = 14% Yes, the investment should be made CF(df) = I for the IRR, thus, CF = I/df = $2,400,000/4.001 =$599,850 13-6 Larson Blood Analysis Equipment: Year NPV Cash Flow $(200,000) 120,000 100,000 80,000 40,000 20,000 Discount Factor 1.000 0.893 0.797 0.712 0.636 0.567 429 Present Value $(200,000) 107,160 79,700 56,960 25,440 11,340 $ 80,600 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-6 Concluded Lawton Blood Analysis Equipment: Year NPV Cash Flow $(200,000) 20,000 20,000 120,000 160,000 180,000 Discount Factor 1.000 0.893 0.797 0.712 0.636 0.567 Present Value $(200,000) 17,860 15,940 85,440 101,760 102,060 $ 123,060 CF(df) – I = NPV CF(3.605) - $200,000 = $123,060 (3.605)CF = $323,060 CF = $323,060/3.605 CF = $89,614 per year Thus, the annual cash flow must exceed $89,614 to be selected 13–7 Payback period = Original investment/Annual cash inflow = $800,000/($1,300,000 – $1,000,000) = $800,000/$300,000 = 2.67 years a Initial investment (Average depreciation = 160,000): Accounting rate of return = Average accounting income/Investment = ($300,000 – $160,000)/$800,000 = 17.5% 430 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-7 Concluded Year NPV P = CF(df) = I for the IRR, thus, Cash Flow $(800,000) 300,000 300,000 300,000 300,000 300,000 Discount Factor 1.000 0.909 0.826 0.751 0.683 0.621 Present Value $(800,000) 272,700 247,800 225,300 204,900 186,300 $ 337,000 df = Investment/Annual cash flow = $800,000/$300,000 = 2.67 For five years and a discount factor of 2.67, the IRR is between 24 and 26% 13-8 Payback period: Project A: $ 3,000 4,000 3,000 $10,000 1.00 year 1.00 year 0.60 year 2.60 years Project B: $ 3,000 4,000 3,000 $10,000 1.00 year 1.00 year 0.50 year 2.50 years Both projects have about the same payback so the most profitable should be chosen (Project A) 431 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-8 Concluded Accounting rate of return (ARR): Project A: ARR = ($6,400 – $2,000)/$10,000 = 44% Project B: ARR = ($3,800 – $2,000)/$10,000 = 18% Project A should be chosen P = 9.818 × $24,000 = $235,632 Wilma should take the annuity NPV = P – I = (4.623 × $6,000) – $20,000 = $7,738 Yes, he should make the investment df = $130,400/$25,000 = 5.216 IRR = 14% Yes, the investment should be made 13–9 a Return of the original investment b Cost of capital ($200,000 × 10%) c Profit earned on the investment ($231,000 – $220,000) $200,000 20,000 11,000 Present value of profit: P = F × Discount factor = $11,000 × 0.909 = $9,999 Cash Flow Year $(200,000) 231,000 Net present value Discount Factor 1.000 0.909 Present Value $(200,000) 209,979 $ 9,979 Net present value gives the present value of future profits (the slight difference is due to rounding error in the discount factor) 432 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–10 Bond cost = $6,000/$120,000 = 0.05 Cost of capital = 0.05(0.6) + 0.175(0.4) = 0.03 + 0.07 = 0.10 Year Cash Flow $(200,000) 100,000 100,000 100,000 Net present value Discount Factor 1.000 0.909 0.826 0.751 Present Value $(200,000) 90,900 82,600 75,100 $ 48,600 It is not necessary to subtract the interest payments and the dividend payments because these are associated with the cost of capital and are included in the firm’s cost of capital of 10 percent 433 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–11 P = I = df × CF 2.914* × CF = $120,000 CF = $41,181 *From Exhibit 13B-2, 14 percent for four years For IRR (discount factors from Exhibit 13B-2): I = df × CF = 2.402 × CF (1) For NPV: NPV = df × CF – I = 2.577 × CF – I (2) Substituting equation (1) into equation (2): NPV = (2.577 × CF) – (2.402 × CF) $1,750 = 0.175 × CF CF = $1,750/0.175 = $10,000 in savings each year Substituting CF = $10,000 into equation (1): I = 2.402 × $10,000 = $24,020 original investment For IRR: I = df × CF $60,096 = df × $12,000 df = $60,096/$12,000 = 5.008 From Exhibit 13B-2, 18 percent column, the year corresponding to df = 5.008 is 14 Thus, the lathe must last 14 years 434 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–29 Concluded Year 2–5 NPV Cash Flow* $(920,000) 186,800 223,600 186,800 150,000 150,000 Discount Factor 1.000 0.862 2.412 0.410 0.354 0.305 Present Value $(920,000) 161,022 539,323 76,588 53,100 45,750 $ (44,217) *After-tax cash flow = (0.60 × $250,000) + (0.40 × annual depreciation) for Years 1–6 Depreciation = $920,000/5 = $184,000 with ½ taken in Year and ½ taken in Year After the fact, the decision was not a good one The $100,000 per year is an annuity that produces an after-tax cash flow of $60,000 ($100,000 × 0.60) The present value of this annuity is $260,640 (4.344 × $60,000) This restores the project to a positive NPV position ($260,640 – $44,217 = $216,423) A postaudit can help ensure that a firm’s resources are being used wisely It may reveal that additional resources ought to be invested or that corrective action be taken so that the performance of the investment is improved A postaudit may even signal the need to abandon a project or replace it with a more viable alternative Postaudits also provide information to managers so that their future capital decision making can be improved Finally, postaudits can be used as a means to hold managers accountable for their capital investment decisions 458 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–30 Old system (dollars in thousands): Year 1–9 10 NPV (1 – t)Ra –(1 – t)Cb tNCc $18,000 18,000 $(13,440) (13,440) $240 — Cash Flow $ 4,800 4,560 df 1.000 4.303 0.191 Present Value* $ 20,654 871 $ 21,525 Cash Flow $(50,040) 12,840 df 1.000 4.494 Present Value* $ (50,040) 57,703 $ 7,663 a 0.6 × $300 × 100,000 0.6 × $224 × 100,000 c 0.4 × $600,000 *Rounded b New system (dollars in thousands): Year 1–10 NPV a (1 – t)Ra –(1 – t)Cb $18,000 $(7,320) Direct materials (0.75 × $80) Direct labor (1/3 × $90) Volume-related OH ($20 – $5) Direct FOH ($34 – $17) Unit cost tNCc $2,160 $ 60 30 15 17 $122 Total cash expenses = $122 × 100,000 = $12,200,000 After-tax cash expenses = 0.6 × $12,200,000 b Year 0: Tax savings on loss from sale of old machine = 0.4 × ($6,000,000 – $600,000 – $3,000,000) = $960,000 Years 1–10: Depreciation = 0.4 × $54,000,000/10 c Net outlay = $54,000,000 – $3,000,000 – $960,000 = $50,040,000 The company should keep the old system 459 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–30 Continued Old system (dollars in thousands): Year 1–9 10 NPV (1 – t)R –(1 – t)C tNC $18,000 18,000 $(13,440) (13,440) $240 — Cash Flow $ 4,800 4,560 df 1.000 5.328 0.322 Present Value* $ 25,574 1,468 $ 27,042 Cash Flow $(50,040) 12,840 df 1.000 5.650 Present Value $ (50,040) 72,546 $ 22,506 New system (dollars in thousands): Year 1–10 NPV (1 – t)R –(1 – t)C $18,000 $(7,320) tNC $2,160 Notice how much more attractive the automated system becomes when the cost of capital is used as the discount rate *Rounded Old system with declining sales (dollars in thousands): Year 10 NPV (1 – t)R –(1 – t)C tNC $18,000 16,200 14,400 12,600 10,800 9,000 7,200 5,400 3,600 1,800 $(13,440) (12,300) (11,160) (10,020) (8,880) (7,740) (6,600) (5,460) (4,320) (3,180) $240 240 240 240 240 240 240 240 240 — Cash Flow $ 4,800 4,140 3,480 2,820 2,160 1,500 840 180 (480) (1,380) df Present Value** 1.000 $ 0.893 4,286 0.797 3,300 0.712 2,478 0.636 1,794 0.567 1,225 0.507 761 0.452 380 0.404 73 0.361 (173) 0.322 (444) $13,680 *Cash expenses = Fixed + Variable = $3,400,000 (Direct fixed) + $190X where X = Units sold After-tax cash expense = $2,040,000 + $114X (0.6 × formula above) **Rounded 460 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–30 Concluded For the new system, salvage value would increase after-tax cash flows in Year 10 by $2,400,000 (0.6 × $4,000,000) Using the discount factor of 0.322, the NPV of the new system will increase from $22,506,000 to $23,278,800 (an increase of 0.322 × $2,400,000), making the new investment more attractive The NPV analysis for the old system remains unchanged Requirement illustrates the importance of using the correct discount rate The rate of 18 percent made the automated alternative look totally unappealing By using the correct rate, the alternative showed a large net present value, although it was still less than the NPV of the old system The old system’s projections of future revenues, however, were overly optimistic The old system was not able to produce the same level of quality as the new system and took longer to produce—factors that, when taken together, would reduce the competitive position of the firm and cause sales to decline When this effect was considered (with the correct discount rate), the new system dominated the old Inclusion of salvage value simply increased this dominance 13–31 Old operating system: Year 1–10 NPV Cash Flow* $ (197,000) df 1.000 5.650 Present Value $ (1,113,050) $(1,113,050) *[–(0.66 × $350,000) + (0.34 × $100,000)] 461 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–31 Continued Flexible system (using MACRS depreciation): Year 10 NPV (1 – t)Ca — $(62,700) (62,700) (62,700) (62,700) (62,700) (62,700) (62,700) (62,700) (62,700) (62,700) tNCb — $ 60,733 104,083 74,333 53,083 37,953 37,910 37,953 18,955 Cash Flow $(1,250,000) (1,967) 41,383 11,633 (9,617) (24,747) (24,790) (24,747) (43,745) (62,700) (62,700) df 1.000 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 Present Value* $(1,250,000) (1,757) 32,982 8,283 (6,116) (14,032) (12,569) (11,186) (17,673) (22,635) (20,189) $(1,314,892) a $95,000 × 0.66 $1,250,000 × 0.1429 × 0.34, $1,250,000 × 0.2449 × 0.34, etc (MACRS depreciation for a seven-year asset) *Rounded b Old operating system (with adjustment for inflation): Year 10 NPV Cash Flow* $ (206,240) (215,850) (225,844) (236,237) (247,047) (258,289) (269,981) (282,140) (294,786) (307,937) Discount Factor 1.000 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 n Present Value** $ (184,172) (172,032) (160,801) (150,247) (140,076) (130,953) (122,031) (113,985) (106,418) (99,156) $(1,379,871) *{–[(1.04) × $350,000 × 0.66] + [0.34 × $100,000]}, n = 10 **Rounded 462 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–31 Concluded Flexible system (with adjustment for inflation): Year 10 NPV Cash Flow* $(1,250,000) (4,475) 36,267 3,804 (20,267) (38,331) (41,426) (44,556) (66,854) (89,242) (92,811) Discount Factor 1.000 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 Present Value $(1,250,000) (3,996) 28,905 2,708 (12,890) (21,734) (21,003) (20,139) (27,009) (32,216) (29,885) $(1,387,259) *{–[(1.04)n × $95,000 × 0.66] + [Annual depreciation × 0.34]}, n = 10; depreciation is MACRS It is very important to adjust cash flows for inflationary effects Since the required rate of return for capital budgeting analysis reflects an inflationary component at the time NPV analysis is performed, a correct analysis also requires that the predicted operating cash flows be adjusted to reflect inflationary effects If the operating cash flows are not adjusted, then an erroneous decision may be the outcome Notice, for example, that after adjusting for inflation, there is virtually no difference between the two systems—and given the intangibles associated with the flexible system, it would likely be chosen 463 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com MANAGERIAL DECISION CASES 13–32 The statement that Manny would normally have taken the first bid without hesitation implies that the bid met all of the formal requirements outlined by the company If Manny’s friend had met the bid as requested, then presumably Manny would have offered the business to his friend The motive for this was friendship and possibly carried with it past experience in dealing with Todd’s company Perhaps there was some uncertainty in Manny’s mind about the low bidder’s ability to execute the requirements of the bid, especially since the winning bid was from out of state If there was some legitimate concern about the winning bid and Manny was hopeful of eliminating this concern by dealing with a known quantity, then it could be argued that the call to Todd was justifiable If, on the other hand, the only motive was friendship and Manny was confident that the winning bid could execute (as he appears to have been), then the call was improper Objectivity and integrity in carrying out the firm’s bidding policies are essential The fact that Manny was tempted by Todd’s enticements and appeared to be leaning toward accepting Todd’s original offer compounds the difficulty of the issue If Manny actually accepts Todd’s offer and grants the business at the original price and accepts the gifts, then his behavior is unquestionably unethical Some of the standards of ethical conduct that would be violated are listed below II Confidentiality Refrain from disclosing confidential information acquired in the course of their work except when authorized, unless legally obligated to so Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage either personally or through a third party III Integrity Refuse any gift, favor, or hospitality that would influence their actions 464 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–33 Shaftel Ready Mix Income Statement For the Year Ended 20XX Sales (35,000 × $45) Less: Variable expenses ($35.08 × 35,000) Contribution margin Less fixed expenses: Salaries Insurance Telephone Depreciation Utilities Net income $ 1,575,000 1,227,800 $ 347,200 $135,000 75,000 5,000 56,200* 25,000 $ 296,200 51,000 *Reported depreciation erroneously included $2,000 for the land Ratio of net income to sales = $51,000/$1,575,000 = 3.24% Karl is correct that the return on sales is significantly lower than the company average Payback period = Original investment/Annual cash flow = $352,000/$107,200* = 3.28 years *Net income of $51,000 + depreciation of $56,200 Karl is not right The book value of the equipment and the furniture should not be included in the amount of the original investment because there is no opportunity cost associated with them Excluding the book value reduces the investment from $582,000 to $352,000 Karl’s payback would be correct if the equipment and furniture could be sold for their book value because there would now be an opportunity cost associated with them and that cost should be included in the original investment 465 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–33 Continued NPV: Year 1–10 NPV Cash Flow $(352,000) 107,200 Discount Factor 1.000 6.145 Present Value $(352,000) 658,744 $ 306,744 IRR: df = I/CF = $352,000/$107,200 = 3.284 Thus, the IRR is between 26 percent and 28 percent If the furniture and equipment can be sold for book value: NPV: Year 1–10 NPV Cash Flow (582,000) 107,200 Discount Factor 1.000 6.145 Present Value $(582,000) 658,744 $ 76,744 IRR: df = 582,000/$107,200 = 5.4291 Thus, the IRR is between 12 percent and 14.88 percent Using equipment and furniture for the plant INSTEAD of selling it represents an investment equal to the market value of the assets; the opportunity cost is the key concept here 466 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–33 Continued Break-even: $45X = $35.08X + $296,200 $9.92X = $296,200 X = 29,859 cubic yards NPV (using break-even amount): Year 1–10 NPV Cash Flow $(352,000) 56,200 Discount Factor 1.000 6.145 Present Value $(352,000) 345,349 $ (6,651) IRR: df = $352,000/$56,200 = 6.263 Thus, the IRR is between percent and 10 percent The investment is not acceptable, although it came close It is possible to have a positive NPV at the break-even point Break-even is defined for accounting income, not for cash flow Since there are noncash expenses deducted from revenues, accounting income understates cash income Zero income does not mean zero cash inflows 467 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–33 Concluded Cost of capital = 10 percent for 10 years, so df = 6.145 df 6.145 6.145 × CF CF = I/CF = $352,000/CF = $352,000 = $57,282 Cash flow Less: Depreciation Net income Net income $1,082 $1,082 $297,282 X $ 57,282 56,200 $ 1,082 = Sales – Variable expenses – Fixed expenses = $45X – $35.08X – $296,200 = $9.92X – $296,200 = $9.92X = 29,968 cubic yards Sales Less: Variable expenses Contribution margin Less: Fixed expenses Net income $ 1,348,560 1,051,277 $ 297,283 296,200 $ 1,083* *Difference due to rounding 13–34 After-tax cash flows Manual system: Year 1–10 (1 – t)Ra $264,000 –(1 – t)Cb $(198,000) a tNCc $6,800 0.66 × $400,000 0.66 × $228,000 + [0.66 × ($92,000 – $20,000)] c 0.34 × $20,000 b 468 Cash Flow $72,800 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–34 Continued Robotic system: Year 10 (1 – t)Ra –(1 – t)Cb tNCc $264,000 297,000 330,000 396,000 396,000 396,000 396,000 396,000 396,000 409,200 $(136,720) (146,220) (155,720) (174,720) (174,720) (174,720) (174,720) (174,720) (174,720) (174,720) $25,265 43,298 30,922 22,082 15,788 15,771 15,788 7,885 Cash Flow $(425,600)d 152,545 194,078 205,202 243,362 237,068 237,051 237,068 229,165 221,280 234,480 a Year 1: 0.66 × $400,000; Year 2: 0.66 × $450,000; Year 3: 0.66 × $500,000; Years 4–9: 0.66 × $600,000; Year 10: 0.66 × $620,000 (includes salvage value as a gain) b After-tax cash expenses: Fixed: Direct labor Other $20,000 × 0.66 = $13,200 (one operator) $72,000 × 0.66 = 47,520 (from income statement) $60,720 Variable: Direct materials Variable overhead Variable selling Total (0.16 × Sales) (0.09 × Sales) (0.12 × Sales) 0.19 × × × × 0.75 × 0.66 0.6667 × 0.66 0.90 × 0.66 Sales Total after-tax cash expenses = $60,720 + (0.19 × Sales) c Years 1–8: MACRS: 0.1429 × $520,000 × 0.34, 0.2449 × $520,000 × 0.34, etc d Net investment: Purchase costs Recovery of capital Tax savings on loss $(520,000) 40,000 54,400* $(425,600) *Year 0: 0.34 × ($200,000 – $40,000) 469 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–34 Continued Manual system: Cash Flow Year $ 1–10 72,800 NPV Discount Factor 1.000 5.650 Present Value $ 411,320 $411,320 Discount Factor 1.000 0.893 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.322 Present Value $(425,600) 136,223 154,680 146,104 154,778 134,418 120,185 107,155 92,583 79,882 75,503 $ 775,911 Robotics system: Year 10 NPV Cash Flow $(425,600) 152,545 194,078 205,202 243,362 237,068 237,051 237,068 229,165 221,280 234,480 The company should invest in the robotic system 470 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13–34 Concluded Managers may use a higher discount rate as a way to deal with the uncertainty in future cash flows The higher rate “protects” the manager from unpleasant surprises Since a higher rate favors investments that provide returns quickly, managers may be motivated by personal short-run considerations (e.g., bonuses and promotion opportunities) Using a discount rate of 12 percent: Year 1–10 NPV Cash Flow $(340,000) 80,000 Discount Factor 1.000 5.650 Present Value $(340,000) 452,000 $ 112,000 Using a discount rate of 20 percent: Year 1–10 NPV Cash Flow $(340,000) 80,000 Discount Factor 1.000 4.192 Present Value $(340,000) 335,360 $ (4,640) If the 20 percent discount rate is used, the company would not acquire the robotic system Using an excessive discount rate could seriously impair the ability of the firm to stay competitive An excessive discount rate may lead a firm to reject new technology that would increase quality and productivity As other firms invest in the new technology, their products will be priced lower and be of higher quality—features that would likely cause severe difficulty for the more conservative firm RESEARCH ASSIGNMENTS 13–35 Answers will vary 13–36 Answers will vary 471 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 472 ... From Exhibit 13B-2, IRR = 18 percent Project II should be chosen using IRR NPV is an absolute profitability measure and reveals how much the value of the firm will change for each project; IRR... wealth change attributable to each project, it is preferred to the IRR measure 436 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13 13 Project... more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13 3 Initial investment (Average depreciation = 300,000): Accounting rate of return = Average accounting income/Investment