Week Five Assignment
Exercises
Basic present value calculations
Calculate the present value of the following cash flows, rounding to the nearest dollar:A single cash inflow of $12,000 in 5 years, discounted at a 12% rate of return.
An annual receipt of $16,000 over the next 12 years, discounted at a 14% rate of return.
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.
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.
Present value analysis: Working backward
The following information pertains to four independent investments:A
B
C
D
Present value
$ ?
$19,646
$34,625
$50,852
Interest rate
10%
% ?
14%
12%
Investment period
4 years
5 years
? years
10 years
Annual cash inflows
$8,000
$ 6,000
$ 7,000
$ ?
Determine the unknown for each of the investments. (Note: Amounts have been rounded to the nearest dollar; please consider this procedure in your calculations. Do not interpolate.)
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%.Compute the net present value of the proposed investment. Ignore income taxes and round to the nearest dollar.
Considering the time value of money , should Contempo acquire the new equipment? Why?
Cash flow calculations and net present value
On January 2, 20X1, Bruce Greene invested $10,000 in the stock market and purchased 500 shares of Heartland Development Inc. Heartland paid cash dividends of $2.60 per share in 20X1 and 20X2; the dividend was raised to $3.10 per share in 20X3. On December 31, 20X3, Greene sold his holdings and generated proceeds of $13,000. Greene uses the net present value method and desires a 16% return on investments.Prepare a chronological list of the investment's cash flows. Note: Greene is entitled to the 20X3 dividend.
Compute the investment's net present value, rounding calculations to the nearest dollar.
Given the results of part (b), should Greene have acquired the Heartland stock? Briefly explain.
Straightforward net present value and internal rate of return
The City of Bedford is studying a 600-acre site on Route 356 for a new landfill. The startup cost has been calculated as follows:
Purchase cost: $450 per acre
Site preparation: $175,000
The site can be used for 20 years before it reaches capacity. Bedford, which shares a facility in Bath Township with other municipalities, estimates that the new location will save $40,000 in annual operating costs.
Should the landfill be acquired if Bedford desires an 8% return on its investment?
Use the net present value method to determine your answer.Compute the internal rate of return on this project.
Problems
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 (including straight-line depreciation)
$160,000
Variable operating costs per trip
$1,000
Ticket price
$5 per passenger
All operating costs, except depreciation, require cash outlays. On the basis of similar operations in other areas of the country, management anticipates that each trip 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 Entertainment should acquire the boat. Assume a 14% desired return on all investments; round calculations to the nearest dollar.
Basketball player decision
The Phoenix Kings of the United Basketball League have a moody center by the name of Orlando Dawkins. Dawkins is under contract with the team and is scheduled to earn $650,000 in both 20X3 and 20X4. A $75,000 salary increase will take effect in 20X5.
Dawkins has not gotten along with several of his teammates and, as a result, management is exploring the possibility of a trade with the Philadelphia Rockets to acquire George Harper, a star player. The Kings would pay the Rockets $350,000 immediately for the trade to take place. Harper would be paid a $270,000 signing bonus at the beginning of 20X3 that management plans to expense over the next 3 years by using straight-line amortization. Harper's annual salary would be $950,000 from 20X3 through 20X5, highest on the team because of his ability to attract fans. The Kings expect that increased attendance will produce added annual net cash inflows of $525,000.
Phoenix officials believe that both players would play 3 more years for the Kings, at which time they would become free agents and move along to other clubs. The Kings would receive $380,000 compensation from the other club for Dawkins; for Harper, the figure would increase to $500,000. Regardless of whether the trade takes place, the Kings are obligated to pay Dawkins $200,000 at the end of 20X4 under the terms of his original contract.
The Kings desire a rate of return of 14% and use the net present value method to analyze investments. Round all calculations to the nearest dollar, and ignore income taxes.
Instructions
Determine whether the Kings should keep Dawkins or trade for Harper . Assume the trade would occur on January 1, 20X3.
Future cash flows are, in many cases, subject to change. List several events that could occur that might influence the cash flows in this situation.
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 is studying the possibility of expanding the team's present facility to accommodate increased crowds. A $2.4 million expansion is planned that has a $200,000 residual value and will be depreciated by the straight-line method over four seasons. Information about the expansion follows:Number of seats
Occupancy rate
Ticket price
Class 1 seats
2,500
80%
$6
Class 2 seats
2,000
60
4
The team will play 50 home games each season. Total added operating costs per game (ushers, cleanup, and depreciation) are expected to average $11,800. All such costs, except depreciation, require cash outlays.
Instructions
By using the net present value method and a 16% desired rate of return, determine whether the expansion should be undertaken.
In addition to the cash flows presented here, what other cash flows might change if the Eskimos add on to the arena?
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
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.
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.
