Question

Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows. Campbell Manufacturing is considering the purchase of a new welding system. The cash benefits will be $480,000 per year. The system costs $2,050,000 and will last 10 years. Evee Cardenas is interested in investing in a women's specialty shop. The cost of the investment is $330,000. She estimates that the return from owning her own shop will be $45,000 per year. She estimates that the shop will have a useful life of 6 years. Barker Company calculated the NPV of a project and found it to be $63,900. The project's life was estimated to be 8 years. The required rate of return used for the NPV calculation was 10%. The project was expected to produce annual after-tax cash flows of $135,000. Required: 1. Compute the NPV for Campbell Manufacturing, assuming a discount rate of 12%. If required, round all present value calculations to the nearest dollar. Use the minus sign to indicate a negative NPV. $ Should the company buy the new welding system? Yes 2. Conceptual Connection: Assuming a required rate of return of 8%, calculate the NPV for Evee Cardenas' investment. Round to the nearest dollar. If required, round all present value calculations to the nearest dollar. Use the minus sign to indicate a negative NPV. $ Should she invest? No What if the estimated return was $135,000 per year? Calculate the new NPV for Evee Cardenas' investment. Would this affect the decision? What does this tell you about your analysis? Round to the nearest dollar. $ The shop should now be purchased. This reveals that the decision to accept or reject in this case is affected by differences in estimated cash flow 3. What was the required investment for Barker Company's project? Round to the nearest dollar. If required, round all present value calculations to the nearest dollar. $

Answer 1

Campbell manufacturing:

Cash benefits=$4,80,000 per year for 10 years

Discount rate=12%

Cost of the system=$20,50,000

NPV = ${4,80,000PVAF(12%,10)-20,50,000}

=$(4,80,000*5.6502-20,50,000)

=$(27,12,107-20,50,000)

=$6,62,107

Since NPV is positive, Company should buy the new welding system.

Evee Cardenas:

Cost of investing in the shop=$3,30,000

Return from owning the shop=$45,000 for 6 years

Required rate of return=8%

NPV=${45,000*PVAF(8%,6)-3,30,000}=$(45,000*4.6229-3,30,000)=$(2,08,030-3,30,000)=-$1,21,970

She should not invest because NPV is negative.

If return was $1,35,000 per year then NPV=$(1,35,000*4.6229-3,30,000)=$(6,24,092-3,30,000)=$2,94,092

In that case she should invest.

Barker Company:

NPV of project=$63,900

Life=8 years

Required rate of return=10%

Annual after tax cash flow=$1,35,000

NPV=cash flow*PVAF(r%,n) - Initial Investment

63,900=1,35,000PVAF(10%,8) - Initial Investment

=1,35,000*5.3349 - Initial Investment

=7,20,215 - Initial Investment

Initial Investment = $(7,20,215-63,900)=$6,56,315