Question

Use Exhibit 12B.1 and Exhibit 12B.2 to locate the present value of an annuity of $1, which is the amount to be multiplied times the future annual cash flow amount.

Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows.

1. Campbell Manufacturing is considering the purchase of a new welding system. The cash benefits will be $480,000 per year. The system costs $1,850,000 and will last 10 years.
2. 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 $55,000 per year. She estimates that the shop will have a useful life of 6 years.
3. 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

1	NPV for Campbell Manufacturing:
	Cost of investment=$ 1850000
	Present value of cash benefits=Cash benefits*PV annutiy factor at 12% for 10 years=480000*5.65022=$ 2712106
	NPV=Present value of cash benefits-Cost of investment=2712106-1850000=$ 862106
	Company should buy the new welding system since the NPV is positive
2	Cost of investment=$ 330000
	Present value of return=Return per year*PV annuity factor at 8% for 6 years=55000*4.62288=$ 254258
	NPV=Present value of return-Cost of investment=254258-330000=$-75742
	Should not invest since the NPV is negative
	Cost of investment=$ 330000
	Present value of return=Return per year*PV annuity factor at 8% for 6 years=135000*4.62288=$ 624089
	NPV=Present value of return-Cost of investment=624089-330000=$ 294089
	Should invest since the NPV is positive
	This reveals that the decision to accept or reject in this case is affected by differences in estimated cash flow
3	NPV=Present value of annual cash flows-Required investment
	Required investment=Present value of annual cash flows-NPV
	Present value of annual cash flows=Annual cash flow*PV annuity factor at 10% for 8 years=135000*5.334926=$ 720215
	Required investment=720215-63900=$ 656315