If a potential investment’s internal rate of return is above the company’s hurdle rate, should the investment be made?
Samsung’s annual report includes information about its debt and interest rates. Its annual report reveals that Samsung recently issued bonds with an interest rate of 4.1%. Required Explain how Samsung would use that 4.1% rate to evaluate its investments in capital projects.
Aikman Company has an opportunity to invest in one of two projects. Project A requires a \(240,000 investment for new machinery with a four-year life and no salvage value. Project B also requires a \)240,000 investment for new machinery with a three-year life and no salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation, and cash flows occur evenly throughout each year. Company
Project A Project B
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \(250,000 \)200,000
Expenses Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,000 25,000
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000 30,000
Overhead including depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,000 90,000
Selling and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . 18,000 18,000
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193,000 163,000
Pretax income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57,000 37,000
Income taxes (30%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,100 11,100
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \( 39,900 \) 25,900
Required
1. Compute each project’s annual expected net cash flows. (Round net cash flows to the nearest dollar.)
2. Determine each project’s payback period. (Round the payback period to two decimals.)
3. Compute each project’s accounting rate of return. (Round the percentage return to one decimal.)
4. Determine each project’s net present value using 8% as the discount rate. For part 4 only, assume that cash flows occur at each year-end. (Round net present values to the nearest dollar.)
Analysis Component
5. Identify the project you would recommend to management and explain your choice.
A company is considering investing in a new machine that requires a cash payment of \(47,947 today. The machine will generate annual cash flows of \)21,000 for the next three years. Assume the company uses an 8% discount rate. Compute the net present value of this investment. (Round your answer to the nearest dollar.)
Santana Rey is considering the purchase of equipment for Business Solutions that would allow the company to add a new product to its computer furniture line. The equipment is expected to cost \(300,000 and to have a six-year life and no salvage value. It will be depreciated on a straight-line basis. Business Solutions expects to sell 100 units of the equipment’s product each year. The expected annual income related to this equipment follows.
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \)375,000
Costs Materials, labor, and overhead (except depreciation) . . . . . . . . . . . . . . 200,000
Depreciation on new equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Selling and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . 37,500
Total costs and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287,500
Pretax income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87,500
Income taxes (30%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,250
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 61,250
Required Compute the (1) payback period and (2) accounting rate of return for this equipment. (Record ARR answers as percents, rounded to one decimal.)
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