Summer Company is considering three capital expenditure projects. Relevant data for the projects are as follows. Project Investment Annual Income Life of Project 22A $240,000 $15,000 6 years 23A 270,000 24,400 9 years 24A 280,000 21,000 7 years Annual income is constant over the life of the project. Each project is expected to have zero salvage value at the end of the project. Summer Company uses the straight-line method of depreciation. Instructions • (a) Determine the internal rate of return for each project. Round the internal rate of return factor to three decimals. • (b) If Summer Company’s required rate of return is 11%, which projects are acceptable? Calculate annual rate of return. E10-8 Morgan Company is considering a capital investment of $180,000 in additional productive facilities. The new machinery is expected to have a useful life of 6 years with no salvage value. Depreciation is by the straight-line method. During the life of the investment, annual net income and net annual cash flows are expected to be $20,000 and $50,000 respectively. Morgan has a 15% cost of capital rate which is the required rate of return on the investment. Instructions (Round to two decimals.) • (a) Compute (1) the cash payback period and (2) the annual rate of return on the proposed capital expenditure. • (b) Using the discounted cash flow technique, compute the net present value. Carolina Clinic is considering investing in new heart monitoring equipment. It has two options: Option A would have an initial lower cost but would require a significant expenditure for rebuilding after 4 years. Option B would require no rebuilding expenditure, but its maintenance costs would be higher. Since the option B machine is of initial higher quality, it is expected to have a salvage value at the end of its useful life. The following estimates were made of the cash flows. The company’s cost of capital is 11%. Option A Option B Initial cost $160,000 $227,000 Annual cash inflows $75,000 $80,000 Annual cash outflows $35,000 $30,000 Cost to rebuild (end of year 4) $60,000 $0 Salvage value $0 $12,000 Estimated useful life 8 years 8 years Instructions (a) Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each option. (Hint: To solve for internal rate of return, experiment with alternative discount rates to arrive at a net present value of zero.) (b) Which option should be accepted?
