Capital Investment
Decisions
Chapter 26
Exercises
Payback Period
• In-Class Exercises (Form groups and work exercises):
Exercise No.
E26-18
E26-19
Page
1633
Payback Period (Even)
1633
Payback Period (Uneven)
Payback Period
• In-Class Exercise:
Exercise No.
E26-18
Page
1633
Payback Period (Even)
Payback Period
Exercise E26-18:

Preston Co. is considering acquiring a manufacturing plant.

The purchase price is $1,100,000.

The owners believe the plant will generate net cash inflows of $297,000 annually.

The plant will have to be replaced in six years.
Requirement:
Use the payback method to determine whether Preston should purchase this
plant. Round answer to one decimal place.
Payback Period
Payback Period
End of Exercise
Payback Period
• In-Class Exercise:
Exercise No.
E26-19
Page
1633
Payback Period (Uneven)
Payback Period
Exercise E26-19:

Robinson Hardware is adding a new product line that will require an investment
of $1,454,000.

Managers estimate that this investment will have a 10-year life.

The investment will generate the following net cash flows:
Year 1……… $ 300,000
Year 2……… 270,000
Years 3-10… 260,000 (each of the eight years)
Requirement:
Compute the payback period.
Payback Period
Payback Period
The proposed $1,454,000 investment would be
recovered in approximately 5.4 years.
Payback Period
Fractional year computation
Payback Period
Fractional year computation
Payback Period
Fractional year computation
Payback Period
Fractional year computation
Payback Period
Fractional year computation
Payback Period
Fractional year computation
Payback Period
End of Exercise
Accounting Rate of Return
• In-Class Exercise (Form groups and work exercise):
Exercise No.
E26-20
Page
1633
Accounting Rate of Return
Accounting Rate of Return
Exercise E26-20:

Use the information from Exercise E26-19.

Assume that the project has no residual value. Therefore, the project’s
investment cost of $1,454,000 will be fully depreciated over its useful life.

The operating (useful) life is 10 years.
Requirement:
Compute the Accounting Rate of Return (ARR) for the investment. Round your
answer to two decimal places.
Accounting Rate of Return
Net Cash Outflows from Exercise E26-19
Accounting Rate of Return
Formulas for Exercise E26-20
Accounting Rate
=
of Return
Average
Investment =
Average annual
operating Income
Average amount invested
Asset Cost + Residual Value
2
Accounting Rate of Return
Computation of Annual Operating Income
From Exercise E26-19
Accounting Rate of Return
Computation of Annual Operating Income
Accounting Rate of Return
First, calculate the average investment.
Average
Investment =
Average
Investment =
Asset Cost + Residual Value
2
$1,454,000 + $ 0
2
= $727,000
Accounting Rate of Return
Next, calculate the accounting rate of return.
Accounting Rate
=
of Return
Accounting Rate
of Return
Average annual
operating Income
Average amount invested
=
$119,600
$727,000
= 16.45%
Accounting Rate of Return
End of Exercise
Net Present Value
• In-Class Exercise (Form groups and work exercise):
Exercise No.
E26-24
Page
1635
Net Present Value & Probability
Index
Net Present Value
Exercise E26-24:

Use the NPV method to determine whether Kyler Products should
invest in the following projects.
(1) Project A: Costs $260,000 and offers seven annual net cash
inflows of $57,000. Kyler requires an annual return of 16% on
investments of this nature.
(2) Project B: Costs $375,000 and offers ten annual net cash inflows
of $75,000. Kyler demands an annual return of 14% on
investments of this nature.

Requirements:
(1) What is the NPV of each project? Assume neither project has a
residual value. Round your answer to two decimal places.
(2) What is the maximum acceptable price to pay for each project?
(3) What is the profitability index of each project? Round to 2 places.
Net Present Value
Present value of annuity (Table B-2)
(Period 7, 16% column)
Net Present Value
Net Present Value
Present value of annuity (Table B-2)
(Period 10, 14% column)
Net Present Value
Net Present Value
Maximum acceptable price
Profitability Index
Net Present Value
End of Exercise
Internal Rate of Return
• In-Class Exercise (Form groups and work exercise):
Exercise No.
E26-25
Page
1635
Internal Rate of Return
Internal Rate of Return
Project A
Computation of the IRR using data
from Exercise E26-24.
Internal Rate of Return
PV Factor
Investment Amount
Annual Cash Flow
=
Calculated PV Factor:
PV Factor
=
$260,000 =
$57,000
4.561
PV Table B-2 - (PV of an Annuity):
7 Years (12% column) > 4.564
IRR = Approx. 12%
Internal Rate of Return
PV Factor
Investment Amount
Annual Cash Flow
=
Calculated PV Factor:
PV Factor
=
$260,000 =
$57,000
4.561
PV Table B-2 - (PV of an Annuity):
7 Years (12% column) > 4.564
IRR = Approx. 12%
Internal Rate of Return
PV Factor
Investment Amount
Annual Cash Flow
=
Calculated PV Factor:
PV Factor
=
$260,000 =
$57,000
4.561
(Compared to)
PV Table B-2 - (PV of an Annuity):
7 Years (12% column) > 4.564
IRR = Approx. 12%+
Since Smart Touch requires a 16% return, the
project would not be acceptable.
Internal Rate of Return
Project B
Computation of the IRR using data
from Exercise E26-24.
Internal Rate of Return
PV Factor
Investment Amount
Annual Cash Flow
=
Calculated PV Factor:
PV Factor
=
$375,000 =
$75,000
5.000
PV Table B-2 - (PV of an Annuity):
10 Years (15% column) > 5.019
IRR = Approx. 15%+
Internal Rate of Return
PV Factor
Investment Amount
Annual Cash Flow
=
Calculated PV Factor:
PV Factor
=
$375,000 =
$75,000
5.000
PV Table B-2 - (PV of an Annuity):
10 Years (15% column) > 5.019
IRR = Approx. 15%+
Internal Rate of Return
PV Factor
Investment Amount
Annual Cash Flow
=
Calculated PV Factor:
PV Factor
=
$375,000 =
$75,000
5.000
(Compared to)
PV Table B-2 - (PV of an Annuity):
10 Years (15% column) > 5.019
IRR = Approx. 15%+
Since Smart Touch requires a minimum return of 14%, the
project is considered acceptable and is the best investment.
Internal Rate of Return
End of Exercise