Question

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

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 $2,250,000 and will last 10 years. Evee Cardenas is interested in investing in a women's specialty shop. The cost of the investment is $280,000. She estimates that the return from owning her own shop will be $50,000 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. $

Homework Answers

Answer #1

1. Campbell Manufacturing

NPV = -$2250000 + ($480000 x 5.6502) = -$2250000 + $2712096 = $462096

Yes, the company should buy the new welding system since it has a positive net present value.

2. Evee Cardenas

NPV = -$280000 + ($50000 x 4.6229) = -$280000 + $231145 = -$48855

No. The investment in the shop should not be made since it has a negative net present value.

NPV = -$280000 + ($135000 x 4.6229) = -$280000 + $624092 = $344092

With an annual return of $135000, the shop should be purchased since it has a positive net present value.

The decision to accept or reject an investment proposal is affected by the estimated cash flows.

3. Barker Company

Assume the required investment to be 'X'

NPV = -$X + ($135000 x 5.3349)

$63900 = -$X + $720212

$X = $720212 - $63900 = $656312

Required investment for Barker Company's project is $656312.

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