Question Details

CHAPTER 24 PLANNING FOR CAPITAL INVESTMENTS BRIEF EXERCISES QUESTION PART 10


Ex. 181
Shilling Corp. is thinking about opening a baseball camp in Florida. In order to start the camp, the company would need to purchase land, build five baseball fields, and a dormitory-type sleeping and dining facility to house 100 players. Each year the camp would be run for 10 sessions of 1 week each. The company would hire college baseball players as coaches. The camp attendees would be baseball players age 12-18. Property values in Florida have enjoyed a steady increase in value. It is expected that after using the facility for 20 years, Shilling can sell the property for more than it was originally purchased for. The following amounts have been estimated:
	Cost of land	$   630,000
	Cost to build dorm and dining facility	2,100,000
	Annual cash inflows assuming 100 players and 10 weeks	2,520,000
	Annual cash outflows	2,260,000
	Estimated useful life	20 years
	Salvage value	4,400,000
	Discount rate	10%
	Present value of an annuity of 1	8.514
	Present value of 1	.149
Ex. 182
Ace Corporation recently purchased a new machine for its factory operations at a cost of $950,000. The investment is expected to generate $250,000 in annual cash flows for a period of five years. The required rate of return is 8%. The new machine is expected to have zero salvage value at the end of the five-year period.

Instructions
Calculate the internal rate of return. (Table 4 from Appendix C is needed.)



COMPLETION STATEMENTS
	183.	For purposes of capital budgeting, estimated ____________ and outflows are preferred for inputs into the capital budgeting decision tools.


	184.	The technique which identifies the time period required to recover the cost of the investment is called the ________________ method.

	185.	The two discounted cash flow techniques used in capital budgeting are (1) the _______________________ method and (2) the ______________________ method.


	186.	Under the net present value method, the interest rate to be used in discounting the future cash inflows is the ________________.


	187.	In using the net present value approach, a project is acceptable if the project's net present value is ____________ or_______________.

188.	A project- ________________, such as increased quality or safety, are often incorrectly ignored in capital budgeting decisions.


	189.	The _______________ is a method of comparing alternative projects that takes into account both the size of the investment and its discounted future cash flows.


	190.	A well-run organization should perform an evaluation, called a _____________, of its investment projects after their completion.


	191.	The internal rate of return method differs from the net present value method in that it results in finding the ___________________ of the potential investment.


	192.	A major limitation of the annual rate of return approach is that it does not consider the _______________ of money.




MATCHING
193.	Match the items below by entering the appropriate code letter in the space provided.

	A.	Profitability index	E.	Annual rate of return method
	B.	Internal rate of return method	F.	Cash payback technique
	C.	Discounted cash flow techniques	G.	Cost of capital
	D.	Capital budgeting	H.	Net present value method
	

____	1.	A capital budgeting technique that identifies the time period required to recover the cost of a capital investment from the annual cash inflow produced by the investment.

____	2.	Capital budgeting techniques that consider both the estimated total cash inflows from the investment and the time value of money.

____	3.	A method used in capital budgeting in which cash inflows are discounted to their present value and then compared to the capital outlay required by the capital investment.

____	4.	A method of comparing alternative projects that take into account both the size of the investment and its discounted cash flows.

____	5.	A method used in capital budgeting that results in finding the interest yield of the potential investment.

____	6.	The average rate of return that the firm must pay to obtain borrowed and equity funds.

____	7.	The determination of the profitability of a capital expenditure by dividing expected annual net income by the average investment.

____	8.	The process of making capital expenditure decisions in business.


SHORT-ANSWER ESSAY QUESTIONS
S-A E  194
Management uses several capital budgeting methods in evaluating projects for possible investment.  Identify those methods that are more desirable from a conceptual standpoint, and briefly explain what features these methods have that make them more desirable than other methods.  Also identify the least desirable method and explain its major weaknesses.


S-A E  195
Manny Perez is trying to understand the term "cost of capital." Define the term, and indicate its relevance to the decision rule under the annual rate of return technique.


S-A E  196	(Ethics)
Sam Stanton is on the capital budgeting committee for his company, Canton Tile. Ed Rhodes is an engineer for the firm. Ed expresses his disappointment to Sam that a project that was given to him to review before submission looks extremely good on paper. "I really hoped that the cost projections wouldn't pan out," he tells his friend. "The technology used in this is pie in the sky kind of stuff. There are a hundred things that could go wrong. But the figures are very convincing. I haven't sent it on yet, though I probably should."

"You can keep it if it's really that bad,"  assures Sam. "Anyway, you can probably get it shot out of the water pretty easily, and not have the guy who submitted it mad at you for not turning it in. Just fix the numbers. If you figure, for instance, that a cost is only 50% likely to be that low, then double it. We do it all the time, informally. Best of all, the rank and file don't get to come to those sessions. Your engineering genius need never know. He'll just think someone else's project was even better than his."

Required:
1.	Who are the stakeholders in this situation?
2.	Is it ethical to adjust the figures to compensate for risk? Explain.
3.	Is it ethical to change the proposal before submitting it? Explain.


S-A E  197	(Communication)
You are the general accountant for Word Systems, Inc., a typing service based in Los Angeles, California.  The company has decided to upgrade its equipment. It currently has a widely used version of a word processing program. The company wishes to invest in more up-to-date software and to improve its printing capabilities.

Two options have emerged.  Option #1 is for the company to keep its existing computer system, and upgrade its word processing program. The memory of each work station would be enhanced, and a larger, more efficient printer would be used. Better telecommunications equipment would allow for the electronic transmission of some documents as well.

Option #2 would be for the company to invest in an entirely different computer system. The software for this system is impressive, and it comes with individual laser printers. However, the company is not well known, and the software does not connect well with well-known software.  The net present value information for these options follows:

	 Option #1	  Option #2	
Initial Investment	$(95,000)	$(270,000)
Returns	Year 1	55,000	90,000
		Year 2	30,000	90,000
		Year 3	10,000	90,000
		Net present value	0	0

Required:
Prepare a brief report for management in which you make a recommendation for one system or the other, using the information given.