Time value of money
• A. What is the present value of $8,000 received in 7 years at 8% interest?
• B. Bonnie Lee buys a savings bond for $125. The bond pays 6% and matures in 10 years. What
amount will Bonnie receive when she redeems the bond?
• C. Erik Peterson needs to have $10,000 at the end of 5 years for home repairs. His investment
• D. Conan Bardwell will receive $1,000 in 6 years from an investment that returns 12%. How
much did he invest?
12.17
Q1
Capital budgeting process Put the following 6 steps for capital budgeting in the most likely order,
numbering the first activity as number 1, the second as 2, and so on.
• __________Perform sensitivity analysis.
• __________Identify decision alternatives.
• __________Analyze qualitative factors.
• __________Identify relevant cash flows.
• __________Apply the relevant quantitative analysis technique.
• __________Consider quantitative and qualitative information to make a decision.
12.18
Q3, Q7
NPV calculations with taxes Overnight Laundry is considering the purchase of a new pressing
machine that would cost $100,000 and would produce incremental cash flows of $25,000 annually for
6 years. The machine has a terminal value of $10,000 and qualifies for the 5–year MACRS schedule. The
laundry’s marginal tax rate is 30%, and its required rate of return is 8%.
REQUIRED: What is the net present value of the project?
12.19
Q5
Payback in Months The International Netherlands Group (ING) built its new headquarters building in
Amsterdam using “green” principles to reduce energy consumption. The building used primarily
passive cooling systems, made use of daylight, and applied various other energy efficiency techniques
which increased the building’s construction costs by about $700,000. These systems reduced energy
costs by approximately $2.9 million per year.
SOURCE: “Buildings & Land: International Netherlands Group (ING) Bank, Amsterdam, Netherlands,”
Rocky Mountain Institute,www.rmi.org/sitepages/pid208.php (accessed February 15, 2007).
REQUIRED: Calculate the payback period in months for ING’s energy investment.
12.20
Q3, Q5
NPV and IRR calculations (CPA) Axel Corporaton is planning to buy a new machine with the
expectation that this investment should earn a rate of return of at least 15%. This machine, which costs
$150,000, would yield an estimated net cash flow of $30,000 per year for 10 years.
REQUIRED: 1. What is the net present value for this proposal?
2. What is the internal rate of return for this proposal
12.21
Q3, Q5
NPV, IRR, ARR, and payback methods (CPA) Amaro Hospital, a not–for–profit institution not subject
to income taxes, is considering the purchase of new equipment costing $20,000 to achieve cash savings
of $5,000 per year in operating costs. The estimated useful life is 10 years, with no terminal value.
Amaro’s minimum expected return is 14%.
REQUIRED: 1. What is the net present value of this investment?
2. What is the internal rate of return?
3. What is the accrual accounting rate of return based on the initial investment?
4. What is the payback period?
12.22
Q7
NPV with taxes Fox Tool and Die would like to purchase special tools with a cost of $60,000 that
qualify for the 3–year MACRS schedule and should result in annual operating cash flow savings of
$25,000 for four years. At the end of 4 years, the tools will have no terminal value. The company’s
marginal tax rate is 25% and the required discount rate is 9%.
REQUIRED: 1. Calculate the present value of the incremental operating cash flows.
2. Calculate the present value of the depreciation tax shield.
3. Calculate the net present value.
12.23
Q3
Present value and future value calculations (CMA) Crown Corporation agreed to sell some used
equipment to one of its employees. Alternative financing arrangements for the sale have been
discussed, and the present and future values of each alternative have been determined.
REQUIRED: 1. Crown offered to accept a $1,000 down payment and set up a note receivable that calls for four
$1,000 payments at the end of each of the next four years. What is the net present value of this note if it
is discounted at 6%?
2. The employee agrees to the down payment but would like the note for $4,000 to be payable in
full at the end of the fourth year. Because of the increased risk associated with the terms of this
note, Crown would apply an 8% discount rate. What is the true selling price of the equipment?
3. Suppose the employee borrows the $5,000 at 8% interest for four years from a bank so that he
can pay Crown the full price of the equipment immediately. Also, suppose that Crown could invest the
$5,000 for 3 years at 7%. What is the selling price of the equipment? What would be the future value of
Crown’s investment?
12.24
Q2, Q3, Q4,
Q7, Q8
Relevant cash flows, NPV analysis with taxes and inflation (Appendix 12A)Clearwater Bottling
Company sells bottled spring water for $12 per case, with variable costs of $7 per case. The company
has been selling 200,000 cases per year and expects to continue at that rate unless it accepts a special
order from Blue Danube Restaurant. Blue Danube has offered to buy 20,000 cases per year at $9 per
case. Clearwater must agree to make the sales for a 5–year period. Blue Danube will not take fewer than
20,000 cases, but is willing to take more.
Clearwater’s current capacity is 210,000 cases per year. Capacity could be increased to 260,000 per year if
new equipment costing $80,000 were purchased. The equipment would have a useful life of 5 years and no
terminal value. Maintenance on the new equipment would increase fixed costs by $15,000 each year.
Variable costs per unit would be unchanged. Clearwater has a marginal income tax rate of 25%. Inflation is
estimated to be 4% over each of the next 5 years. The risk–free rate is estimated to be 5%. Clearwater can
earn a rate of 12% if it invests in an alternative investment having similar risk.
REQUIRED: 1. Create a timeline showing the relevant cash flows for this problem.
2. Including inflation and using a three–year MACRS schedule, determine an appropriate discount
rate and calculate the NPV of this project if Blue Danube purchases 20,000 cases per year. Perform
calculations using a spreadsheet.
