ACCT1101 Lecture Notes - Lecture 12: Net Present Value, Mutual Exclusion, Cash Flow

Bookmark Capital Investment Decision Hampton Company: Theproduction department has been investigating possible ways to trimtotal production costs. One possibility currently being examined isto make the cans instead of purchasing them. The equipment neededwould cost $1,000,000, with a disposal value of $200,000, and wouldbe able to produce 27,500,000 cans over the life of the machinery.The production department estimates that approximately 5,500,000cans would be needed for each of the next 5 years. The companywould hire six new employees. These six individuals would befull-time employees working 2,000 hours per year and earning $15.00per hour. They would also receive the same benefits as otherproduction employees, 15% of wages in addition to $2,000 of healthbenefits. It is estimated that the raw materials will cost 30¢ percan and that other variable costs would be 10¢ per can. Becausethere is currently unused space in the factory, no additional fixedcosts would be incurred if this proposal is accepted. It isexpected that cans would cost 50¢ each if purchased from thecurrent supplier. The company's minimum rate of return (hurdlerate) has been determined to be 11% for all new projects, and thecurrent tax rate of 35% is anticipated to remain unchanged. Thepricing for the company’s products as well as number of units soldwill not be affected by this decision. The unitof-productiondepreciation method would be used if the new equipment ispurchased. Required: 1. Based on the above information and usingExcel, calculate the following items for this proposed equipmentpurchase. o Annual cash flows over the expected life of theequipment o Payback period o Simple rate of return o Net presentvalue o Internal rate of return The check figure for the totalannual after-tax cash flows is $271,150. 2. Would you recommend theacceptance of this proposal? Why or why not? Prepare a short,double-spaced paper in MS Word elaborating on and supporting youranswer.

Bookmark Capital Investment Decision Hampton Company: Theproduction department has been investigating possible ways to trimtotal production costs. One possibility currently being examined isto make the cans instead of purchasing them. The equipment neededwould cost $1,000,000, with a disposal value of $200,000, and wouldbe able to produce 27,500,000 cans over the life of the machinery.The production department estimates that approximately 5,500,000cans would be needed for each of the next 5 years. The companywould hire six new employees. These six individuals would befull-time employees working 2,000 hours per year and earning $15.00per hour. They would also receive the same benefits as otherproduction employees, 15% of wages in addition to $2,000 of healthbenefits. It is estimated that the raw materials will cost 30¢ percan and that other variable costs would be 10¢ per can. Becausethere is currently unused space in the factory, no additional fixedcosts would be incurred if this proposal is accepted. It isexpected that cans would cost 50¢ each if purchased from thecurrent supplier. The company's minimum rate of return (hurdlerate) has been determined to be 11% for all new projects, and thecurrent tax rate of 35% is anticipated to remain unchanged. Thepricing for the company’s products as well as number of units soldwill not be affected by this decision. The unitof-productiondepreciation method would be used if the new equipment ispurchased. Required: 1. Based on the above information and usingExcel, calculate the following items for this proposed equipmentpurchase. o Annual cash flows over the expected life of theequipment o Payback period o Simple rate of return o Net presentvalue o Internal rate of return The check figure for the totalannual after-tax cash flows is $271,150. 2. Would you recommend theacceptance of this proposal? Why or why not? Prepare a short,double-spaced paper in MS Word elaborating on and supporting youranswer.

A.) The textbook seems to favor two techniques for two differentreasons Net present value seems to be the most widely usedtechnique because of its ability to predict the expected dollaramount of wealth that a project should produce. The other widelyused technique is the internal rate of return. Both of thesetechniques can be used to make accept or reject decisions andsometimes IRR is used because of its focus on percentage rates ofreturn as it pertains to the cost of capital of the firm. This wayan analyst can identify any problems with the IRR before theirbosses can implement the project. I am fairly new to this but cansee why a combination of these two techniques could be very usefulto decision makers especially IRR which can show if investmentreturns can exceed a company’s requirements. Personally my interestis in small business and I enjoyed learning about the paybackperiod. Baby steps.

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B.)The textbook favors the net present valueinvestment valuation technique. The reasoning is that it goes intodeeper detail about the financial standing of a company, than othervaluation methods. It subtracts the value of the initial investmentfrom the firm's cash flows at a rate comparable to the firm's costof capital, as a percentage. It demonstrates more than just thefact that a company can pay back their debts, but whether a companyis profitable or not. An investment firm would be most interestedin an investment that has a greater cash flow than that of theinitial investment. It may seem obvious that someone would want toinvest in a company that makes money, but our textbook has alsoshown us that investments do not always make money at the samepace. For example an investment could break even the first year,but then have accelerated growth year 2 and 3, or vice versa. Thisis a reason why, to me, NPV is a good way to value an investment.It leaves room for this information if you calculate the yearsseparately (unlike you would an annuity).

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