ACCT 311 Lecture Notes - Lecture 11: Payback Period, Capital Budgeting, Compound Interest

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violetfox768

26 Jul 2018

School

American River College

Department

Accounting

Course

ACCT 311

Professor

Pollard

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Document Summary

Student learning outcomes: explain the nature of capital expenditure decisions and apply and evaluate various methods used in making these decisions; including the time value of money. Chapter outline: capital budgeting, time value of money, net present value method, the internal rate of return, the payback method. The process used to plan expenditures on long-term. Decisions made to determine whether a project meets a. Screening decisions particular, preset criteria such as a minimum rate of return. Decisions made to determine the most financially advantageous. Principal: interest - cost for use of money; principal x rate x time. Compound interest - interest on principal interest - interest on principal and interest (fv) - amount of investment at future date if invested now. Present value with compound interest to produce given future value of time, with compound interest on the payments: how to use factor tables. Ordinary annuity (pv) - amount must be invested now with compound interest.

Related Questions

RozzisRozzis

Construction is analyzing its capital expenditure proposals forthe purchase of equipment in the coming year. The capital budget islimited to

$ 5 comma 000 comma 000$5,000,000

for the year.

LindaLinda

BensonBenson?,

staff analyst at

RozzisRozzis?,

is preparing an analysis of the three projects underconsideration by

ChesterChester

RozzisRozzis?,

the? company's owner.

Requirement 1. Because the? company's cash is?limited,

RozzisRozzis

thinks the payback method should be used to choose between thecapital budgeting projects.

a. What are the benefits and limitations ofusing the payback method to choose between? projects?

Benefits of the payback? method:

Easy to understand and captures uncertainty about expected cashflows in later years of a project

Your answer is correct.

Indicates whether or not the project will earn the? company'sminimum required rate of return

Utilizes the time value of money and computes each? project'sunique rate of return

All of the above

Limitations of the payback? method:

Cannot be used when? management's required rate of return variesfrom one period to the next.

Cannot be used for projects with unequal periodic cash flows

Fails to incorporate the time value of money and does notconsider a? project's cash flows after the payback period

All of the above

Data Table:

Project A

Project B

Project C

Projected cash outflow

Net initial investment

$3,000,000

$2,100,000

$3,000,000

Projected cash inflows

Year 1

$1,200,000

$1,700,000

Year 2

1,200,000

600,000

1,700,000

Year 3

1,200,000

500,000

200,000

Year 4

1,200,000

100,000

Required rate of return

Requirements:

1.	Because the? company's cash is? limited, RozzisRozzis thinks the payback method should be used to choose between thecapital budgeting projects.
	a.	What are the benefits and limitations of using the paybackmethod to choose between? projects?
	b.	Calculate the payback period for each of the three projects. Ignoreincome taxes. Using the payback? method, which projects should RozzisRozzis ?choose?
2.	BensonBenson thinks that projects should be selected based on their NPVs. Assumeall cash flows occur at the end of the year except for initialinvestment amounts. Calculate the NPV for each project. Ignoreincome taxes.
3.	Which? projects, if? any, would you recommend? funding? Brieflyexplain why.

amaranthtrout588

1. An increase in the discount rate:

A) will increase the present value of future cash flows.

B) will have no effect on net present value.

C) will reduce the present value of future cash flows.

D) is one method of compensating for reduced risk.

2. Suddeth Corporation has entered into a 6 year lease for a building it will use as a warehouse. The annual payment under the lease will be $2,468. The first payment will be at the end of the current year and all subsequent payments will be made at year-ends. If the discount rate is 5%, the present value of the lease payments is closest to (Ignore income taxes.):

See separate handout to determine the appropriate discount factor(s) using table.

A) $12,528

B) $14,103

C) $14,808

D) $11,050

3. At an interest rate of 14%, approximately how much would you need to invest today if you wanted to have $2,000,000 in 10 years? (Ignore income taxes.)

See separate handout to determine the appropriate discount factor(s) using table.

A) $383,436

B) $540,000

C) $740,741

D) $1,043,200

4. A company wants to have $20,000 at the end of a ten-year period by investing a single sum now. How much needs to be invested in order to have the desired sum in ten years, if the money can be invested at 12%? (Ignore income taxes.)

See separate handout to determine the appropriate discount factor(s) using table.5

A) $3,254.68

B) $3,539.82

C) $6,440

D) $7,720

5. Amster Corporation has not yet decided on the required rate of return to use in its capital budgeting. This lack of information will prevent Amster from calculating a project's:

Payback

Net Present Value

Internal Rate of Return

Yes

THIS IS THE handout to determine the appropriate discount factor(s) using table.5

Time Value of Money Factor for the Present Value of a Sum
PV =FV * TVM Factor					Present Value of a Sum = FV * 1/ (1 + i) ⁿ
	2%	3%	4%	5%	6%	8%	10%	12%
1	0.9804	0.9709	0.9615	0.9524	0.9434	0.9259	0.9091	0.8929
2	0.9612	0.9426	0.9246	0.9070	0.8900	0.8573	0.8264	0.7972
3	0.9423	0.9151	0.8890	0.8638	0.8396	0.7938	0.7513	0.7118
4	0.9238	0.8885	0.8548	0.8227	0.7921	0.7350	0.6830	0.6355
5	0.9057	0.8626	0.8219	0.7835	0.7473	0.6806	0.6209	0.5674
6	0.8880	0.8375	0.7903	0.7462	0.7050	0.6302	0.5645	0.5066
7	0.8706	0.8131	0.7599	0.7107	0.6651	0.5835	0.5132	0.4523
8	0.8535	0.7894	0.7307	0.6768	0.6274	0.5403	0.4665	0.4039
9	0.8368	0.7664	0.7026	0.6446	0.5919	0.5002	0.4241	0.3606
10	0.8203	0.7441	0.6756	0.6139	0.5584	0.4632	0.3855	0.3220
20	0.6730	0.5537	0.4564	0.3769	0.3118	0.2145	0.1486	0.1037
25	0.6095	0.4776	0.3751	0.2953	0.2330	0.1460	0.0923	0.0588
Time Value of Money Factor for the Present Value of an Annuity
PV = Annuity * TVM Factor						Present Value of an Annuity = X*((1-(1/(1+i)^n))/i)
	2%	3%	4%	5%	6%	8%	10%	12%
1	0.9804	0.9709	0.9615	0.9524	0.9434	0.9259	0.9091	0.8929
2	1.9416	1.9135	1.8861	1.8594	1.8334	1.7833	1.7355	1.6901
3	2.8839	2.8286	2.7751	2.7232	2.6730	2.5771	2.4869	2.4018
4	3.8077	3.7171	3.6299	3.5460	3.4651	3.3121	3.1699	3.0373
5	4.7135	4.5797	4.4518	4.3295	4.2124	3.9927	3.7908	3.6048
6	5.6014	5.4172	5.2421	5.0757	4.9173	4.6229	4.3553	4.1114
7	6.4720	6.2303	6.0021	5.7864	5.5824	5.2064	4.8684	4.5638
8	7.3255	7.0197	6.7327	6.4632	6.2098	5.7466	5.3349	4.9676
9	8.1622	7.7861	7.4353	7.1078	6.8017	6.2469	5.7590	5.3282
10	8.9826	8.5302	8.1109	7.7217	7.3601	6.7101	6.1446	5.6502
20	16.3514	14.8775	13.5903	12.4622	11.4699	9.8181	8.5136	7.4694
25	19.5235	17.4131	15.6221	14.0939	12.7834	10.6748	9.0770	7.8431

5. An investment proposal has an outlat of $60.000 today and annual cash inflow of $15,000 from year 1 to year 6. Find its net present value of the required rate of return is 15%. Is the investment viable?

6. A debt of $5,300 due in four years and another $11,500 due in twelve years will be settled by making two equal payment, one at the end of six years and the other at the end of 9 years, Find the total payment assuming that money is worth 8% compounded quarterly. Use the twelve years as a focal date.

7. On 5 februrary 2012, Anna borrows $80,000 and agree to repay the loan in 110 days at 9% per annum simple interest, Find the simple amount of the loan and the settlement date of the loan, Using the bankers rule

8. The net price of an item listed for $1,500 after deducting trade discount of 20%, 15% and x% is $969. FInd X

9. AAA and BBB need an additional $6565 for a down payment on a home they hope to buy in 2 years, They invest $808 at the end of each quarter in an account earning6% compounded quarterly. Find the amount of the annuity and the interest earned.

10. Find the value in 2 years time of $4,444 invested at 5% compounded annually. In the following 2 years, the interest rate is expected to rise to 8%. Find the value of the investment at the end of the 4 years period, and find the overall percentage increase.

11. A debt of $5,555 due 5 month ago and another $8,888 due in 12 month are to be settled by making three equal payment. One at the end of the two months, One at the end of six months and the other at the end of ten months. Find the size of payment using. the seconf month as the focal date. Assuming money is worth 9% per annum simple interest.

12. Four years ago John borrowed $3000 from Arlette. The principal with interest at 10% compounded semi-annually is to be repaid six years from the date of the loan. Fifteen month ago, John borrowed another $1500 for 3 and haly year at 9% compounded quarterly. John is now proposing to settle both debts with two equal payment to be made 2 and 3 and half years from now. what should the payment be if money now earns 8% compounded quarterly.

13. Mathew buys a house for $250,000, He makes a 10% down payment and finances the balance through a bank for 25 years. A. if the interest rate is 7% compounded monthly, find the monthly payment that Mathew has to make to settle the loan. How much is the total interest charged? B. Suppose Mathew misses the first four payments. How much should he pay on the fifth month if he wants to settle the outstanding arrears? C. Immediately after paying for 15 years, Mathwe wants to settle the loan in full, How much is the amount he needs to pay?

14. Nania bough a piece of land for $150,000, She made an initial down payment of $40,000 and the balanced is financed through a bank. For the repayment of the bank loan, She has to pay $1975.50 a month. A) If the bank rate is 12% compounded monthly, Find the number of monthly payment that will settle the loan. B) If Nania intends to settle the loan by making a final payment immediately after paying the first 40 monthly payment, Find the value of this payment. What is the total interest payment she has to pay? C) If Nania intends to settle the loan by making a final payment on the 41st payment immediately after paying the first 40 monthly payments, Find the value of this payment.

15a. What is an annuity?

b. Fatimah purchased a house costing $450,000. She made a down payment of 10%, The balance was borrowed from Capital one bank which charges 9% compounded monthly. to setle the loan, Fatimah had to make equal monthly payment for 15 years.

i) How much is the down payment ii) Find Fatimah's Monthly payment iii) Find the total interst that she has to pay.

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ACCT 311 Lecture Notes - Lecture 11: Payback Period, Capital Budgeting, Compound Interest

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