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Below are two investment ideas to work with: Use straight-line amortization in a

ID: 2445857 • Letter: B

Question

Below are two investment ideas to work with:

Use straight-line amortization in all calculations and exclude income taxes.

IDEA ONE

IDEA TWO

Initial capital investment

$120,000

$180,000

Estimated useful life

3 years

3 years

Estimated terminal salvage value

0

0

Estimated annual savings in cash

operating costs

$50,000

$80,000

Minimum desired rate of return

10 %

12 %

Present Value of $1 (3 years)

Present Value of an Annuity of $1 (3 years)

8%

0.7938

2.5771

10%

0.7513

2.4869

12%

0.7118

2.4018

14%

0.6750

2.3216

16%

0.6407

2.2459

The net present value in IDEA ONE is

A) $4,345

B) $82,435

C) $50,000

D) $90

The net present value in IDEA TWO is

A) $80,000

B) $12,144

C) $-328 (negative amount)

D) $123,056

3. Using the Present Value table above, calculate the present value of 5-year annuity of $10,000 and an annual earning return of 8%.

A) $31,700

B) $34,700

C) $37,910

D) $39,930

IDEA ONE

IDEA TWO

Initial capital investment

$120,000

$180,000

Estimated useful life

3 years

3 years

Estimated terminal salvage value

0

0

Estimated annual savings in cash

operating costs

$50,000

$80,000

Minimum desired rate of return

10 %

12 %

Explanation / Answer

NPV of IDEA ONE :

As the saving is annual we would use the annuity table ,

As the desired rate of return is 10 % , the value corresponding to 10% in the annuity table is 2.4869

Hence NPV = Annual Saving * Annuity factor - Initial investment

= 50000 * 2.4869 - 120000

= 124345 - 120000

= 4345

Hence option A is correct for IDEA ONE

NPV for IDEA TWO

annuity factor for IDEA TWO is 2.4018 which corresponds to 12% return ,

Hence NPV = Annual saving * annuity factor - Initial Investment

= 80000 * 2.4018 - 180000

= 192144 - 180000

= 12144

Hence option B is correct for IDEA TWO

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