18. The management of Arkansas Corporation is considering the purchase of a mach

Question

18. The management of Arkansas Corporation is considering the purchase of a machine costing $490,000. The company's desired rate of retum is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability of this investment: new Income from Net Cash Operations Flow $100,000 $180,000 40,000 40,000 10,000 90,000 10,000 120,000 Year 2 3 4 5 120,000 100,000 The net present value for this investment is a. $36,400 b. $55,200 c. $(16,170) d. $(126,800) 19. Motel Corporation is analyzing a capital expenditure that will involve a cash outlay of $208,240. Estimated cash flows are expected to be $40,000 annually for 7 years. The present value factors for an annuity of $1 for 7 years at interest of 6%, 8%, 10%, and 12% are 5.582, 5.206, 4.868, and 4.564, respectively. The internal rate of return for this investment is a. 10% b. 6% C. 12% d. 8% 20. Which of the following method is best for evaluating proposed capital investment projects? a. NPV b. Payback period c. Accounting rate of return on investment d. Return on equity

Explanation / Answer

1

Option C

NPV=-490000+180000*0.909+120000*0.826+100000*0.751+90000*0.683+120000*0.621
=-16170

2

Option D

IRR is the rate at which NPV is zero

NPV=-208240+40000*PVIFA(r,7)

So, 0=-208240+40000*PVIFA(r,7)

Hence, PVIFA=208240/40000=5.206

Given PVFA for r=8% and 7 years is 5.206

hence, IRR=8%

3

Option A

NPV because it accounts for 1) time value of money 2) it takes into account all cash flows 3) it uses discount rate appropriate to the risk of the project 4) it is based on current market value and not book value 5) it handles non-normal cash flows as well

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