The following questions are discussion questions from the end of chapter 13. Bas

Question

The following questions are discussion questions from the end of chapter 13. Based on your study of chapter 13, think through and answer these questions.

Question 1:

As the discount rate increases, the present value of a given future cash flow also

increases. Do you agree? Explain.

Question 2:

What is meant by the term payback period? How is the payback period determined?

How can the payback method be useful?

Question 3:

What is the major criticism of the payback and simple rate of return methods of making

capital budgeting decisions

Question 4:

Wendell’s Donut Shoppe is investigating the purchase of a new $18,600 donut-making machine. The new machine would permit the company to reduce the amount of part-time help needed, at a cost savings of $3,800 per year. In addition, the new machine would allow the company to produce one new style of donut, resulting in the sale of 1,000 dozen more donuts each year. The company realizes a contribution margin of $1.20 per dozen donuts sold. The new machine would have a six- year useful life.

What would be the total annual cash inflows associated with the new machine for capital budgeting purposes?

Find the internal rate of return promised by the new machine to the nearest whole percent.

In addition to the data given previously, assume that the machine will have a $9,125 salvage value at the end of six years. Under these conditions, compute the internal rate of return to the nearest whole percent.

(Hint: You may find it helpful to use the net present value approach; find the discount rate that will cause the net present value to be closest to zero.)

Explanation / Answer

1. As the discount rate increases, the present value of a given future cash flow also increases.

I don't agree with this statement. Because, as the discount rate increases the present value of the given future cash flow decreases. There is an inverse relationship between the discount rate to be used the present value of the given cash flow using that discount rate.

Explanation:

Suppose,

We have a future cash flow of $1,000 after 1 year. the discount rate is 10%.

The present value = $1,000/(1+0.10)1 = $1,000/(1.1) = $909.09

If the discount rate increase to 15%

The present value = $1,000/(1+0.15)1 = $1,000/(1.15) = $869.57

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.