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E12-3 E12-6 E12-7 E12-11 P12-1A P12-3A

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ACC560 Chapter 12

E12-3 Hiland Inc. manufactures snowsuits. Hiland is considering purchasing a new sewing
machine at a cost of $2.45 million. Its existing machine was purchased five years ago
at a price of $1.8 million; six months ago, Hiland spent $55,000 to keep it operational. The
existing sewing machine can be sold today for $260,000. The new sewing machine would
require a one-time, $85,000 training cost. Operating costs would decrease by the following
amounts for years 1 to 7:

Year 1  $390,000
2 400,000
3 411,000
4 426,000
5 434,000
6 435,000
7 436,000

The new sewing machine would be depreciated according to the declining-balance method
at a rate of 20%. The salvage value is expected to be $350,000. This new equipment would
require maintenance costs of $100,000 at the end of the fifth year. The cost of capital is 9%.

Use the net present value method to determine whether Hiland should purchase the new
machine to replace the existing machine, and state the reason for your conclusion.

E12-6 BSU Inc. wants to purchase a new machine for $29,300, excluding $1,500 of
installation costs. The old machine was bought five years ago and had an expected
economic life of 10 years without salvage value. This old machine now has a book value
of $2,000, and BSU Inc. expects to sell it for that amount. The new machine would
decrease operating costs by $7,000 each year of its economic life. The straight-line
depreciation method would be used for the new machine, for a six-year period with no
salvage value.

(a) Determine the cash payback period.
(b) Determine the approximate internal rate of return.
(c) Assuming the company has a required rate of return of 10%, state your conclusion on
whether the new machine should be purchased.

E12-7 Ueker Company is considering three capital expenditure projects. Relevant data for
the projects are as follows.
Project Investment Annual Income Life of Project
 22A  $240,000 $16,700 6 years 
23A  270,000 20,600 9 years 
24A  280,000 17,500 7 years 

Annual income is constant over the life of the project. Each project is expected to have
zero salvage value at the end of the project. Ueker Company uses the straight-line method
of depreciation.

(a) Determine the internal rate of return for each project. Round the internal rate of
return factor to three decimals.

E12-11 BAP Corporation is reviewing an investment proposal. The initial cost and estimates
of the book value of the investment at the end of each year, the net cash flows for
each year, and the net income for each year are presented in the schedule below. All cash
flows are assumed to take place at the end of the year. The salvage value of the investment
at the end of each year is equal to its book value. There would be no salvage value at the
end of the investment’s life.
Year  Initial Cost and Book Value  Cash Flows  Net Income
0 $105,000
1 70,000 $45,000 $10,000
2 42,000 40,000 12,000
3 21,000 35,000 14,000
4 7,000 30,000 16,000
5 0 25,000 18,000

BAP Corporation uses a 12% target rate of return for new investment proposals.

(a) What is the cash payback period for this proposal?
(b) What is the annual rate of return for the investment?
(c) What is the net present value of the investment?

P12-1A Henkel Company is considering three long-term capital investment proposals.
Each investment has a useful life of 5 years. Relevant data on each project are as follows.

Depreciation is computed by the straight-line method with no salvage value. The company’s
cost of capital is 15%. (Assume that cash flows occur evenly throughout the year.)

(a) Compute the cash payback period for each project. (Round to two decimals.)
(b) Compute the net present value for each project. (Round to nearest dollar.)
(c) Compute the annual rate of return for each project. (Round to two decimals.) (Hint:
Use average annual net income in your computation.)
(d) Rank the projects on each of the foregoing bases. Which project do you recommend?

P12-3A Goltra Clinic is considering investing in new heart-monitoring equipment. It has
two options: Option A would have an initial lower cost but would require a significant expenditure
for rebuilding after 4 years. Option B would require no rebuilding expenditure,
but its maintenance costs would be higher. Since the Option B machine is of initial higher
quality, it is expected to have a salvage value at the end of its useful life. The following
estimates were made of the cash flows. The company’s cost of capital is 8%.

Option A Option B
Initial cost  $160,000 $227,000
Annual cash inflows  $70,000 $80,000
Annual cash outflows  $30,000 $26,000
Cost to rebuild (end of year 4)  $50,000 $0
Salvage value  $0 $8,000
Estimated useful life  7 years  7 years 

(a) Compute the (1) net present value, (2) profitability index, and (3) internal rate of return
for each option. (Hint: To solve for internal rate of return, experiment with alternative
discount rates to arrive at a net present value of zero.)
(b) Which option should be accepted?

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