Solutions Chapter 11

Chapter 11 Capital Budgeting
ANSWERS TO QUESTIONS
1. Screening decisions require managers to determine whether a proposed capital
investment meets a minimum criteria or threshold set by the company. Preference
decisions require a choice among several alternatives.
2. Independent projects are unrelated to one another, so that investing in one project
does not preclude or affect the choice about investing in the other alternatives.
Mutually exclusive projects involve a choice among competing alternatives, where
selection of one project implies rejection of all the other alternatives.
3. The time value of money refers to the fact that a $1 today is worth more than a $1 in
the future. The dollar you receive today can be invested. So long as the investment
earns a positive return, you will have more than $1 in the future
4. Non-discounting methods do not incorporate the time value of money, while
discounting methods do incorporate the time value of money. Discounting methods
are considered superior because they recognize that a $1 today is worth more than
a $1 in the future.
5. A hurdle rate is the minimum return that a project must generate in order to be
considered an acceptable investment. Projects that do not meet or exceed a
companys hurdle rate are not acceptable and should be rejected.
6. Net income includes non-cash expenses such as depreciation. This distinction is
important because some methods use net income while others utilize cash flow.
7. The payback period is the amount of time it will take for a project to pay for itself or
pay back its original investment.
8. A positive NPV indicates that the present value of a projects cash inflows is greater
than the present value of the cash outflows. It also indicates that the project has met
its hurdle rate, since the projects internal rate of return is higher than the hurdle rate.
A negative NPV indicates that the present value of a projects cash inflows is less
than the present value of the cash outflows. It also indicates that the project has not
met its hurdle rate, since the projects internal rate of return is less than the hurdle
rate.
9. An annuity factor is used for cash flows that occur evenly across a number of years,
while a PV factor is used for cash flows that occur in a single year.
Managerial Accounting, 2/e
11-1
2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
10. A positive NPV occurs when a projects IRR is greater than the companys hurdle
rate. A negative NPV occurs when a projects IRR is less than the companys hurdle
rate. If a project generates a $50,000 NPV using a discount or hurdle rate of 10%,
this indicates that the projects IRR is greater than 10%.
11. The NPV method is generally preferred over the internal rate of return because the
NPV method assumes that future cash flows will be reinvested at the minimum
required rate of return. In contrast, the IRR method assumes that future cash flows
will be reinvested to earn the same internal rate of return, which is a less realistic
assumption.
12. The profitability index is the ratio of the present value of future cash flows divided by
the initial investment. A profitability index greater than one means that a project has
a positive NPV, since the present value of the future cash flows is greater than the
initial investment.
13. In future value of a single amount problems, you will be asked to calculate how
much money you will have in the future as the result of investing a certain amount in
the present. The present value of a single amount is the worth to you today of
receiving that amount sometime in the future.
14. From Future Value of $1 table where n=10 and i = 10%: factor = 2.5937
$10,000 x 2.5937 = $25,937. Thus, $10,000 invested today at 10% will be $25,937
in 10 years.
15. From Present Value of $1 table where n = 10 and i = 10%; factor = 0.3855
$8,000 x 0.3855 = $3,084. Thus, a contract that pays $8,000 in 10 years is worth
$3,084 today.
16. The PV of annuity table can be used when the cash flows are equal for each year.
The PV of $1 must be used when the cash flows are uneven from year to year.
17.
FV of $1
PV of $1
FV of annuity of $1
PV of annuity of $1
11-2
I =5%, n = 4 I = 10%, n = 7 I =14%, n = 10

1.2155
1.9487
3.7072
0.8227
0.5132
0.2697
4.3101
9.4872
19.3373
3.5460
4.8684
5.2161
Solutions Manual
Authors' Recommended Solution Time

(Time in minutes)
Mini-exercises
No.
Time
1
3
4
2
3
3
3
4
4
5
4
6
3
7
4
8
4
9
4
10
3
11
4
12
Exercises
No.
Time
5
1
6
2
6
3
5
4
5
5
6
6
6
7
5
8
5
9
10
6
11
6
12
6
13
8
Problems
No.
Time
9
PA1
8
PA2
6
PA3
8
PA4
9
PA5
8
PB1
8
PB2
7
PB3
8
PB4
9
PB5
Cases and
Projects*
No.
Time
1
30
* Due to the nature of cases, it is very difficult to estimate the amount of time students
will need to complete them. As with any open-ended project, it is possible for students
to devote a large amount of time to these assignments. While students often benefit
from the extra effort, we find that some become frustrated by the perceived difficulty of
the task. You can reduce student frustration and anxiety by making your expectations
clear, and by offering suggestions (about how to research topics or what companies to
select).
11-3
ANSWERS TO MINI-EXERCISES
M111
H
F
J
A, K
G
I
A, C
D
B, E
1. Time value of money

2. Profitability Index
3. Payback period
4. Net present value method
5. Future value
6. Preference decision
7. Internal rate of return method
8. Screening decision
9. Accounting rate of return
M112
Accounting Rate of Return = Annual Net Income / Initial Investment
= ($390,000 / 3) / $920,000
= $130,000 / $920,000
= 14.13% (rounded)
M113
Payback Period
= Initial Investment / Annual Net Cash Flow

= $340,000 / $80,000
= 4.25 years
M114
= $25,000 / $250,000
= 10%
Payback Period
11-4

= Initial Investment / (Net Income + Depreciation)
= $250,000 / ($25,000 + $40,000)
= 3.85 years
Solutions Manual
M115
Year
0
1-6
NPV
Annual Cash Flow

$( 150,000)
$ 32,000
PV Factor (8%)
4.6229
Present Value
$(150,000.00)
147,932.80
$( 2,067.20)
The negative NPV shows that the present value of the future cash inflows for the
project is less than the original investment it requires. A negative NPV suggests the
project is unacceptable.
M116
From Excel, the IRR is 0.13% for this project.
Year
0
1
2
3
4
5
Cash flow
-286500
57523
57523
57523
57523
57523
0.13%
M11-7
Req. 1
Year
0
1-10
NPV
Annual Cash Flow

$( 400,000)
$ 70,000
PV Factor (11%)
5.8892
Present Value
$(400,000)
412,244
$ 12,244
The positive NPV shows that the present value of the future cash inflows for the
project is greater than the original investment it requires. A positive NPV suggests
that a project is acceptable.
Req. 2
The internal rate of return (IRR) on the project must be greater than 11% because the
NPV of the project is positive.
11-5
M11-8
Profitability Index = PV of Future Cash Flows / Initial Investment
PI for Project A = $265,000 / $110,000
= 2.4091 (rounded)
PI for Project B = $400,000 / $220,000
= 1.8182 (rounded)
PI for Project C = $115,000 / $112,000
= 1.0268 (rounded)
Project A has the highest profitability index and is the preferred option, Project B would
be the 2nd preference, and Project C is the least preferred.
M11-9
$100,000
$100,000
+ $50,000 0.9434
47,170
+ $ 20,000 11.4699
229,398
Total
$376,568
M11-10
$30,000 14.4866
$434,598
$15,000 45.7620
$686,430
It is much better to save $15,000 for 20 years.
11-6
Solutions Manual
M 11-11
Tremaine Company should select project XYZ because it has a positive NPV based on
the following analysis:
Project ABC:
Cash flows
Discount factor, Present value*

12%, 4 periods
$78,000
3.0373
$236,909
(240,000)
$(3,091)
PV of future cash flows

Original investment
NPV
* Rounded
Project XYZ:
Cash flows
PV of future cash flows
Original investment
NPV
Discount factor, Present value*

12%, 5 periods
$66,000
3.6048
$237,917
(230,000)
$7,917
* Rounded
M11-12
Project
A
B
C
PI
1.70
1.55
1.89
Ranking
2
3
1
11-7
ANSWERS TO EXERCISES
E111
Req. 1
Accounting rate of return
Req. 2
Payback period
E112
Req. 1
Accounting rate of return
Req. 2
Payback period
11-8
= Annual Net Income / Initial Investment

= $45,000 / $300,000
= 15%
= $300,000 / [$45,000 + (($300,000 - $100,000) / 5 years)]
= 3.53 years
= Annual Net Income / Initial Investment

= $53,000 / $510,000
= 10.39% (rounded)
= Initial Investment/(Net Income + Depreciation)
= $510,000 / [$53,000 + (($510,000 - $50,000) / 8 years)]
= $510,000 / ($53,000 + $57,500)
= 4.62 years (rounded)
Solutions Manual
E113
Req. 1
Year
Annual Cash Flow
0
$(1,600,000)
1-8
406,250*
8
350,000
NPV
*$250,000 + [($1,600,000 - $350,000) / 8]
PV Factor
(10%)
5.3349
0.4665
Present
Value
$(1,600,000)
2,167,303
163,275
$ 730,578
The positive NPV shows that the present value of the future cash inflows for the
project is greater than the original investment it requires. A positive NPV suggests
that a project is acceptable.
Req. 2
The internal rate of return must be greater than 10% since the project yields a positive
NPV using a 10% discount rate.
Req. 3
Year
Annual Cash Flow
0
$(1,600,000)
1-8
406,250*
8
350,000
NPV
*$250,000 + [($1,600,000 - $350,000) / 8]
PV Factor
(20%)
3.8372
0.2326
Present
Value
$(1,600,000)
1,558,863
81,410
$
40,273
Req. 4
The internal rate of return must be slightly higher than 20% because the NPV is
positive. Optional: If you use Excel to calculate the exact IRR, you will find that the IRR
is 20.79%.
11-9
E114
Req. 1
= $48,000 / $600,000
= 8%
Req. 2
Payback Period

= $600,000 / ($48,000 + [($600,000 - $100,000) / 8]
= 5.43 years
Req. 3
Year
Annual Cash Flow
0
$(600,000)
1-8
110,500*
8
100,000
NPV
* $48,000 + [($600,000 - $100,000) / 8]
PV Factor
(12%)
4.9676
0.4039
Present
Value
$(600,000)
548,920
40,390
$ (10,690)
Req. 4
Since the NPV is negative when using a 12% discount rate, the internal rate of return on
the project must be less than 12%. Estimate is around 11%. The actual IRR using
Excel (not required) is 11.52%.
E115
Answers are shaded below:
Project 1
Project 2
Project 3
Project 4
Project 5
Project 6
Net present value

<0
<0
>0
>0
<0
<0
Cost of capital
13%
>10%
12%
8%
9%
10%
Internal rate of return

<13%
10%
14%
>8%
<9%
9%
Explanation:
If the NPV is > 0, the internal rate of return must be > the cost of capital.
If the NPV is < 0, the internal rate of return must be < the cost of capital.
11-10
Solutions Manual
E116
Req. 1.
Option 1:
$1,000,000 7.4694
$7,469,400
$8,000,000
$7,228,580
Option 2:
$8,000,000
Option 3:
$2,000,000 + ($700,000 7.4694)
Req. 2
Option 2 is the best option because it provides the greatest present value when all
options are discounted at 12%.
E117
Req. 1
Purchase Option
Year
0
1
2
3
4
5
Cash Flow PV of $1 (10%) Present Value

$(26,500)
1.000
$(26,500.00)
(500)
0.9091
(454.55)
(500)
0.8264
(413.20)
(500)
0.7513
(375.65)
(500)
0.6830
(341.50)
10,500
0.6209
6,519.45
NPV =
$(21,565.45)
Lease Option
PV of annuity of $1 (i = 10%, n = 5) = 3.7908
NPV of Lease Option = $3,480 x 3.7908
= $(13,191.98)
Req. 2
Harold should choose to lease the car since leasing has a lower cost (higher NPV).
11-11
E118
Req. 1
No, Shaylee cannot invest in all of the projects because the company has $2 million
available, but the total investment for all four projects combined is $2,310,000.
Therefore, Shaylee must choose from among the four options.
Req. 2
PI for Project A = $765,000 / $415,000
= 1.8434 (rounded)
PI for Project B = $415,000 / $230,000
= 1.8043 (rounded)
PI for Project C = $1,200,000 / $720,000
= 1.6667 (rounded)
PI for Project D = $1,560,000 / $945,000
= 1.6508 (rounded)
Shaylees order of preference based on profitability index is:
Project A
Project B
Project C
Project D
Given its $2 million available, Shaylee can only invest in Projects A, B, and C. These 3
projects will require $1,365,000 of Shaylees capital which doesnt leave enough to
undertake Project D.
E119
Req. 1
$8,000 x 2.1589 = $17,271.20
Req. 2
$17,271.20 $8,000 = $9,271.20 (time value of money, or interest)
Req. 3
2013: $8,000 x 8% = $640 (interest)
2014: ($8,000 + $640) x 8% = $691.20 (interest)
11-12
Solutions Manual
E11-10
Req. 1
FV of annuity of $1 (i = 8%, n = 10): 14.4866
$15,000 x 14.4866 = $217,299 after 10 years
Req. 2
$17,500 x 14.4866 = $253,515.50 after 10 years
Req. 3
FV of annuity of $1 (i = 10%, n = 10): 15.9374
$15,000 x 15.9374 = $239,061 after 10 years
E11-11
Tulsa should select Option A because it has a higher NPV.
Option A:
Cash flows
PV of annual cash flows
PV of cost to rebuild
PV of salvage
Capital investment
NPV
Discount
Present value*
factor, 11%
$80,000
5.1461
$411,688
120,000
.6587
(79,044)
0
.4339
0
$332,644
(320,000)
$12,644
* Rounded
Option B:
Cash flows
PV of annual cash flows
PV of cost to rebuild
PV of salvage
Capital investment
NPV
Discount
Present value*
factor, 11%
$85,000
5.1461
$437,419
0
.6587
0
24,000
.4339
10,414
$447,833
(454,000)
$(6,167)
* Rounded
11-13
E11-12
Project X
Initial investment
Project Y
Project Z
$40,000
$20,000
$50,000
Annual cash
inflows
25,000
10,000
25,400
PV of cash inflows
45,000
33,000
70,000
Payback
NPV
PI
1.60
$5,000
1.13
2.00
$13,000
1.65
1.97
$20,000
1.40
Req. 1
Based on the payback, the investment manager would rank the projects as: X, Z, Y.
Req. 2
Based on the NPV, the investment manager would rank the projects as: Z, Y, X.
Req. 3
Based on the profitability index, the investment manager would rank the projects as:
Y, Z, X.
Req. 4
Since limited investment funds are available, the investment manager should
recommend that the company prioritize the products based on the profitability index:
Y, Z, X.
11-14
Solutions Manual
E11-13
Req. 1 No, Granite Company would not invest in the new machine because, as shown
below, the payback period is about mid-way through the 6th year.
Year
1
2
3
4
5
6
7
8
Initial
Investment
$112,000
82,000
58,000
38,000
23,200
8,400
NA
NA
Annual cash Unpaid Investment

flow
$30,000
$82,000
24,000
58,000
20,000
38,000
14,800
23,200
14,800
8,400
14,800
(6,400)
NA
NA
NA
NA
Req. 2 Yes, Granite Company would accept the investment if the NPV method is used
because the project results in a net positive amount of cash when using a 12% return.
Year
Cash Flow
0
1
2
3
4
5
6
7
8
Residual
NPV
*rounded
$(112,000)
30,000
24,000
20,000
14,800
14,800
14,800
14,800
14,800
50,000
PV of $1
(12%)
--0.8929
0.7972
0.7118
0.6355
0.5674
0.5066
0.4523
0.4039
0.4039
Present
Value*
$(112,000)
26,787
19,133
14,236
9,405
8,398
7,498
6,694
5,978
20,195
$ 6,324
Req. 3 The machine Granite Company is considering has a large residual value (about
45% of the machines price) that the company will receive at the end of 8 years. The
NPV method includes this large cash flow in the calculations, but the payback method
ignores anything that happens after the payback period. Management will want to
exercise caution when considering this machines NPV. A small downward change in
the estimated residual value will cause the NPV to become negative. For this reason,
management may want to review its estimates for accuracy.
Req. 4 Since the machine has a positive NPV at 12%, it would have an even larger NPV
if the companys cost of capital was 10%. This larger NPV could act as a buffer against
any downward revisions in the machines estimated cash flows or residual value.
11-15
GROUP A PROBLEMS
PA111
Req. 1
= $37,800 / $420,000
= 9.0%
Req. 2
Payback Period

= $420,000 / ($37,800 + [($420,000 - $50,000) / 10]
= $420,000 / $74,800
= 5.62 years
Req. 3
Year
Annual Cash Flow
0
$(420,000)
1-10
74,800*
10
50,000
NPV
* $37,800 + [($420,000 - $50,000) / 10]
PV Factor
(11%)
5.8892
0.3522
Present
Value
$(420,000)
440,512
17,610
$ 38,122
PV Factor
(15%)
5.0188
0.2472
Present
Value
$(420,000)
375,406
12,360
$( 32,234)
Req. 4
Year
Annual Cash Flow
0
$(420,000)
1-10
74,800*
10
50,000
NPV
* $37,800 + [($420,000 - $50,000) / 10]
Req. 5
The internal rate of return for this project must be between 11% and 15%, since the
NPV is positive at 11% and negative at 15%. The IRR using Excel (not required) is
13.03%.
11-16
Solutions Manual
PA112
Req. 1
Production and Sales Volume
Sales Revenue
Variable Costs:
Direct Materials
Direct Labor
Variable Manufacturing Overhead
Total Variable Manufacturing Costs
Contribution Margin
Fixed Manufacturing Costs
Net Income
Current (No Automation)

80,000 units
Per Unit
Total
$90
$7,200,000
$18
25
10
53
$37
2,960,000
1,250,000
$1,710,000
Proposed (Automation)
120,000 units
Per Unit
Total
$90 $10,800,000
$18
20
10
48
$42
5,040,000
2,350,000
$2,690,000
Automation would generate a total increase in net income of $980,000.

Req. 2
= $980,000 / $15,000,000
= 6.53%
Req. 3
Payback Period

= $15,000,000 / ($980,000 + [($15,000,000 - $500,000) / 10]
= $15,000,000 / $2,430,000
= 6.17 years
Req. 4
Year
Annual Cash Flow
0
$(15,000,000)
1-10
2,430,000*
10
500,000
NPV
* $980,000 + [($15,000,000 - $500,000) / 10]
PV Factor
(15%)
1.0000
5.0188
0.2472
Present
Value
$(15,000,000.00)
12,195,684.00
123,600.00
$( 2,680,716.00)
11-17
PA112 (Continued)
Req. 5
PV Factor
(10%)
6.1446
0.3855
Year
Annual Cash Flow
0
$(15,000,000)
1-10
2,430,000*
10
500,000
NPV
* $980,000 + [($15,000,000 - $500,000) / 10]
Present
Value
$(15,000,000.00)
14,931,378.00
192,750.00
$
124,128.00
Req. 6 The answer to this question depends on the assumed required rate of return.
The project has a positive NPV using a discount rate of 10%, but a negative NPV using
a discount rate of 15%. We need to know what Beacons cost of capital is in order to
determine the appropriate discount rate, which will determine whether this is an
acceptable project.
11-18
Solutions Manual
PA113
Req. 1
Project 1:
Annual Net Income = Annual Cash Flow Depreciation
= [$865,000 (($4,850,000 1,000,000) / 8 years)]
=$383,750
= $383,750 / $4,850,000
= 7.91%
Project 2:
= $425,000 / $3,400,000
= 12.50%
Project 3:
= $200,000 / $2,875,000
= 6.96% (rounded)
Based on the accounting rates of return, Project 2 is the best. Project 1 is the second
best, while Project 3 gives the lowest accounting rate of return.
Req. 2
Project 1:
Payback Period
Project 2:
Payback Period
Project 3:
Payback Period

= $4,850,000 / $865,000

= $3,400,000 / ($425,000 + [($3,400,000 / 5)]
= $3,400,000 / $1,105,000

= $2,875,000 / ($200,000 + [($2,875,000 - $125,000) / 10]
= $2,875,000 / $475,000
= 6.05 years rounded
Based on payback period, Project 2 is preferred, Project 1 is the second preference,

while Project 3 has the longest payback period.
11-19
PA113 (Continued)
Req. 3
Project 1
Year
0
1-8
8
NPV
Annual Cash Flow

$(4,850,000)
865,000
1,000,000
PV Factor
(10%)
1.0000
5.3349
0.4665
Present
Value
$ (4,850,000.00)
4,614,688.50
466,500.00
$ 231,188.50
PV Factor
(10%)
1.0000
3.7908
Present
Value
$(3,400,000.00)
4,188,834.00
0.00
$ 788,834.00
PV Factor
(10%)
1.0000
6.1446
0.3855
Present
Value
$(2,875,000.00)
2,918,685.00
48,187.50
$ 91,872.50
Project 2
Year
Annual Cash Flow
0
$(3,400,000)
1-5
1,105,000*
5
0
NPV
*($425,000 + [($3,400,000 / 5)
Project 3
Year
Annual Cash Flow
0
$(2,875,000)
1-10
475,000*
10
125,000
NPV
*($200,000 + [($2,875,000 - $125,000) / 10]
Req. 4
PI for Project 1
= $5,081,188.50 / $4,850,000
= 1.0477 (rounded)
PI for Project 2
= $4,188,834 / $3,400,000
= 1.2320 (rounded)
PI for Project 3
= $2,966,872.50 / $2,875,000
= 1.0320 (rounded)
The projects should be prioritized as follows:

Project 2 ranks highest with a profitability index of 1.2320.
Project 1 ranks second highest with a profitability index of 1.0477.
Project 3 ranks last with a profitability index of 1.0320.
11-20
Solutions Manual
PA114
Req. 1
= $4,200 / $110,000
= 3.82% (rounded)
Req. 2
Payback Period

= $110,000 / ($4,200 + [($110,000 - $10,000) / 10]
= $110,000 / $14,200
= 7.75 years
Req. 3
Year
Annual Cash Flow
0
$(110,000)
1-10
14,200*
10
10,000
NPV
* $4,200 + [($110,000 - $10,000) / 10]
PV Factor
(10%)
6.1446
0.3855
Present
Value
$(110,000)
87,253
3,855
$( 18,892)
PV Factor
(6%)
7.3601
0.5584
Present
Value
$(110,000)
104,513
5,584
$
97
Req. 4
Year
Annual Cash Flow
0
($110,000)
1-10
14,200*
10
10,000
NPV
* $4,200 + [($110,000 - $10,000) / 10]
Req. 5
The internal rate of return for this project must be between 6% and 10% since the NPV
is negative at 10% and positive at 6%. Based on the absolute dollar value of the NPV, it
should be very close to 6%. The IRR using Excel (not required) is 6.02%.
11-21
PA115
Req. 1
Option 1:
$1,000,000
$1,000,000
$903,265
$82,000 6.7101**
$550,228
$95,000 (9.8181 - 6.7101)***
295,260
Option 2:
$92,000 9.8181*
Option 3:
* 9.8181 is the PV of $1 Annuity for 20 years
$845,488
**6.7101 is the PV of $1 Annuity for 10 years.

*** (9.8181 6.7101) is the PV of $1 Annuity for years 11-20.
Req. 2
Option 1 is the best because it gives you the highest return. The time value of money
makes a dollar received today worth more than a dollar received one year from now;
therefore, option one is the best because you receive the greatest value.
11-22
Solutions Manual
GROUP B PROBLEMS
PB111
Req. 1
= $20,000 / $200,000
= 10.00%
Req. 2
Payback period

= $200,000 / ($20,000 + [($200,000 - $12,000) / 5]
= $200,000 / $57,600
Req. 3
Year
Annual Cash Flow
0
$(200,000)
1-5
57,600*
5
12,000
NPV
* $20,000 + [($200,000 - $12,000) / 5]
PV Factor
(9%)
3.8897
0.6499
Present
Value
$(200,000)
224,047
7,799
$ 31,846
PV Factor
(15%)
3.3522
0.4972
Present
Value
$(200,000)
193,087
5,966
$( 947)
Req. 4
Year
Annual Cash Flow
0
$(200,000)
1-5
57,600*
5
12,000
NPV
* $20,000 + [($200,000 - $12,000) / 5]
Req. 5
The internal rate of return for this project must be between 9% and 15% since the NPV
is negative at 15% and positive at 9%. Based on the absolute dollar value of the NPV, it
should be very close to 15%. The IRR using Excel (not required) is 14.80%.
11-23
PB112
Req. 1
Production and Sales Volume
Sales Revenue
Variable Costs:
Direct Materials
Direct Labor
Variable Manufacturing Overhead
Total Variable Manufacturing Costs
Contribution Margin
Fixed Manufacturing Costs
Net Income
Current (No Automation)

60,000 units
Per Unit
Total
$70
$4,200,000
$15
20
7
42
$28
1,680,000
800,000
$ 880,000
Proposed (Automation)
80,000 units
Per Unit
Total
$70
$5,600,000
$15
12
7
34
$36
2,880,000
1,612,500
$1,267,500
Automation would generate a total increase in annual net income of $387,500.

Req. 2
= $387,500 / $5,800,000
= 6.68% (rounded)
Req. 3
Payback Period

= $5,800,000 / [$387,500 + (($5,800,000 - $400,000) / 8)]
= $5,800,000 / $1,062,500
Req. 4
Year
Annual Cash Flow
0
$(5,800,000)
1-8
1,062,500*
8
400,000
NPV
* [$387,500 + (($5,800,000 - $400,000) / 8)]
11-24
PV Factor
(15%)
1.0000
4.4873
0.3269
Present
Value
$ (5,800,000.00)
4,767,756.25
130,760.00
$ ( 901,483.75)
Solutions Manual
PB112 (Continued)
Req. 5
Year
Annual Cash Flow
0
$(5,800,000)
1-8
1,062,500*
8
400,000
NPV
* [$387,500 + (($5,800,000 - $400,000) / 8)]
PV Factor
(10%)
1.0000
5.3349
0.4665
Present
Value
$ (5,800,000.00)
5,668,331.25
186,600.00
$ 54,931.25
Req. 6
Gondola should carefully consider whether it should invest in automation since the NPV
is negative using a 15% discount rate. When using a 10% discount rate, the NPV is
relatively small. It also has a relatively low accounting rate of return and long payback
period. The IRR using Excel (not required) is 10.25%.
11-25
PB113
Req. 1
Project 1:
Annual Net Income = Annual Cash Flow Depreciation
= [$975,000 (($2,700,000 600,000) / 7 years)]
= $675,000
= $675,000 / $2,700,000
= 25%
Project 2:
= $1,650,000 / $8,200,000
= 20.12% (rounded)
Project 3:
= $30,000 / $250,000
= 12%
Based on the accounting rates of return, Project 1 is the best. Project 2 is the second
best, while Project 3 gives the lowest accounting rate of return.
Req. 2
Project 1:
Payback Period
Project 2:
Payback Period
Project 3:
Payback Period

= $2,700,000 / $975,000

= $8,200,000 / ($1,650,000 + ($8,200,000 / 10))
= $8,200,000 / $2,470,000

= $250,000 / ($30,000 + ($250,000 - $25,000) / 10))
= $250,000 / $52,500
Based on payback period, Project 1 is preferred, Project 2 is the second preference,

while Project 3 has the longest payback period.
11-26
Solutions Manual
PB113 (Continued)
Req. 3
Project 1
Year
0
1-7
7
NPV
Annual Cash Flow

$(2,700,000)
975,000
600,000
PV Factor
(10%)
1.0000
4.8684
0.5132
Present
Value
$ (2,700,000.00)
4,746,690.00
307,920.00
$2,354,610.00
PV Factor
(10%)
1.0000
6.1446
0.3855
Present
Value
$(8,200,000.00)
15,177,162.00
0.00
$ 6,977,162.00
PV Factor
(10%)
1.0000
6.1446
0.3855
Present
Value
$ (250,000.00)
322,591.50
9,637.50
$
82,229.00
Project 2
Year
Annual Cash Flow
0
$(8,200,000)
1-10
2,470,000*
10
0
NPV
*[$1,650,000 + ($8,200,000 / 10)]
Project 3
Year
Annual Cash Flow
0
$(250,000)
1-10
52,500*
10
25,000
NPV
*($30,000 + [($250,000 - $25,000) / 10
Req. 4
PI for Project 1 = $5,054,610 / $2,700,000
= 1.8721 (rounded)
PI for Project 2 = $15,177,162 / $8,200,000
= 1.8509 (rounded)
PI for Project 3 = $332,229 / $250,000
= 1.3289 (rounded)
The projects should be prioritized as follows:
Project 1 ranks highest with a profitability index of 1.8721.
Project 2 ranks second highest with a profitability index of 1.8509.
Project 3 ranks last with the lowest profitability index of 1.3289.
11-27
PB114
Req. 1
= $66,000 / $860,000
= 7.67% (rounded)
Req. 2
Payback Period

= $860,000 / ($66,000 + [($860,000 - $20,000) / 6]
= $860,000 / $206,000
Req. 3
Year
Annual Cash Flow
0
$(860,000)
1-6
206,000*
6
20,000
NPV
* $66,000 + [($860,000 - $20,000) / 6]
PV Factor
(11%)
4.2305
0.5346
Present
Value
$(860,000)
871,483
10,692
$ 22,175
PV Factor
(12%)
4.1114
0.5066
Present
Value
$(860,000)
846,948
10,132
$( 2,920)
Req. 4
Year
Annual Cash Flow
0
$(860,000)
1-6
206,000*
6
20,000
NPV
* $66,000 + [($860,000 - $20,000) / 6]
Req. 5
The internal rate of return for this project must be between 11% and 12% because the
NPV is positive using an 11% discount rate and slightly negative using a 12% discount
rate. The IRR using Excel (not required) is 11.88%.
11-28
Solutions Manual
PB115
Req. 1
Option 1:
$100,000
Present Values
=
$100,000.00
$ 98,181.00
$7,000 6.7101
$ 46,970.70
+ $10,000 6.7101 0.4632
31,081.18
Total
$ 78,051.88
Option 2:
$10,000 9.8181
Option 3:
Req. 2
Option 1 is the best because it gives the highest return. The time value of money
makes a dollar received today worth more than a dollar received one year from
now; therefore, Option 1 is the best because it yields the greatest present value.
11-29
ANSWERS TO SKILLS DEVELOPMENT CASES

S 111
The solution to this problem may vary slightly over time and depending on the
assumptions the student makes about the rate of increase in future salary. The
following table shows the comparison of Arizona State and Harvard that were obtained
in July of 2008. The numbers may change as Forbes updates the website with more
recent information.
Req. 1
The expected five-year gain from an MBA at Arizona State is $77,149, which is slightly
higher than at BYU. The primary difference is the lower cost of in-state tuition at ASU
vs. BYU. However, the expected growth rate in salary was lower at ASU than BYU.
Forbes provides a default value for these numbers based on the median increase
salary changes reported in survey data. Students are allowed to modify these
numbers if they want.
11-30
Solutions Manual
S 111 (Continued)
Req. 2
The expected five-year gain from an MBA at Harvard is substantially higher than at
BYU, in spite of a much higher tuition rate. Part of the difference is the higher postMBA salary. The bigger effect comes from the anticipated growth in the post-MBA
salary, which is 11.4% at Harvard versus only 6.2% at BYU. Interestingly the payback
period at Harvard and BYU is similar because most of the salary benefit comes after
the payback period is over.
Req. 3
Out of pocket costs include the tuition and fees. Opportunity costs include the salary
values and the time value of money.
Req. 4
The time value of money calculations will penalize the Harvard option more than the
ASU option. The reason is that Harvard requires greater up-front costs. While the
salary benefits are greater from an MBA at Harvard, these benefits happen further
down the road, and thus are worth less in todays dollars.
Req. 5
The $45,000 pre-MBA salary is not relevant to the decision about which MBA program
to attend, because it will be the same under any of the alternatives. Once Greg has
decided to get an MBA, his current salary is not relevant to the decision about which
school to choose.
Req. 6
If Greg was deciding whether to keep his job or get an MBA, his current salary would
be relevant to that decision, because it is an opportunity cost associated with getting an
MBA. He must give up his current salary in order to go to school.
11-31

Solutions Chapter 11

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Solutions Chapter 11

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Chapter 11 Capital Budgeting

I =5%, n = 4 I = 10%, n = 7 I =14%, n = 10

Authors' Recommended Solution Time

Managerial Accounting, 2/e

1. Time value of money

= Initial Investment / Annual Net Cash Flow

= Initial Investment / Annual Net Cash Flow

Annual Cash Flow

Annual Cash Flow

Managerial Accounting, 2/e

It is much better to save $15,000 for 20 years.

Discount factor, Present value*

PV of future cash flows

Discount factor, Present value*

Managerial Accounting, 2/e

= Annual Net Income / Initial Investment

= Annual Net Income / Initial Investment

Managerial Accounting, 2/e

= Initial Investment / Annual Net Cash Flow

Net present value

Internal rate of return

Cash Flow PV of $1 (10%) Present Value

Managerial Accounting, 2/e

Managerial Accounting, 2/e

Annual cash Unpaid Investment

Managerial Accounting, 2/e

= Initial Investment / Annual Net Cash Flow

Current (No Automation)

Automation would generate a total increase in net income of $980,000.

= Initial Investment / Annual Net Cash Flow

Managerial Accounting, 2/e

= Initial Investment / Annual Net Cash Flow

= Initial Investment / Annual Net Cash Flow

= Initial Investment / Annual Net Cash Flow

Based on payback period, Project 2 is preferred, Project 1 is the second preference,

Annual Cash Flow

The projects should be prioritized as follows:

= Initial Investment / (Net Income + Depreciation)

Managerial Accounting, 2/e

$95,000 (9.8181 - 6.7101)***

* 9.8181 is the PV of $1 Annuity for 20 years

**6.7101 is the PV of $1 Annuity for 10 years.

= Initial Investment / (Net Income + Depreciation)

Managerial Accounting, 2/e

Current (No Automation)

Automation would generate a total increase in annual net income of $387,500.

= Initial Investment / Annual Net Cash Flow

Managerial Accounting, 2/e

= Initial Investment / Annual Net Cash Flow

= Initial Investment / Annual Net Cash Flow

= Initial Investment / Annual Net Cash Flow

Based on payback period, Project 1 is preferred, Project 2 is the second preference,

Annual Cash Flow

= Initial Investment / (Net Income + Depreciation)

+ $10,000 6.7101 0.4632

Managerial Accounting, 2/e

ANSWERS TO SKILLS DEVELOPMENT CASES

Managerial Accounting, 2/e

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