On January 2, 20X7, Brian Rein invested $10,000 in the stock market and purchased 500 shares of

Week Five Assignment

  

1. Basic present value calculations

   

Calculate the present value of the following cash flows, rounding to the nearest dollar:

   

a.      

A single cash inflow of $12,000 in five years, discounted at an 11% rate of return.

   

b.      An annual receipt of $16,000 over the next 12 years, discounted at an 11% rate of return.

   

c.       A single receipt of $15,000 at the end of Year 1 followed by a single receipt of $10,000 at the end of Year 3. The company has a 12% rate of return.

   

d.      An annual receipt of $8,000 for three years followed by a single receipt of $10,000 at the end of Year 4. The company has an 11% rate of return.

     

2. Cash flow calculationsand net present value

   

On January 2, 20X7, Brian Rein invested $10,000 in the stock market and purchased 500 shares of Heartland Development, Inc. Heartland paid cash dividends of $2.70 per share in 20X7 and 20X8; the dividend was raised to $3.30 per share in 20X9. On December 31, 20X9, Rein sold his holdings and generated proceeds of $13,100. Rein uses the net-present- value method and desires a 16% return on investments.

   

a.       Prepare a chronological list of the investment’s cash flows. Note: Rein is entitled to the 20X9 dividend.

   

b.      Compute the investment’s net present value, rounding calculations to the nearest dollar.

   

c.       Given the results of part (b), should Rein have acquired the Heartland stock? Briefly explain.

     

3. Net present value

   

The City of Brighton is studying a 550-acre site on Route 401 for a new landfill. The startup cost has been calculated as follows:

   

Purchase cost: $400 per acre

   

Site preparation: $180,000

     

The site can be used for 20 years before it reaches capacity. Brighton, which shares a facility in Bath Township with other municipalities, estimates that the new location will save $40,000 in annual operating costs.

   

a.       Should the landfill be acquired if Brighton desires an 8% return on its investment? Use the net-present-value method to determine your answer.

      

4. Net-present-value

   

ABC Entertainment is considering the acquisition of a sight-seeing boat for summer tours along the Mississippi River. The following information is available:

   

Cost of boat	$550,000
Service life	10 summer seasons
Disposal value at the end of 10 seasons	$100,000
Capacity per trip	260 passengers
Fixed operating costs per season (including straight-line depreciation)	$160,000
Variable operating costs per trip	$1,000
Ticket price	$6 per passenger

      

All operating costs, except depreciation, require cash outlays. On the basis of similar operations in other parts of the country, management anticipates that each trip will be sold out and that 130,000 passengers will be carried each season. Ignore income taxes.

     

Instructions:

   

By using the net-present-value method, determine whether ABC Entertainment should acquire the boat. Assume a 14% desired return on all investments,- round calculations to the nearest dollar.

       

5. Equipment replacement decision

   

Richardson Enterprises is studying the replacement of some equipment that originally cost $74,000. The equipment is expected to provide six more years of service if $8,500 of major repairs are performed in two years. Annual cash operating costs total $28,000. Richardson  can sell the equipment now for $37,000; the estimated residual value in six years is $5,000.

   

New equipment is available that will reduce annual cash operating costs to $21,000. The equipment costs $105,000, has a service life of six years, and has an estimated residual value of $13,000. Company sales will total $430,000 per year with either the existing or the new equipment. Richardson has a minimum desired return of 12% and depreciates all equipment by the straight-line method.

     Instructions:    

a.       By using the net-present-value method, determine whether Richardson should keep its present equipment or acquire the new equipment. Round all calculations to the nearest dollar, and ignore income taxes.

   

b.      Richardson’s management feels that the time value of money should be considered in all long-term decisions. Briefly discuss the rationale that underlies management’s belief.