Solutions Guide: Please reword the answers to essay type parts so as to guarantee

that your answer is an original. Do not submit as your own.

Chapter 9: Exercises 9-4, 9-7, 9-8, 9-9, 9-11, 9-12, 9-14, 9-16 (pages 347-348)
Problems 9-7, 9-12, 9-17 (pages 351-355)
EXERCISE 9-4. Using Present Value Tables [LO 1] What is the present value of $600 per
year for five years if the required return is 10 percent (answer using Table 2 in Appendix
B).
Cash Present Value
Flow
$600

Factor
3.7908

Total
$2,274.48

EXERCISE 9-7. Calculate Present Value [LO 2] Juanita Martinez is ready to retire and
has a choice of three pension plans. Plan A provides for an immediate cash payment of
$200,000. Plan B provides for the payment of $20,000 per year for 10 years and the
payment of $200,000 at the end of year 10. Plan C will pay $35,000 per year for 10 years.
Juanita Martinez desires a return of 8 percent.Determine the present value of each plan
and select the best one.
Plan A
Total
$200,000
Plan B
Cash
Flow
$ 20,000
200,000

Present Value
Factor
6.7101
.4632

Total
$134,202
92,640
$226,842

Plan C
Cash
Flow
$35,000

Present Value
Factor
6.7101

Total
$234,853.50

Plan C should be selected as it has the highest present value.

EXERCISE 9-8. Calculate Net Present Value [LO 2] An investment that costs $60,000
will return $25,000 per year for five years.Determine the net present value of the

investment if the required rate of return is 14 percent. (Ignore taxes.) Should the
investment be undertaken?
Cash
Present Value
Flow
Factor
Total
($60,000)
1.0000
($60,000.00)
25,000
3.4331
85,827.50
$ 25,827.50
EXERCISE 9-9. Calculate the Internal Rate of Return [LO 3] An investment that costs
$100,000 will reduce operating costs by $20,000 per year for 10 years.Determine the
internal rate of return of the investment (ignore taxes).Should the investment be
undertaken if the required rate of return is 18 percent?
The investment should not be undertaken because the internal rate of return of 15%
is less than the required rate of 18%.
Initial outlay
Annuity amount
Outlay annuity amount = PV of
annuity factor
Internal rate of return

$100,000
20,000
5.00
15%

EXERCISE 9-11. Depreciation Tax Shield [LO 4] Strauss Corporation is making a

$60,000 investment in equipment with a five-year life.The company uses the straight-line
method of depreciation and has a tax rate of 40 percent.The companys required rate of
return is 12 percent. Required What is the present value of the tax savings related to
depreciation of the equipment?
Annual depreciation
$60,000 5 years

$12,000.00

Annual tax savings

$12,000 .40

$4,800.00

Present value of $4,800 per year

for 5 years at 12%
$4,800 3.6048

$17,303.04

EXERCISE 9-12. Cash Flow Implications of Tax Losses [LO 4] WesternGear.com is

expected to have operating losses of $250,000 in its first year of business and $150,000 in
its second year. However, the company expects to have income before taxes of $300,000

in its third year and $450,000 in its fourth year.The companys required rate of return is
12 percent. Required Assume a tax rate of 40 percent and that current losses can be used
to offset taxable income in future years.What is the present value of tax savings related to
the operating losses in years 1 and 2?
Year Income (Loss)
1
2
3
4

($250,000)
(150,000)
300,000
450,000

The $250,000 loss in year 1 will offset income in year 3 resulting in a tax
savings of $100,000 (i.e., $250,000 40% tax rate) in year 3.
With respect to the $150,000 loss in year 2, $50,000 of it can be used to offset
income in year 3 (resulting in a tax savings of $20,000 in year 3) and $100,000
of it can be used to offset income in year 4 (resulting in a tax savings of $40,000
in year 4).
Cash
Flow
$100,000
20,000
40,000

Present Value
Factor
.7118
.7118
.6355

Total
$71,180
14,236
25,420
$110,836

EXERCISE 9-14. Calculate the Payback Period [LO 6] The Sunny Valley Wheat
Cooperative is considering the construction of a new silo. It will cost $75,000 to construct
the silo. Determine the payback period if the expected cash inflows are $15,000 per year.
The payback period is 5 years as follows:
Cost
Cash inflows

$75,000
15,000

Cost Cash inflows = Payback period

5 years

EXERCISE 9-16. IRR and Unequal Cash Flows [LO 3] Newport Department Store is
considering development of an e-commerce business. The company estimates that
development will require an initial outlay of $1,470,000.Other cash flows will be as
follows: Year 1 ($700,000) Year 2 $221,000 Year 3 $750,000 Year 4 $850,000 Year 5
$940,000 Required Assuming the company limits its analysis to five years, estimate the

internal rate of return of the e-commerce business. Should the company develop the ecommerce business if the required rate of return is 12 percent?
As indicated, the NPV is close to zero ($289) at a rate of 7%. Thus, the IRR is
approximately 7%. Given that the required rate of return is 12%, the ecommerce business should not be developed.
PV at Cash
6%

PV
Flow
$(1,470,000)
(700,000)
221,000
750,000
850,000
940,000

Factor
1.0000
0.9434
0.8900
0.8396
0.7921
0.7473

PV at
7%

Cash
Flow
$(1,470,000)
(700,000)
221,000
750,000
850,000
940,000

PV
Factor
1.0000
0.9346
0.8734
0.8163
0.7629
0.7130

Total
$(1,470,000)
(660,380)
196,690
629,700
673,285
702,462
$ 71,757
Total
$(1,470,000)
(654,220)
193,021
612,225
648,465
670,220
$
(289)

PROBLEM 9-7. Net Present Value, Internal Rate of Return, Payback, Accounting Rate of
Return, and Taxes [LO 2, 3, 4, 6] Adrian Sonnetson, the owner of Adrian Motors, is
considering the addition of a paint and body shop to his automobile
dealership.Construction of a building and the purchase of necessary equipment is
estimated to cost $800,000, and both the building and equipment will be depreciated over
10 years using the straight-line method.The building and equipment have zero estimated
residual value at the end of 10 years.Sonnetsons required rate of return for this project is
12 percent.Net income related to each year of the investment is as follows: Revenue
$500,000 Less: Material cost 70,000 Labor 150,000 Depreciation 80,000 Other 10,000
Income before taxes 190,000 Taxes at 40% 76,000 Net income $114,000 Required a.
Determine the net present value of the investment in the paint and body shop. Should
Sonnetson invest in the paint and body shop? b. Calculate the internal rate of return of the
investment (approximate). c. Calculate the payback period of the investment. d. Calculate
the accounting rate of return.
a. The net present value is positive $296,138.80. Thus the company should invest
in the paint and body shop.

Net income
Add depreciation
Annual cash flow

$ 114,000
80,000
$194,000

Cash

Present Value

Flow
$194,000
(800,000)

Factor
5.6502
1.0000

Total
$1,096,138.80
(800,000.00)
$ 296,138.80

b. A present value of an annuity factor of 4.1237 implies an IRR of

approximately 20 percent.
Initial outlay
Annuity amount

$800,000
194,000

Cost annuity = PV of annuity factor

4.1237

Notethe annuity factor for 20% is 4.1925.

c. The payback period is approximately 4.1 years:
Initial outlay
Annual cash flow
Cost annuity = number of years to
recover initial investment

$800,000
194,000
4.1237

d. The accounting rate of return is approximately 29%:

Average income
Average investment
($800,000 2)
Average income average investment =
accounting rate of return

$114,000
400,000
28.5%

PROBLEM 9-12. Comprehensive Capital Budgeting Problem [LO 2,6] Van Doren
Corporation is considering producing a new product,Autodial.Marketing data indicate
that the company will be able to sell 45,000 units per year at $30.The product will be
produced in a section of an existing factory that is currently not in use. To produce
Autodial,Van Doren must buy a machine that costs $500,000.The machine has an
expected life of five years and will have an ending residual value of $15,000. Van Doren

will depreciate the machine over five years using the straight-line method for both tax
and financial reporting purposes. In addition to the cost of the machine, the company will
incur incremental manufacturing costs of $370,000 for component parts, $425,000 for
direct labor, and $200,000 of miscellaneous costs. Also, the company plans to spend
$150,000 annually to advertise Autodial. Van Doren has a tax rate of 40 percent, and the
companys required rate of return is 12 percent. Required a. Compute the net present
value. b. Compute the payback period. c. Compute the accounting rate of return. d.
Should Van Doren make the investment required to produce Autodial? PROBLEM 9-17.
Conflict between Performance Evaluation and Use of NPV [LO 7] Division managers at
Creighton Aerospace are evaluated and rewarded based on ROI (return on investment)
targets. In the current year, Delmar Richards, the president of the commercial products
division, has an ROI target of 12 percent. If the division has an ROI of 12 percent or
greater, Delmar will receive 250,000 options on Creighton stock in addition to a base
salary of $400,000. The commercial products division is considering a major investment
in product development, which has a net present value of $25,000,000.However, the
investment will have a negative effect on reported profit over the next two years, after
which the investment will begin to have a significant positive effect on firm profitability
for the next eight years. Required a. Discuss the potential conflict between the companys
evaluation/compensation system and Delmars focus on the NPV of the investment in
product development. b. Suppose Delmar currently holds stock in Creighton Aerospace
with a market value of $1,250,000 and has options on 500,000 shares (awarded in
previous years). Is this likely to acerbate or mitigate the conflict you discussed in part a?
a. Revenue (45,000 $30)
Less:
Component cost
Direct labor
Depreciation
Miscellaneous
Advertising
Income before taxes
Taxes
Net income
Depreciation
Annual cash flow
Cash
Flow
$161,800
15,000
(500,000)

$1,350,000
370,000
425,000
97,000
200,000
150,000
108,000
43,200
64,800
97,000
$ 161,800
Present Value
Factor
3.6048
.5674
1.0000

b. The payback period is approximately 3.09 years:

Total
$583,256.64
8,511.00
(500,000.00)
$ 91,767.64

Initial outlay
Annual cash flow

$500,000
161,800

Number of years to recover

initial investment

3.09 years

c. The accounting rate of return is 26%:

Average income
Average investment
($500,000 2)
Accounting rate of return

$64,800
$250,000
26%

d. Given the positive NPV, the company should invest in Autodial.