8 Determining the payback period LO 16-4 Bailey Airline Company is considering e
ID: 2420610 • Letter: 8
Question
8 Determining the payback period LO 16-4
Bailey Airline Company is considering expanding its territory. The company has the opportunity to purchase one of two different used airplanes. The first airplane is expected to cost $13,800,000; it will enable the company to increase its annual cash inflow by $6,000,000 per year. The plane is expected to have a useful life of five years and no salvage value. The second plane costs $29,700,000; it will enable the company to increase annual cash flow by $9,900,000 per year. This plane has an eight-year useful life and a zero salvage value.
Determine the payback period for each investment alternative. (Round your answers to 1 decimal place.)
PAYBACK PERIOD
ALTERNATIVE 1 ( ) YEARS
ALTERNATIVE 2 ( ) YEARS
ALTERNATIVE 1 OR ALTERNATIVE 2
7 Determining the internal rate of return LO 16-3
Merton Manufacturing Company has an opportunity to purchase some technologically advanced equipment that will reduce the company’s cash outflow for operating expenses by $1,290,000 per year. The cost of the equipment is $6,408,255.60. Merton expects it to have a 8-year useful life and a zero salvage value. The company has established an investment opportunity hurdle rate of 15 percent and uses the straight-line method for depreciation. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)
INTERNAL RATE OF RETURN ( )%
Indicate whether the investment opportunity should be accepted.
ACCEPTED ( ) OR REJECTED ( )
6 Determining the cash flow annuity with income tax considerations LO 16-2
To open a new store, Linton Tire Company plans to invest $342,000 in equipment expected to have a six -year useful life and no salvage value. Linton expects the new store to generate annual cash revenues of $323,000 and to incur annual cash operating expenses of $187,000. Linton’s average income tax rate is 30 percent. The company uses straight-line depreciation.
Determine the expected annual net cash inflow / outflow for each of the first four years after Linton opens the new store. (Negative amounts should be indicated by a minus sign.)
NET CASH INFLOW/OUTFLOW
YEAR 1 ____________ ________________
YEAR 2 ____________ ________________
YEAR 3 ____________ ________________
YEAR 4 ____________ ________________
5 Using the present value index LO 16-2
Drinkwater Company has a choice of two investment alternatives. The present value of cash inflows and outflows for the first alternative is $92,000 and $86,000, respectively. The present value of cash inflows and outflows for the second alternative is $211,000 and $204,700, respectively.
Calculate the net present value of each investment opportunity.
NET PRESENT VALUE
ALTERNATIVE 1 __________________
ALTERNATIVE 2 __________________
Calculate the present value index for each investment opportunity. (Round your answers to 2 decimal places.)
PRESENT VALUE INDEX
ALTERNATIVE 1 _____________
ALTERNATIVE 2 _____________
Bailey Airline Company is considering expanding its territory. The company has the opportunity to purchase one of two different used airplanes. The first airplane is expected to cost $13,800,000; it will enable the company to increase its annual cash inflow by $6,000,000 per year. The plane is expected to have a useful life of five years and no salvage value. The second plane costs $29,700,000; it will enable the company to increase annual cash flow by $9,900,000 per year. This plane has an eight-year useful life and a zero salvage value.
Required a-1.Determine the payback period for each investment alternative. (Round your answers to 1 decimal place.)
PAYBACK PERIOD
ALTERNATIVE 1 ( ) YEARS
ALTERNATIVE 2 ( ) YEARS
a-2. Identify the alternative Bailey should accept if the decision is based on the payback approach.ALTERNATIVE 1 OR ALTERNATIVE 2
7 Determining the internal rate of return LO 16-3
Merton Manufacturing Company has an opportunity to purchase some technologically advanced equipment that will reduce the company’s cash outflow for operating expenses by $1,290,000 per year. The cost of the equipment is $6,408,255.60. Merton expects it to have a 8-year useful life and a zero salvage value. The company has established an investment opportunity hurdle rate of 15 percent and uses the straight-line method for depreciation. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)
Required a. Calculate the internal rate of return of the investment opportunity.INTERNAL RATE OF RETURN ( )%
b.5Indicate whether the investment opportunity should be accepted.
ACCEPTED ( ) OR REJECTED ( )
6 Determining the cash flow annuity with income tax considerations LO 16-2
To open a new store, Linton Tire Company plans to invest $342,000 in equipment expected to have a six -year useful life and no salvage value. Linton expects the new store to generate annual cash revenues of $323,000 and to incur annual cash operating expenses of $187,000. Linton’s average income tax rate is 30 percent. The company uses straight-line depreciation.
RequiredDetermine the expected annual net cash inflow / outflow for each of the first four years after Linton opens the new store. (Negative amounts should be indicated by a minus sign.)
NET CASH INFLOW/OUTFLOW
YEAR 1 ____________ ________________
YEAR 2 ____________ ________________
YEAR 3 ____________ ________________
YEAR 4 ____________ ________________
5 Using the present value index LO 16-2
Drinkwater Company has a choice of two investment alternatives. The present value of cash inflows and outflows for the first alternative is $92,000 and $86,000, respectively. The present value of cash inflows and outflows for the second alternative is $211,000 and $204,700, respectively.
Required a.Calculate the net present value of each investment opportunity.
NET PRESENT VALUE
ALTERNATIVE 1 __________________
ALTERNATIVE 2 __________________
b.Calculate the present value index for each investment opportunity. (Round your answers to 2 decimal places.)
PRESENT VALUE INDEX
ALTERNATIVE 1 _____________
ALTERNATIVE 2 _____________
Explanation / Answer
1. A
Alternative 1:-
Year
Airplane 1
Tax saving on depreciation
Total cashflow
Cumulative Inflow
0
-13800000
-13800000
1
6000000
828000
6828000
6828000
2
6000000
828000
6828000
13656000
3
6000000
828000
6828000
20484000
4
6000000
828000
6828000
27312000
5
6000000
828000
6828000
34140000
Payback period = 2+((1/(20484000-13656000))*(13800000-12656000))
= 2.17 years
*Tax saving on depreciation =((13800000)/5)*30%
* Assuming tax rate is 30%
Alternative 2
Year
Airplane 2
Tax saving on depreciation
Total cashflow
Cumulative Inflow
0
-29700000
0
-29700000
1
9900000
1782000
11682000
11682000
2
9900000
1782000
11682000
23364000
3
9900000
1782000
11682000
35046000
4
9900000
1782000
11682000
46728000
5
9900000
1782000
11682000
58410000
payback period = 2+((1/(35046000-23364000))*(29700000-23364000))
= 2.54 years
*Tax saving on depreciation =((29700000)/5)*30%
* Assuming tax rate is 30%
a.2 Alternative 1 should be accepted since payback period is lesser than alternative 2
Answer 6
Tax saving on depreciation = =(342000/6)*30%
Annual inflow (323000-187000)=136000
5.a
Year
Airplane 1
Tax saving on depreciation
Total cashflow
Cumulative Inflow
0
-13800000
-13800000
1
6000000
828000
6828000
6828000
2
6000000
828000
6828000
13656000
3
6000000
828000
6828000
20484000
4
6000000
828000
6828000
27312000
5
6000000
828000
6828000
34140000
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