you are the CFO of a company of your choice. Provide an example of a long-term c

Question

you are the CFO of a company of your choice. Provide an example of a long-term capital asset that the business would need to operate and/or grow its business. Following the example on page 162 in ACCT2 for Bud and Rose’s Flower Shop, come up with your own example of a net present value analysis.

To illustrate NPV decisions, let’s discuss Bud and Rose’s Flower Shop, which is considering the purchase of a new refrigerated delivery van that will cost $50,000. Having the van will allow the company to accept large flower orders for weddings, receptions, and so on and is expected to increase cash income from sales (net of increased expenses) by $14,000 per year for six years. The van is not expected to have any salvage value at the end of the six years. Bud and Rose have a minimum required rate of return of 12 percent and use that as their discount rate. If the present value of cash inflows is greater than or equal to the present value of cash outflows (the NPV is greater than or equal to zero), then the investment provides a return at least equal to the discount rate (the minimum required rate of return) and the investment is acceptable. The only cash outflow in this case is the initial purchase price of $50,000. The annual cash inflow of $14,000 can most easily be viewed as an ordinary annuity for purposes of calculating present value. NPV calculations using present-value factors are as follows:

1 Transaction Cash Flow Year Amount 12% Factor Present Value Purchase of refrigerated van Initial investment Now $(50,000) 1.0000 $(50,000.00) Sales of flowers Annual cash income (net of increased expenses) 1–6 14,000 4.1114 57,559.60 Net present value $ 7,559.60

Explanation / Answer

Present value of an annuity of one dollar for 6 years at 12% is 4.111

Therefore, the present value of an annuity of $ 14,000 for 6 years at 12% is 14,000 x 4.111 = $ 57,554.

Present of cash outflows is $ 50,000.

Hence net present value is Present value of cash inflows- present value of cash outflows or $ (57,554- 50,000) =

$ 7,554.

As the NPV is positive, investment in the refrigerated van should be made.

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