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Capital Budgeting Decisions with uneven cash flows

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Capital budgeting with uneven cash flows, no income taxes.

Southern Cola is considering the purchase of a special-purpose bottling ma chine for $23,000, It is expected to have a useful life of four years with a $0 terminal disposal value. The plant manager estimates the following savings in cash operating costs:

____Year_____Amount

_____1______$10,000
_____2________8,000
_____3________6,000
_____4________5,000

Total_______$29,000

Southern Cola uses a required rate of return of 16% in its capital budgeting decisions. Ignore income taxes in your analysis,

Compute the following:

1. Net present value
2. Payback period
3. Internal rate of return
4. Accrual accounting rate of return based on net initial investment (Assume straight-line depreciation.
Use the average annual savings in cash operating costs when computing the numerator of the accrual accounting rate of return.)

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Solution Summary

The solution calculates Net present value, Payback period, Internal rate of return, Accrual accounting rate of return based on net initial investment.

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Time Value Analysis

Capital Budgeting and Investment Decisions

1. Find the following values for a lump sum assuming annual compounding:
a). The future value of $599 invested at 8 percent for one year.
b). The future value of $500 invested at 8 percent for five years.
c). The present value of $500 to be received in one year when the opportunity cost rate is 8 percent.
d). The present value of $500 to be received in five years when the opportunity cost rate is 8 percent.

2. Find the following values assuming a regularly, or ordinary, annuity:
a). The present value of $400 per year for ten years at 10 percent.
b). The future value of $400 per year for ten years at 10 percent.
c). The present value of $200 per year for five years at 5 percent.
d). The future value of $200 per year for five years at 5 percent.

3. Consider the following uneven cash flow stream:
Year Cash Flow
0 $ 0
1 250
2 400
3 500
4 600
5 600
a). What is the present (Year 0) value if the opportunity cost (discount) rate is 10 percent.
b). Add an outflow (or cost) of $1,000 at Year 0. What is the present value (or net present
value) of the stream?

4. Consider another uneven cash flow stream:
Year Cash Flow
0 $2,000
1 2,000
2 0
3 1,500
4 2,500
5 4,000
a). What is the present (Year 0) value of the cash flow stream if the opportunity cost rate is 10 percent.
b). What is the value of the cash flow stream at the end of Year 5 if the cash flows are invested in an account that pays 10 percent annually?

5. Assume that you just won $35 million in the Florida lottery, and hence the state will pay you 20 annual payments of $1.75 million each beginning immediately. If the rate of return on securities of similar risk to the lottery earnings (e.g., the rate on 20-year U.S. Treasury bonds) is 6 percent. What would happen to the present value of the perpetuity?

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