Capital Budgeting
Not what you're looking for?
1) Tom Thurlow wants to buy a boat but is short of cash. Two alternatives are available: Tom can accept $2,000 per year from his brother for partial ownership in the boat, or he can earn money by renting the boat to others. Rental income would be $2,500 per year. Under either alternative, the boat will last eight years. If Tom rents the boat out, he will have to pay $3,000 to overhaul the engine at the end of the fourth year.
Which alternative should Tom select, assuming that the cost of capital is 12% and that only quantitative considerations are involved?
2) Net Present Value Used to Rank Alternatives
Taglioni's Pizza Company has to choose a new delivery car from among three alternatives. Assume that gasoline costs $1.30 per gallon and that the firm's cost of capital is 12%. The car will be driven 12,000 miles per year.
Car 1 Car 2 Car 3
Cost 12,000 4,000 8,000
Mileage per gallon 40 8 12
Useful life 5 yrs 5yrs 5yrs
Salvage value 2,000 500 1,000
Required:
1. Which car should the company purchase?
2. How would your answer change if the price of gasoline increased to $2 per gallon?
Purchase this Solution
Solution Summary
Answers 2 questions on Capital Budgeting.
1) Choosing between the alternatives: accepting $2,000 per year from his brother for partial ownership in the boat and renting the boat out
2) Net Present Value Used to Rank Alternatives: choose a new delivery car from among three alternatives
Solution Preview
Note: For the following answers the abbreviations have the following meanings
PVIF= Present Value Interest Factor
PVIFA= Present Value Interest Factor for an Annuity
They can be read from tables or calculated using the following equations
PVIFA( n, r%)= =[1-1/(1+r%)^n]/r%
PVIF( n, r%)= =1/(1+r%)^n
1) Tom Thurlow wants to buy a boat but is short of cash. Two alternatives are available: Tom can accept $2,000 per year from his brother for partial ownership in the boat, or he can earn money by renting the boat to others. Rental income would be $2,500 per year.N Under either alternative, the boat will last eight years. If Tom rents the boat out, he will have to pay $3,000 to overhaul the engine at the end of the fourth year.
Which alternative should Tom select, assuming that the cost of capital is 12% and that only quantitative considerations are involved?
Alternative 1: Accepting $2,000 per year from brother
Since the cash flows are the same over 8 years we can use PVIFA factor to calculate NPV
PVIFA= Present Value Interest Factor for an Annuity
It can be read from tables or calculated using the following equations
PVIFA( n, r%)= =[1-1/(1+r%)^n]/r%
Annual cash flow= $2,000
n= 8
r= 12.00%
PVIFA (8 periods, 12.% rate ) = 4.96764
Annuity= $2,000
Therefore, present value= 9,935 =2000x4.96764
Alternative 2: Accepting $2,500 per year from rental
Since the cash flows are the same over 8 years we can use PVIFA factor to calculate NPV
PVIFA= Present Value Interest Factor for an Annuity
It can be read from tables or calculated using the following equations
PVIFA( n, r%)= =[1-1/(1+r%)^n]/r%
Annual cash flow= $2,500
We first calculate the Present value of $2,500 to be received each year for 8 years
n= 8
r= 12.00%
PVIFA (8 periods, 12.% rate ) = 4.96764
Annuity= $2,500
Therefore, present value= 12,419 =2500x4.96764
We then subtract the present value (PV) of the cost to be incurred at the end of 4 years
n= 4
r= 12.00%
PVIF (4 periods, 12.% rate ) = 0.635518
Future value= 3,000 to overhaul the engine
Therefore, present value= 1,906.55 =3000x0.635518
Therefore present value of alternative 2= 10,512.45 =12419-1906.55
Since the present value of alternative 2 = 10,512.45 is more than the present value of alternative ...
Purchase this Solution
Free BrainMass Quizzes
Change and Resistance within Organizations
This quiz intended to help students understand change and resistance in organizations
Marketing Research and Forecasting
The following quiz will assess your ability to identify steps in the marketing research process. Understanding this information will provide fundamental knowledge related to marketing research.
Employee Orientation
Test your knowledge of employee orientation with this fun and informative quiz. This quiz is meant for beginner and advanced students as well as professionals already working in the HR field.
MS Word 2010-Tricky Features
These questions are based on features of the previous word versions that were easy to figure out, but now seem more hidden to me.
SWOT
This quiz will test your understanding of the SWOT analysis, including terms, concepts, uses, advantages, and process.