Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 37

Basic Capital-Budgeting Techniques

a. Project A costs $5,000 and will generate annual after-tax net cash inflows of $1,800 for five years. What is the payback period for this investment under the assumption that the cash inflows occur evenly throughout the year?

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b. Project B costs $5,000 and will generate after-tax cash inflows of $500 in year one, $1,200 in year two, $2,000 in year three, $2,500 in year four, and $2,000 in year five. What is the payback period (in years) for this investment assuming that the cash inflows occur evenly throughout the year?

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c. Project C costs $5,000 and will generate net cash inflows of $2,500 before taxes for five years. The firm uses straight-line depreciation with no salvage value and is subject to a 25 percent tax rate. What is the payback period?

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d. Project D costs $5,000 and will generate sales of $4,000 each year for five years. The cash expenditures will be $1,500 per year. The firm uses straight-line depreciation with an estimated salvage value of $500 and has a tax rate of 25 percent.

(1) What is the book rate of return based on the original investment?

(2) What is the book rate of return based on the average book value?

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e. What is the NPV for each of the projects a through d above? Assume that the firm requires a minimum after-tax return of 8 percent on all investments.

Step 1 of 12

Net present value:

NPV creates the differentiation between the value of the cash outflow and cash inflow at a specified discount rate. Net present value is applied in the planning of investment and the budgeting of the capital for examining the profitability of a project. The net present value depends on the rate of discount.