DVU Capital Budgeting Analysis Questions

1.

Windhoek

Mines,

Limited,

of

Namibia,

is

contemplating

the

purchase of equipment to exploit a mineral deposit on land to which the company has mineral rights. An engineering and cost analysis has been made, and it is expected that the following cash flows would be associated with opening and operating a mine in the area:

Cost of new equipment and timbers

Working capital required

Annual net cash receipts

Cost to construct new roads in three years

Salvage value of equipment in four years

$ 430,000

$ 215,000

$ 150,000*

$ 63,000

$ 88,000

*Receipts from sales of ore, less out-of-pocket costs for salaries, utilities, insurance, and so forth.

The mineral deposit would be exhausted after four years of mining. At that point, the working capital would be released for reinvestment elsewhere. The company’s required rate of return is 18%.

Click here to view

Exhibit 14B-1

and

Exhibit 14B-2

, to determine the appropriate discount factor(s) using tables.

Required:

a. What is the net present value of the proposed mining project?

b. Should the project be accepted?

2. Casey Nelson is a divisional manager for Pigeon Company. His annual pay raises are largely determined by his division’s return on investment (ROI), which has been above 24% each of the last three years. Casey is considering a capital budgeting project that would require a $4,800,000 investment in equipment with a useful life of five years and no salvage value. Pigeon Company’s discount rate is 20%. The project would provide net operating income each year for five years as follows:

Sales

Variable expenses

Contribution margin

Fixed expenses:Advertising, salaries, and other fixed out-of-pocket costs

Depreciation

Total fixed expenses

Net operating income

$ 4,500,000

2,040,000

2,460,000

$ 810,000

960,000

1,770,000

$ 690,000

Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using tables.Required:

1. What is the project’s net present value?

2. What is the project’s internal rate of return to the nearest whole percent?

3. What is the project’s simple rate of return?

4-a. Would the company want Casey to pursue this investment opportunity?

4-b. Would Casey be inclined to pursue this investment opportunity?

3. Paul Swanson has an opportunity to acquire a franchise from The Yogurt Place, Incorporated, to dispense frozen yogurt products under The Yogurt Place name. Mr. Swanson has assembled the following information relating to the franchise:

1. A suitable location in a large shopping mall can be rented for $5,000 per month.
2. Remodeling and necessary equipment would cost $408,000. The equipment would have a 20-year life and a $20,400 salvage value. Straight-line depreciation would be used, and the salvage value would be considered in computing depreciation.
3. Based on similar outlets elsewhere, Mr. Swanson estimates that sales would total $530,000 per year. Ingredients would cost 20% of sales.
4. Operating costs would include $93,000 per year for salaries, $5,800 per year for insurance, and $50,000 per year for utilities. In addition, Mr. Swanson would have to pay a commission to The Yogurt Place, Incorporated, of 15.5% of sales.

Required:

1. Prepare a contribution format income statement that shows the expected net operating income each year from the franchise outlet.

2-a. Compute the simple rate of return promised by the outlet.

2-b. If Mr. Swanson requires a simple rate of return of at least 18%, should he acquire the franchise?

3-a. Compute the payback period on the outlet.

3-b. If Mr. Swanson wants a payback of two years or less, will he acquire the franchise?