Chapter 11 Capital Budgeting: Answers To Questions

Chapter 11 Capital Budgeting
ANSWERS TO QUESTIONS
1. Screening decisions require managers to determine whether a proposed capital

investment meets a minimum criteria or threshold set by the company. Preference
decisions require a choice among several alternatives.
2. Independent projects are unrelated to one another, so that investing in one project
does not preclude or affect the choice about investing in the other alternatives.
Mutually exclusive projects involve a choice among competing alternatives, where
selection of one project implies rejection of all the other alternatives.
3. The time value of money refers to the fact that a $1 today is worth more than a $1 in
the future. The dollar you receive today can be invested. So long as the investment
earns a positive return, you will have more than $1 in the future
4. Non-discounting methods do not incorporate the time value of money, while

discounting methods do incorporate the time value of money. Discounting methods
are considered superior because they recognize that a $1 today is worth more than
a $1 in the future.
5. A hurdle rate is the minimum return that a project must generate in order to be
considered an acceptable investment. Projects that do not meet or exceed a
company’s hurdle rate are not acceptable and should be rejected.
6. Net income includes non-cash expenses such as depreciation. This distinction is

important because some methods use net income while others utilize cash flow.
7. The payback period is the amount of time it will take for a project to “pay for itself” or
pay back its original investment.
8. A positive NPV indicates that the present value of a project’s cash inflows is greater
than the present value of the cash outflows. It also indicates that the project has met
its hurdle rate, since the project’s internal rate of return is higher than the hurdle rate.
A negative NPV indicates that the present value of a project’s cash inflows is less
than the present value of the cash outflows. It also indicates that the project has not
met its hurdle rate, since the project’s internal rate of return is less than the hurdle
rate.
9. An annuity factor is used for cash flows that occur evenly across a number of years,
while a PV factor is used for cash flows that occur in a single year.
Managerial Accounting, 2/e 11-1
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10. A positive NPV occurs when a project’s IRR is greater than the company’s hurdle
rate. A negative NPV occurs when a project’s IRR is less than the company’s hurdle
rate. If a project generates a $50,000 NPV using a discount or hurdle rate of 10%,
this indicates that the project’s IRR is greater than 10%.
11. The NPV method is generally preferred over the internal rate of return because the
NPV method assumes that future cash flows will be reinvested at the minimum
required rate of return. In contrast, the IRR method assumes that future cash flows
will be reinvested to earn the same internal rate of return, which is a less realistic
assumption.
12. The profitability index is the ratio of the present value of future cash flows divided by
the initial investment. A profitability index greater than one means that a project has
a positive NPV, since the present value of the future cash flows is greater than the
initial investment.
13. In future value of a single amount problems, you will be asked to calculate how
much money you will have in the future as the result of investing a certain amount in
the present. The present value of a single amount is the worth to you today of
receiving that amount sometime in the future.
14. From Future Value of $1 table where n=10 and i = 10%: factor = 2.5937
$10,000 x 2.5937 = $25,937. Thus, $10,000 invested today at 10% will be $25,937
in 10 years.
15. From Present Value of $1 table where n = 10 and i = 10%; factor = 0.3855
$8,000 x 0.3855 = $3,084. Thus, a contract that pays $8,000 in 10 years is worth
$3,084 today.
16. The PV of annuity table can be used when the cash flows are equal for each year.
The PV of $1 must be used when the cash flows are uneven from year to year.
17.
I =5%, n = 4 I = 10%, n = 7 I =14%, n = 10

FV of $1 1.2155 1.9487 3.7072
PV of $1 0.8227 0.5132 0.2697
FV of annuity of $1 4.3101 9.4872 19.3373
PV of annuity of $1 3.5460 4.8684 5.2161
11-2 Solutions Manual

Authors' Recommended Solution Time
(Time in minutes)
Cases and
Mini-exercises Exercises Problems Projects*
No. Time No. Time No. Time No. Time
1 3 1 5 PA−1 9 1 30
2 4 2 6 PA−2 8
3 3 3 6 PA−3 6
4 3 4 5 PA−4 8
5 4 5 5 PA−5 9
6 4 6 6 PB−1 8
7 3 7 6 PB−2 8
8 4 8 5 PB−3 7
9 4 9 5 PB−4 8
10 4 10 6 PB−5 9
11 3 11 6
12 4 12 6
13 8
* Due to the nature of cases, it is very difficult to estimate the amount of time students
will need to complete them. As with any open-ended project, it is possible for students
to devote a large amount of time to these assignments. While students often benefit
from the extra effort, we find that some become frustrated by the perceived difficulty of
the task. You can reduce student frustration and anxiety by making your expectations
clear, and by offering suggestions (about how to research topics or what companies to
select).

ANSWERS TO MINI-EXERCISES
M11−1
H 1. Time value of money

F 2. Profitability Index
J 3. Payback period
A, K 4. Net present value method
G 5. Future value
I 6. Preference decision
A, C 7. Internal rate of return method
D 8. Screening decision
B, E 9. Accounting rate of return
M11−2
Accounting Rate of Return = Annual Net Income / Initial Investment
= ($390,000 / 3) / $920,000
= $130,000 / $920,000
= 14.13% (rounded)
M11−3
Payback Period = Initial Investment / Annual Net Cash Flow

= $340,000 / $80,000
= 4.25 years
M11−4

= $25,000 / $250,000
= 10%

= Initial Investment / (Net Income + Depreciation)
= $250,000 / ($25,000 + $40,000)
= 3.85 years

M11−5
Year Annual Cash Flow PV Factor (8%) Present Value

0 $( 150,000) - $(150,000.00)
1-6 $ 32,000 4.6229 147,932.80
NPV $( 2,067.20)
The negative NPV shows that the present value of the future cash inflows for the
project is less than the original investment it requires. A negative NPV suggests the
project is unacceptable.
M11−6
From Excel, the IRR is 0.13% for this project.
Year Cash flow

0 -286500
1 57523
2 57523
3 57523
4 57523
5 57523 0.13%
M11-7
Req. 1
Year Annual Cash Flow PV Factor (11%) Present Value
0 $( 400,000) - $(400,000)
1-10 $ 70,000 5.8892 412,244
NPV $ 12,244
The positive NPV shows that the present value of the future cash inflows for the
project is greater than the original investment it requires. A positive NPV suggests
that a project is acceptable.
Req. 2
The internal rate of return (IRR) on the project must be greater than 11% because the
NPV of the project is positive.

M11-8
Profitability Index = PV of Future Cash Flows / Initial Investment
PI for Project A = $265,000 / $110,000

= 2.4091 (rounded)
PI for Project B = $400,000 / $220,000

= 1.8182 (rounded)
PI for Project C = $115,000 / $112,000

= 1.0268 (rounded)
Project A has the highest profitability index and is the preferred option, Project B would
be the 2nd preference, and Project C is the least preferred.
M11-9
$100,000 = $100,000
+ $50,000  0.9434 = 47,170
+ $ 20,000  11.4699 = 229,398
Total = $376,568
M11-10
$30,000  14.4866 = $434,598
$15,000  45.7620 = $686,430
It is much better to save $15,000 for 20 years.

M 11-11
Tremaine Company should select project XYZ because it has a positive NPV based on
the following analysis:
Project ABC:
Cash flows Discount factor, Present value*
12%, 4 periods
PV of future cash flows $78,000 3.0373 $236,909
Original investment (240,000)
NPV $(3,091)
* Rounded
Project XYZ:
Cash flows Discount factor, Present value*
12%, 5 periods
PV of future cash flows $66,000 3.6048 $237,917
Original investment (230,000)
NPV $7,917
* Rounded
M11-12
Project PI Ranking
A 1.70 2
B 1.55 3
C 1.89 1

ANSWERS TO EXERCISES
E11−1
Req. 1
Accounting rate of return = Annual Net Income / Initial Investment
= $45,000 / $300,000
= 15%
Req. 2
Payback period = Initial Investment / Annual Net Cash Flow
= $300,000 / [$45,000 + (($300,000 - $100,000) / 5 years)]
= 3.53 years
E11−2
Req. 1
Accounting rate of return = Annual Net Income / Initial Investment
= $53,000 / $510,000
= 10.39% (rounded)
Req. 2
Payback period = Initial Investment / Annual Net Cash Flow
= Initial Investment/(Net Income + Depreciation)
= $510,000 / [$53,000 + (($510,000 - $50,000) / 8 years)]
= $510,000 / ($53,000 + $57,500)
= 4.62 years (rounded)

E11−3
Req. 1
PV Factor Present
Year Annual Cash Flow (10%) Value
0 $(1,600,000) - $(1,600,000)
1-8 406,250* 5.3349 2,167,303
8 350,000 0.4665 163,275
NPV $ 730,578
*$250,000 + [($1,600,000 - $350,000) / 8]
The positive NPV shows that the present value of the future cash inflows for the
project is greater than the original investment it requires. A positive NPV suggests
that a project is acceptable.
Req. 2
The internal rate of return must be greater than 10% since the project yields a positive
NPV using a 10% discount rate.
Req. 3
PV Factor Present
0 $(1,600,000) - $(1,600,000)
1-8 406,250* 3.8372 1,558,863
8 350,000 0.2326 81,410
NPV $ 40,273
*$250,000 + [($1,600,000 - $350,000) / 8]
Req. 4
The internal rate of return must be slightly higher than 20% because the NPV is
positive. Optional: If you use Excel to calculate the exact IRR, you will find that the IRR
is 20.79%.

E11−4
Req. 1

= $48,000 / $600,000
= 8%
Req. 2

= $600,000 / ($48,000 + [($600,000 - $100,000) / 8]
= 5.43 years
Req. 3
PV Factor Present
0 $(600,000) - $(600,000)
1-8 110,500* 4.9676 548,920
8 100,000 0.4039 40,390
NPV $ (10,690)
* $48,000 + [($600,000 - $100,000) / 8]
Req. 4
Since the NPV is negative when using a 12% discount rate, the internal rate of return on
the project must be less than 12%. Estimate is around 11%. The actual IRR using
Excel (not required) is 11.52%.
E11−5
Answers are shaded below:
Net present value Cost of capital Internal rate of return

Project 1 <0 13% <13%
Project 2 <0 >10% 10%
Project 3 >0 12% 14%
Project 4 >0 8% >8%
Project 5 <0 9% <9%
Project 6 <0 10% 9%
Explanation:
If the NPV is > 0, the internal rate of return must be > the cost of capital.
If the NPV is < 0, the internal rate of return must be < the cost of capital.

E11−6
Req. 1.
Option 1:
$1,000,000  7.4694 = $7,469,400
Option 2:
$8,000,000 = $8,000,000
Option 3:
$2,000,000 + ($700,000  7.4694) = $7,228,580
Req. 2
Option 2 is the best option because it provides the greatest present value when all
options are discounted at 12%.
E11−7
Req. 1
Purchase Option
Year Cash Flow PV of $1 (10%) Present Value

0 $(26,500) 1.000 $(26,500.00)
1 (500) 0.9091 (454.55)
2 (500) 0.8264 (413.20)
3 (500) 0.7513 (375.65)
4 (500) 0.6830 (341.50)
5 10,500 0.6209 6,519.45
NPV = $(21,565.45)
Lease Option
PV of annuity of $1 (i = 10%, n = 5) = 3.7908
NPV of Lease Option = $3,480 x 3.7908

= $(13,191.98)
Req. 2
Harold should choose to lease the car since leasing has a lower cost (higher NPV).

E11−8
Req. 1
No, Shaylee cannot invest in all of the projects because the company has $2 million
available, but the total investment for all four projects combined is $2,310,000.
Therefore, Shaylee must choose from among the four options.
Req. 2
PI for Project A = $765,000 / $415,000

= 1.8434 (rounded)
PI for Project B = $415,000 / $230,000

= 1.8043 (rounded)
PI for Project C = $1,200,000 / $720,000

= 1.6667 (rounded)
PI for Project D = $1,560,000 / $945,000

= 1.6508 (rounded)
Shaylee’s order of preference based on profitability index is:

Project A
Project B
Project C
Project D
Given its $2 million available, Shaylee can only invest in Projects A, B, and C. These 3
projects will require $1,365,000 of Shaylee’s capital which doesn’t leave enough to
undertake Project D.
E11−9
Req. 1
$8,000 x 2.1589 = $17,271.20
Req. 2
$17,271.20 – $8,000 = $9,271.20 (time value of money, or interest)
Req. 3
2013: $8,000 x 8% = $640 (interest)
2014: ($8,000 + $640) x 8% = $691.20 (interest)
E11-10
Req. 1
FV of annuity of $1 (i = 8%, n = 10): 14.4866
$15,000 x 14.4866 = $217,299 after 10 years
Req. 2
$17,500 x 14.4866 = $253,515.50 after 10 years
Req. 3
FV of annuity of $1 (i = 10%, n = 10): 15.9374
$15,000 x 15.9374 = $239,061 after 10 years
E11-11
Tulsa should select Option A because it has a higher NPV.
Option A:
Cash flows Discount Present value*
factor, 11%
PV of annual cash flows $80,000 5.1461 $411,688
PV of cost to rebuild 120,000 .6587 (79,044)
PV of salvage 0 .4339 0
$332,644
Capital investment (320,000)
NPV $12,644
* Rounded
Option B:
Cash flows Discount Present value*
factor, 11%
PV of annual cash flows $85,000 5.1461 $437,419
PV of cost to rebuild 0 .6587 0
PV of salvage 24,000 .4339 10,414
$447,833
Capital investment (454,000)
NPV $(6,167)
* Rounded

E11-12
Project X Project Y Project Z
Initial investment $40,000 $20,000 $50,000
Annual cash
25,000 10,000 25,400
inflows
PV of cash inflows 45,000 33,000 70,000
Payback 1.60 2.00 1.97

NPV $5,000 $13,000 $20,000
PI 1.13 1.65 1.40
Req. 1
Based on the payback, the investment manager would rank the projects as: X, Z, Y.
Req. 2
Based on the NPV, the investment manager would rank the projects as: Z, Y, X.
Req. 3
Based on the profitability index, the investment manager would rank the projects as:
Y, Z, X.
Req. 4
Since limited investment funds are available, the investment manager should
recommend that the company prioritize the products based on the profitability index:
Y, Z, X.

E11-13
Req. 1 No, Granite Company would not invest in the new machine because, as shown
below, the payback period is about mid-way through the 6th year.
Year Initial Annual cash Unpaid Investment

Investment flow
1 $112,000 $30,000 $82,000
2 82,000 24,000 58,000
3 58,000 20,000 38,000
4 38,000 14,800 23,200
5 23,200 14,800 8,400
6 8,400 14,800 (6,400)
7 NA NA NA
8 NA NA NA
Req. 2 Yes, Granite Company would accept the investment if the NPV method is used
because the project results in a net positive amount of cash when using a 12% return.
Year Cash Flow PV of $1 Present

(12%) Value*
0 $(112,000) --- $(112,000)
1 30,000 0.8929 26,787
2 24,000 0.7972 19,133
3 20,000 0.7118 14,236
4 14,800 0.6355 9,405
5 14,800 0.5674 8,398
6 14,800 0.5066 7,498
7 14,800 0.4523 6,694
8 14,800 0.4039 5,978
Residual 50,000 0.4039 20,195
NPV $ 6,324
*rounded
Req. 3 The machine Granite Company is considering has a large residual value (about
45% of the machine’s price) that the company will receive at the end of 8 years. The
NPV method includes this large cash flow in the calculations, but the payback method
ignores anything that happens after the payback period. Management will want to
exercise caution when considering this machine’s NPV. A small downward change in
the estimated residual value will cause the NPV to become negative. For this reason,
management may want to review its estimates for accuracy.
Req. 4 Since the machine has a positive NPV at 12%, it would have an even larger NPV
if the company’s cost of capital was 10%. This larger NPV could act as a buffer against
any downward revisions in the machine’s estimated cash flows or residual value.

GROUP A PROBLEMS
PA11−1
Req. 1

= $37,800 / $420,000
= 9.0%
Req. 2

= $420,000 / ($37,800 + [($420,000 - $50,000) / 10]
= $420,000 / $74,800
= 5.62 years
Req. 3
PV Factor Present
0 $(420,000) - $(420,000)
1-10 74,800* 5.8892 440,512
10 50,000 0.3522 17,610
NPV $ 38,122
* $37,800 + [($420,000 - $50,000) / 10]
Req. 4
PV Factor Present
0 $(420,000) - $(420,000)
1-10 74,800* 5.0188 375,406
10 50,000 0.2472 12,360
NPV $( 32,234)
* $37,800 + [($420,000 - $50,000) / 10]
Req. 5
The internal rate of return for this project must be between 11% and 15%, since the
NPV is positive at 11% and negative at 15%. The IRR using Excel (not required) is
13.03%.

PA11−2
Req. 1
Current (No Automation) Proposed (Automation)
Production and Sales Volume 80,000 units 120,000 units
Per Unit Total Per Unit Total
Sales Revenue $90 $7,200,000 $90 $10,800,000
Variable Costs:
Direct Materials $18 $18
Direct Labor 25 20
Variable Manufacturing Overhead 10 10
Total Variable Manufacturing Costs 53 48
Contribution Margin $37 2,960,000 $42 5,040,000
Fixed Manufacturing Costs 1,250,000 2,350,000
Net Income $1,710,000 $2,690,000
Automation would generate a total increase in net income of $980,000.
Req. 2

= $980,000 / $15,000,000
= 6.53%
Req. 3

= $15,000,000 / ($980,000 + [($15,000,000 - $500,000) / 10]
= $15,000,000 / $2,430,000
= 6.17 years
Req. 4
PV Factor Present
0 $(15,000,000) 1.0000 $(15,000,000.00)
1-10 2,430,000* 5.0188 12,195,684.00
10 500,000 0.2472 123,600.00
NPV $( 2,680,716.00)
* $980,000 + [($15,000,000 - $500,000) / 10]

PA11−2 (Continued)
Req. 5
PV Factor Present
0 $(15,000,000) - $(15,000,000.00)
1-10 2,430,000* 6.1446 14,931,378.00
10 500,000 0.3855 192,750.00
NPV $ 124,128.00
* $980,000 + [($15,000,000 - $500,000) / 10]
Req. 6 The answer to this question depends on the assumed required rate of return.
The project has a positive NPV using a discount rate of 10%, but a negative NPV using
a discount rate of 15%. We need to know what Beacon’s cost of capital is in order to
determine the appropriate discount rate, which will determine whether this is an
acceptable project.

PA11−3
Req. 1
Project 1:
Annual Net Income = Annual Cash Flow – Depreciation

= [$865,000 – (($4,850,000 – 1,000,000) / 8 years)]
=$383,750

= $383,750 / $4,850,000
= 7.91%
Project 2:
= $425,000 / $3,400,000
= 12.50%
Project 3:
= $200,000 / $2,875,000
= 6.96% (rounded)
Based on the accounting rates of return, Project 2 is the best. Project 1 is the second
best, while Project 3 gives the lowest accounting rate of return.
Req. 2
Project 1:
= $4,850,000 / $865,000
Project 2:
= $3,400,000 / ($425,000 + [($3,400,000 / 5)]
= $3,400,000 / $1,105,000
Project 3:
= $2,875,000 / ($200,000 + [($2,875,000 - $125,000) / 10]
= $2,875,000 / $475,000
= 6.05 years rounded
Based on payback period, Project 2 is preferred, Project 1 is the second preference,

while Project 3 has the longest payback period.
PA11−3 (Continued)
Req. 3
Project 1
PV Factor Present
0 $(4,850,000) 1.0000 $ (4,850,000.00)
1-8 865,000 5.3349 4,614,688.50
8 1,000,000 0.4665 466,500.00
NPV $ 231,188.50
Project 2
PV Factor Present
0 $(3,400,000) 1.0000 $(3,400,000.00)
1-5 1,105,000* 3.7908 4,188,834.00
5 0 0.00
NPV $ 788,834.00
*($425,000 + [($3,400,000 / 5)
Project 3
PV Factor Present
0 $(2,875,000) 1.0000 $(2,875,000.00)
1-10 475,000* 6.1446 2,918,685.00
10 125,000 0.3855 48,187.50
NPV $ 91,872.50
*($200,000 + [($2,875,000 - $125,000) / 10]
Req. 4
PI for Project 1 = $5,081,188.50 / $4,850,000

= 1.0477 (rounded)
PI for Project 2 = $4,188,834 / $3,400,000

= 1.2320 (rounded)
PI for Project 3 = $2,966,872.50 / $2,875,000

= 1.0320 (rounded)
The projects should be prioritized as follows:
Project 2 ranks highest with a profitability index of 1.2320.

Project 1 ranks second highest with a profitability index of 1.0477.
Project 3 ranks last with a profitability index of 1.0320.

PA11−4
Req. 1

= $4,200 / $110,000
= 3.82% (rounded)
Req. 2
Payback Period = Initial Investment / (Net Income + Depreciation)

= $110,000 / ($4,200 + [($110,000 - $10,000) / 10]
= $110,000 / $14,200
= 7.75 years
Req. 3
PV Factor Present
0 $(110,000) - $(110,000)
1-10 14,200* 6.1446 87,253
10 10,000 0.3855 3,855
NPV $( 18,892)
* $4,200 + [($110,000 - $10,000) / 10]
Req. 4
PV Factor Present
0 ($110,000) - $(110,000)
1-10 14,200* 7.3601 104,513
10 10,000 0.5584 5,584
NPV $ 97
* $4,200 + [($110,000 - $10,000) / 10]
Req. 5
The internal rate of return for this project must be between 6% and 10% since the NPV
is negative at 10% and positive at 6%. Based on the absolute dollar value of the NPV, it
should be very close to 6%. The IRR using Excel (not required) is 6.02%.

PA11−5
Req. 1
Option 1:
$1,000,000 = $1,000,000
Option 2:
$92,000  9.8181* = $903,265
Option 3:
$82,000  6.7101** = $550,228
$95,000  (9.8181 - 6.7101)*** = 295,260
* 9.8181 is the PV of $1 Annuity for 20 years $845,488

**6.7101 is the PV of $1 Annuity for 10 years.
*** (9.8181 – 6.7101) is the PV of $1 Annuity for years 11-20.
Req. 2
Option 1 is the best because it gives you the highest return. The time value of money
makes a dollar received today worth more than a dollar received one year from now;
therefore, option one is the best because you receive the greatest value.

GROUP B PROBLEMS
PB11−1
Req. 1

= $20,000 / $200,000
= 10.00%
Req. 2
Payback period = Initial Investment / (Net Income + Depreciation)

= $200,000 / ($20,000 + [($200,000 - $12,000) / 5]
= $200,000 / $57,600
Req. 3
PV Factor Present
0 $(200,000) - $(200,000)
1-5 57,600* 3.8897 224,047
5 12,000 0.6499 7,799
NPV $ 31,846
* $20,000 + [($200,000 - $12,000) / 5]
Req. 4
PV Factor Present
0 $(200,000) - $(200,000)
1-5 57,600* 3.3522 193,087
5 12,000 0.4972 5,966
NPV $( 947)
* $20,000 + [($200,000 - $12,000) / 5]
Req. 5
The internal rate of return for this project must be between 9% and 15% since the NPV
is negative at 15% and positive at 9%. Based on the absolute dollar value of the NPV, it
should be very close to 15%. The IRR using Excel (not required) is 14.80%.

PB11−2
Req. 1
Current (No Automation) Proposed (Automation)
Production and Sales Volume 60,000 units 80,000 units
Per Unit Total Per Unit Total
Sales Revenue $70 $4,200,000 $70 $5,600,000
Variable Costs:
Direct Materials $15 $15
Direct Labor 20 12
Variable Manufacturing Overhead 7 7
Total Variable Manufacturing Costs 42 34
Contribution Margin $28 1,680,000 $36 2,880,000
Fixed Manufacturing Costs 800,000 1,612,500
Net Income $ 880,000 $1,267,500
Automation would generate a total increase in annual net income of $387,500.
Req. 2

= $387,500 / $5,800,000
= 6.68% (rounded)
Req. 3

= $5,800,000 / [$387,500 + (($5,800,000 - $400,000) / 8)]
= $5,800,000 / $1,062,500
Req. 4
PV Factor Present
0 $(5,800,000) 1.0000 $ (5,800,000.00)
1-8 1,062,500* 4.4873 4,767,756.25
8 400,000 0.3269 130,760.00
NPV $ ( 901,483.75)
* [$387,500 + (($5,800,000 - $400,000) / 8)]

PB11−2 (Continued)
Req. 5
PV Factor Present
0 $(5,800,000) 1.0000 $ (5,800,000.00)
1-8 1,062,500* 5.3349 5,668,331.25
8 400,000 0.4665 186,600.00
NPV $ 54,931.25
* [$387,500 + (($5,800,000 - $400,000) / 8)]
Req. 6
Gondola should carefully consider whether it should invest in automation since the NPV
is negative using a 15% discount rate. When using a 10% discount rate, the NPV is
relatively small. It also has a relatively low accounting rate of return and long payback
period. The IRR using Excel (not required) is 10.25%.

PB11−3
Req. 1
Project 1:
Annual Net Income = Annual Cash Flow – Depreciation
= [$975,000 – (($2,700,000 – 600,000) / 7 years)]
= $675,000

= $675,000 / $2,700,000
= 25%
Project 2:
= $1,650,000 / $8,200,000
= 20.12% (rounded)
Project 3:
= $30,000 / $250,000
= 12%
Based on the accounting rates of return, Project 1 is the best. Project 2 is the second
best, while Project 3 gives the lowest accounting rate of return.
Req. 2
Project 1:
= $2,700,000 / $975,000
Project 2:
= $8,200,000 / ($1,650,000 + ($8,200,000 / 10))
= $8,200,000 / $2,470,000
Project 3:
= $250,000 / ($30,000 + ($250,000 - $25,000) / 10))
= $250,000 / $52,500
Based on payback period, Project 1 is preferred, Project 2 is the second preference,

while Project 3 has the longest payback period.

PB11−3 (Continued)
Req. 3
Project 1
PV Factor Present
0 $(2,700,000) 1.0000 $ (2,700,000.00)
1-7 975,000 4.8684 4,746,690.00
7 600,000 0.5132 307,920.00
NPV $2,354,610.00
Project 2
PV Factor Present
0 $(8,200,000) 1.0000 $(8,200,000.00)
1-10 2,470,000* 6.1446 15,177,162.00
10 0 0.3855 0.00
NPV $ 6,977,162.00
*[$1,650,000 + ($8,200,000 / 10)]
Project 3
PV Factor Present
0 $(250,000) 1.0000 $ (250,000.00)
1-10 52,500* 6.1446 322,591.50
10 25,000 0.3855 9,637.50
NPV $ 82,229.00
*($30,000 + [($250,000 - $25,000) / 10
Req. 4
PI for Project 1 = $5,054,610 / $2,700,000

= 1.8721 (rounded)
PI for Project 2 = $15,177,162 / $8,200,000

= 1.8509 (rounded)
PI for Project 3 = $332,229 / $250,000

= 1.3289 (rounded)
The projects should be prioritized as follows:
Project 1 ranks highest with a profitability index of 1.8721.

Project 2 ranks second highest with a profitability index of 1.8509.
Project 3 ranks last with the lowest profitability index of 1.3289.

PB11−4
Req. 1

= $66,000 / $860,000
= 7.67% (rounded)
Req. 2
Payback Period = Initial Investment / (Net Income + Depreciation)

= $860,000 / ($66,000 + [($860,000 - $20,000) / 6]
= $860,000 / $206,000
Req. 3
PV Factor Present
0 $(860,000) - $(860,000)
1-6 206,000* 4.2305 871,483
6 20,000 0.5346 10,692
NPV $ 22,175
* $66,000 + [($860,000 - $20,000) / 6]
Req. 4
PV Factor Present
0 $(860,000) - $(860,000)
1-6 206,000* 4.1114 846,948
6 20,000 0.5066 10,132
NPV $( 2,920)
* $66,000 + [($860,000 - $20,000) / 6]
Req. 5
The internal rate of return for this project must be between 11% and 12% because the
NPV is positive using an 11% discount rate and slightly negative using a 12% discount
rate. The IRR using Excel (not required) is 11.88%.

PB11−5
Req. 1
Option 1: Present Values
$100,000 = $100,000.00
Option 2:
$10,000  9.8181 = $ 98,181.00
Option 3:
$7,000  6.7101 = $ 46,970.70
+ $10,000  6.7101  0.4632 = 31,081.18
Total = $ 78,051.88
Req. 2
Option 1 is the best because it gives the highest return. The time value of money
makes a dollar received today worth more than a dollar received one year from
now; therefore, Option 1 is the best because it yields the greatest present value.

ANSWERS TO SKILLS DEVELOPMENT CASES
S 11−1
The solution to this problem may vary slightly over time and depending on the
assumptions the student makes about the rate of increase in future salary. The
following table shows the comparison of Arizona State and Harvard that were obtained
in July of 2008. The numbers may change as Forbes updates the website with more
recent information.
Req. 1
The expected five-year gain from an MBA at Arizona State is $77,149, which is slightly
higher than at BYU. The primary difference is the lower cost of in-state tuition at ASU
vs. BYU. However, the expected growth rate in salary was lower at ASU than BYU.
Forbes provides a default value for these numbers based on the median increase
salary changes reported in survey data. Students are allowed to modify these
numbers if they want.

S 11−1 (Continued)
Req. 2
The expected five-year gain from an MBA at Harvard is substantially higher than at
BYU, in spite of a much higher tuition rate. Part of the difference is the higher post-
MBA salary. The bigger effect comes from the anticipated growth in the post-MBA
salary, which is 11.4% at Harvard versus only 6.2% at BYU. Interestingly the payback
period at Harvard and BYU is similar because most of the salary benefit comes after
the payback period is over.
Req. 3
Out of pocket costs include the tuition and fees. Opportunity costs include the salary
values and the time value of money.
Req. 4
The time value of money calculations will penalize the Harvard option more than the
ASU option. The reason is that Harvard requires greater up-front costs. While the
salary benefits are greater from an MBA at Harvard, these benefits happen further
down the road, and thus are worth less in today’s dollars.
Req. 5
The $45,000 pre-MBA salary is not relevant to the decision about which MBA program
to attend, because it will be the same under any of the alternatives. Once Greg has
decided to get an MBA, his current salary is not relevant to the decision about which
school to choose.
Req. 6
If Greg was deciding whether to keep his job or get an MBA, his current salary would
be relevant to that decision, because it is an opportunity cost associated with getting an
MBA. He must give up his current salary in order to go to school.


Chapter 11 Capital Budgeting: Answers To Questions

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Chapter 11 Capital Budgeting: Answers To Questions

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Chapter 11 Capital Budgeting

1. Screening decisions require managers to determine whether a proposed capital

4. Non-discounting methods do not incorporate the time value of money, while

6. Net income includes non-cash expenses such as depreciation. This distinction is

I =5%, n = 4 I = 10%, n = 7 I =14%, n = 10

11-2 Solutions Manual

Managerial Accounting, 2/e 11-3

H 1. Time value of money

Payback Period = Initial Investment / Annual Net Cash Flow

Accounting Rate of Return = Annual Net Income / Initial Investment

Payback Period = Initial Investment / Annual Net Cash Flow

11-4 Solutions Manual

Year Annual Cash Flow PV Factor (8%) Present Value

From Excel, the IRR is 0.13% for this project.

Year Cash flow

Managerial Accounting, 2/e 11-5

Profitability Index = PV of Future Cash Flows / Initial Investment

PI for Project A = $265,000 / $110,000

PI for Project B = $400,000 / $220,000

PI for Project C = $115,000 / $112,000

+ $50,000  0.9434 = 47,170

+ $ 20,000  11.4699 = 229,398

$30,000  14.4866 = $434,598

$15,000  45.7620 = $686,430

It is much better to save $15,000 for 20 years.

11-6 Solutions Manual

Managerial Accounting, 2/e 11-7

11-8 Solutions Manual

Managerial Accounting, 2/e 11-9

Accounting Rate of Return = Annual Net Income / Initial Investment

Payback Period = Initial Investment / Annual Net Cash Flow

Net present value Cost of capital Internal rate of return

11-10 Solutions Manual

Year Cash Flow PV of $1 (10%) Present Value

PV of annuity of $1 (i = 10%, n = 5) = 3.7908

NPV of Lease Option = $3,480 x 3.7908

Managerial Accounting, 2/e 11-11

PI for Project A = $765,000 / $415,000

PI for Project B = $415,000 / $230,000

PI for Project C = $1,200,000 / $720,000

PI for Project D = $1,560,000 / $945,000

Shaylee’s order of preference based on profitability index is:

FV of annuity of $1 (i = 8%, n = 10): 14.4866

$15,000 x 14.4866 = $217,299 after 10 years

$17,500 x 14.4866 = $253,515.50 after 10 years

FV of annuity of $1 (i = 10%, n = 10): 15.9374

$15,000 x 15.9374 = $239,061 after 10 years

Managerial Accounting, 2/e 11-13

Initial investment $40,000 $20,000 $50,000

PV of cash inflows 45,000 33,000 70,000

Payback 1.60 2.00 1.97

11-14 Solutions Manual

Year Initial Annual cash Unpaid Investment

Year Cash Flow PV of $1 Present

Managerial Accounting, 2/e 11-15

Accounting Rate of Return = Annual Net Income / Initial Investment

Payback Period = Initial Investment / Annual Net Cash Flow

11-16 Solutions Manual

Automation would generate a total increase in net income of $980,000.

Accounting Rate of Return = Annual Net Income / Initial Investment

Payback Period = Initial Investment / Annual Net Cash Flow

Managerial Accounting, 2/e 11-17

11-18 Solutions Manual