Posted: April 24th, 2016

Should the company acquire the drill?

Using the time value of money to compute the present and future values of single lump sums and annuities.

Congratulations! You have won a state lottery. The state lottery offers you the following (after-tax) payout options:
Option #1: $13,000,000 after five years
Option #2: $2,300,000 per year for the next five years
Option #3: $12,000,000 after three years

1. Assuming you can earn 6% on your funds, which option would you prefer?

Multimedia Technology does business in three different business segments: 1) entertainment, 2) publishing/information, and 3) consumer/commercial finance. Results for a recent year were as follows (in millions):

Revenues Operating Income Total Assets
Entertainment $1272 $223 $1120
Publishing/Information $705 $122 $1308
Consumer/Commercial Finance $1235 $244 $924

1. Compute the following for each business segment:
a. Return on sales
b. Capital turnover
c. ROI

2. Comment on the differences in ROI among the business segments. Include reasons for the differences.

The general manager of a West Virginia mining company has a chance to purchase a new drill at a total cost of $250,000. The recovery period is 5 years. Additional annual pretax cash inflow from operations is $82,000, the economic life of the drill is 5 years, there is no salvage value, the income tax rate is 35%, and the after-tax required rate of return is 16%.

1. Compute the NPV, assuming MACRS depreciation for tax purposes. Should the company acquire the drill?
2. Suppose the economic life of the drill is 6 years, which means that there will be an $82,000 cash inflow from operations in the sixth year. The recovery period is still 5 years. Should the company acquire the drill? Show computations.

The Jackson City parks department is considering the purchase of a new, more efficient pool heater for its Moorcroft Swimming Pool at a cost of $15,000. It should save $3,000 in cash operating costs per year. Its estimated useful life is 8 years, and it will have zero disposal value. Ignore taxes.

1. What is the payback time?
2. Compute the NPV if the minimum rate of return desired is 8%. Should the department buy the heater? Why?
3. Using the ARR model, compute the rate of return on the initial investment.

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