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Chapter 4
Capital Investment Decisions
Answers to End of Chapter Exercises

Q 4.1 Happy Ltd.

Year Disc. Fact. Present value 000 Payback
0 -5000 1 -5000.0
1 1600 0.8696 1391.4 -3400
2 1700 0.7561 1285.4 -1700
3 1660 0.6575 1091.4 -40
4 2400 0.5718 1372.3 2360
5 1400 0.4972 696.0

Net present value 836.5

Payback 3 years
Accounting rate of return
Average profit = 3,760,000/5 = 752,000
ARR = 752,000/5,000 = 15.04%

NPV = 836,481

Q 4.2
a) 14% 10%
Present value
Year Disc. Fact. 000 D. Factor Present value Payback
0 -600 1 -600.00 1 -600
1 160 0.8772 140.35 0.909091 145.45 -440
2 160 0.7695 123.11 0.826446 132.23 -280
3 160 0.6750 108.00 0.751315 120.21 -120
4 160 0.5921 94.73 0.683013 109.28 40
5 160 0.5194 83.10 0.620921 99.35
200
-50.71 6.53

Payback 3 years 9 months

Accounting rate of return
Average rate of profit = 200,000/5 = 40,000
ARR = 40,000/600,000 = 6.67%

NPV = -50,710
IRR = 10% + (6.53/57.24 x 4) = 10% + 0.11% = 10% to nearest 0.5%

b) Organisations use different measures. If cash flow is important then payback money may be
used. Theoretically the criterion to use is net present value, as this is consistent with
maximising shareholder value.

2008 John Wiley & Sons Ltd.

www.wileyeurope.com/college/bowhill
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Q 4.3

Annual cash saving

Old New Cash Saving
Labour 30,000 20,000 10,000
Material 720,000 690,000 30,000
Power 9000 4,000 5,000
Maintenance 15,000 10,000 5,000
774,000 724,000 50,000
Net cash
year Capital saving flow disc factor Present value
0 -160,000 -160,000 1 -160000
1 50,000 50,000 0.9091 45455
2 50,000 50,000 0.8264 41322
3 50,000 50,000 0.7513 37566
4 50,000 50,000 0.6830 34151
5 50,000 50,000 0.6209 31046
6 50,000 50,000 0.5645 28224
7 50,000 50,000 0.5132 25658
8 50,000 50,000 0.4665 23325
9 50,000 50,000 0.4241 21205
10 50,000 50,000 0.3855 19277

147228

Therefore the purchase of a new machine would lead to a positive net present value of
147,228 and therefore the purchase would be worthwhile.

Q 4.4
a)

'000 '000 '000 '000 '000

Net
Lost Cost cash
Year Capital contribution Training saving flow
-
0 -4000 -4000 1.0000 4000.00
1 -400 -20 1400 980 0.8772 859.65
2 1400 1400 0.7695 1077.25
3 1400 1400 0.6750 944.96
4 1400 1400 0.5921 828.91
5 1400 1400 0.5194 727.12
6 1000 1400 2400 0.4556 1093.41
1531.30

The project will generate a positive net present value of 1,531,000, and so is
worthwhile.

b) Will the improved quality lead to increased sales, no sales increase is currently included? Will
it be possible to sublet the space released for seven years?

2008 John Wiley & Sons Ltd.

www.wileyeurope.com/college/bowhill
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Q 4.5

'000 '000 '000 '000 '000 '000 '000

Net
other Other sales cash Discount Present
year capital salary staff costs contribution flow factor value
-
0 -7000 -7000 1 7000.00
1 -1300 -120 -3800 -1500 7000 280 0.9174 256.88
2 -120 -3800 -1500 7350 1930 0.8417 1624.44
3 -120 -3800 -2000 7700 1780 0.7722 1374.49
4 -120 -3800 -2000 8050 2130 0.7084 1508.95
5 -120 -3800 -2000 8400 2480 0.6499 1611.83
5 90 -1000
-623.42

Year Sales '000

1 20,000
2 21,000
3 22,000
4 23,000
5 24,000

There is a negative net present value of 623,415 if the company proceeds with the proposal.
On that basis it is recommended that the company does not undertake the development.

2008 John Wiley & Sons Ltd.

www.wileyeurope.com/college/bowhill