Identifying cash inflows and outflows Indicate which of the following items will result in cash inflows and which will result in cash outflows. The first one is shown as an example.
Recovery of working capital
Working capital commitments
Determining the present value of a lump-sum future cash receipt Stan Sweeney turned 20 years old today. His grandfather established a trust fund that will pay Mr. Sweeney $80,000 on his next birthday. However, Stan needs money today to start his college education. His father is willing to help and has agreed to give Stan the present value of the future cash inflow, assuming a 10 percent rate of return. Required A. Use a present value table to determine the amount of cash that Stan Sweeney’s father should give him.
Using the Present Value of $1 table, The factor for 1 year at 10% rate of return is 0. 90909. The PV of $80,000 after year 1 is
PV = 80,000 * PV factor PV = 80000 * 0. 90909 PV = $72,727. 20
Based on The Present Value, Stan Sweeney’s father should give him $72,727. 20 B.
a) Use an algebraic formula to prove that the present value of the trust fund (the amount of cash computed in Requirement
b) is equal to its $80,000 future value.
Investment + (0. 90909 x Investment) = $80,000 $72,727 + (0. 12 x $72,727. 20) =$80,000 $72,727 + $7,273 = $80,000 $80,000 = $80,000
Determining the present value of a lump-sum future cash receipt Marsha Bittner expects to receive a $600,000 cash benefit when she retires five years from today. Ms. Bittner’s employer has offered an early retirement incentive by agreeing to pay her $360,000 today if she agrees to retire immediately. Ms. Bittner desires to earn a rate of return of 12 percent.
A. Assuming that the retirement benefit is the only consideration in making the retirement decision, should Ms. Bittner accept her employer’s offer? Ms. Bittner should not accept her employer’s offer.
B. Identify the factors that cause the present value of the retirement benefit to be less than $600,000 Inflation is one factor that could affect the present value of the retirement benefit. Taxes are another factor that could affect the present value of the retirement benefit.
Determining net present value Metro Shuttle Inc. is considering investing in two new vans that are expected to generate combined cash inflows of $28,000 per year. The vans’ combined purchase price is $91,000. The expected life and salvage value of each is four years and $21,000, respectively. Metro Shuttle has an average cost of capital of 14 percent.
a. Calculate the net present value of the investment opportunity.
FV X PRESENT VALUE
= Present Value Equivalent
28,000 X 0. 877193
28,000 X 0. 769468
28,000 X 0. 74972
28,000 X 0. 592080
b. Indicate whether the investment opportunity is expected to earn a return that is above or below the cost of capital and whether it should be accepted. The investment opportunity is anticipated to earn a return that is below the cost of capital. The investment should not be accepted.