Chapter14

CapitalBudgeting
Questions

1. Capitalassetsarethelonglivedassetsthatareacquiredby
afirm.Capitalassetsprovidetheessentialproductionand
distributionalcapabilitiesrequiredbyallorganizations.

2. Eachcriterionprovidesdifferentinformationaboutprojects.
Byusingmultiplecriteria,moredimensionsofcompeting
projectscanbecomparedasabasisforallocatingscarce
capitaltonewinvestment.

3. Cashflowsarethefinalobjectiveofcapitalbudgeting
investmentsjustascashflowsarethefinalobjectiveofany
investment.Accountingincomeultimatelybecomescashflowbut
isreportedbasedonaccrualsandotheraccountingassumptions
andconventions.Theseaccountingpracticesandassumptions
detractfromthepurityofcashflowsandare,therefore,not
usedincapitalbudgeting.

4. Analystsseparatetheactoffinancingabusiness'smany
integratedinvestmentsandtherelatedfinancingcashflows
fromtheselectionofcapitalprojectsandthecashflows
relatedtosuchselectionsbecauseofthevirtual
impossibilityofconvincinglyassigningdollarsobtainedfrom
themanygeneralfinancingsourcestotheparticularprojects
beingselectedduringagivenyear.

5. Timelinesprovideclearvisualmodelsoftheexpectedcash
inflowsandoutflowsforeachpointintimeforaproject.
Theyprovideanefficientandeffectivemeanstohelporganize
theinformationneededtoperformcapitalbudgetinganalyses.

6. Thepaybackmethodmeasuresthetimeexpectedforthefirmto
recoveritsinvestment.Themethodignoresthereceipts
expectedtooccuraftertheinvestmentisrecoveredand
ignoresthetimevalueofmoney.

113
114 Chapter14
CapitalBudgeting
7. Thetimevalueofmoneyisimportantbecausehavingasumof
moneynowallowsacompanytoearnareturnonit;ifthesame
amountwerenotreceiveduntilsometimeinthefuture,a
returncouldnotbeearnedonitbetweennowandthetimeit
isreceived.Allelsebeingequal,managersprefertohave
cashreceiptsnowratherthaninthefutureandwouldprefer
tomakecashdisbursementsinthefutureratherthannow.
Futurevaluescanbeconvertedintoequivalentpresentvalues
bytheprocessofdiscounting.Thefollowingmethodsusethe
timevalueofmoneyconcept:netpresentvalue,internalrate
ofreturn,andtheprofitabilityindex.Theaccountingrateof
returnandpaybackperioddonotusethetimevalueofmoney
concept.

8. Returnofcapitalmeanstheinvestorisreceivingthe
principalthatwasoriginallyinvested.Returnoncapital
meanstheinvestorisreceivinganamountearnedonthe
investment.

9. TheNPVofaprojectisthepresentvalueofallcashinflows
lessthepresentvaluesofalloutflowsassociatedwitha
project.IftheNPViszero,itisacceptablebecause,in
thatcase,theprojectwillexactlyearntherequiredcostof
capitalrateofreturn.Also,whenNPVequalszero,the
projectsinternalrateofreturnequalsthecostofcapital.

10. ItishighlyunlikelythattheestimatedNPVwillexactly
equaltheactualNPVachievedbecauseofthenumberof
estimatesnecessaryintheoriginalcomputation.These
estimatesincludetheprojectlife,thediscountratechosen
andthetimingandamountsofcashinflowsandoutflows.The
originalinvestmentmayalsoincludeanestimateoftheamount
ofworkingcapitalthatisneededatthebeginningofthe
projectlife.

11. TheNPVmethodsubtractstheinitialinvestmentfromthe
discountednetcashinflowstoarriveatthenetpresent
value.ThePIdividesthediscountedcashinflowsbythe
initialinvestmenttoarriveattheprofitabilityindex.Thus,
eachcomputationusesthesamesetofamountsindifferent
ways.ThePImodelattemptstomeasuretheplannedefficiency
oftheuseofthemoney(i.e.,output/input)inthatit
reflectstheexpecteddollarsofdiscountedcashinflowsper
dollarofinvestmentintheproject.

12. ThePIwillexceed1onlyininstanceswherethenetpresent
valueexceeds0.ThisisbecausetheNPVispositiveonlyif
thepresentvalueofcashinflowsexceedsthepresentvalueof
cashoutflows.Similarly,thepresentvalueofcashinflows
mustexceedthepresentvalueofcashoutflowsifthe
numeratorofthePIformulaistoexceedthedenominator.
 Chapter14 115
CapitalBudgeting
13. TheIRRistheratethatwouldcausetheNPVofaprojectto
equalzero.Aprojectisconsideredpotentiallysuccessful
(allotherfactorsbeingacceptable)ifthecalculatedIRR
exceedsthecompany'scostofcapital.

14. Onanyprospectiveproject,whentheNPVexceedszero,the
project'sIRRwillexceedthefirm'sdiscountratethatwas
usedtofindtheNPV.IftheIRRequalsthefirm'sdiscount
rate,theNPVwillequalzero.IftheIRRislessthanthe
firm'sdiscountrate,theNPVwillbenegative.This
relationshipholdstruebecause,ultimately,undereither
methodthecalculationsforprojectselectionaredesignedto
hingeontheproject'scashflowsinrelationtothefirm's
discountrate.

15. Theamountofdepreciationforayearisonefactorthathelps
determinetheamountofcashoutflowforincometaxes.
Therefore,althoughdepreciationisnotacashflowitem
itself,itdoesaffectthesizeofanotheritem(incometaxes)
thatisacashflow.

16. Thetaxshieldistheamountofrevenueonwhichthe
depreciationpreventstaxation.Thetaxbenefitisthetax
thatissavedbecauseofthedepreciationandisfoundby
multiplyingthecompany'staxratebythetaxshieldprovided
bydepreciation.

17. Thefourquestionsare:
1. Istheactivityworthyofaninvestment?
2. Whichassetscanbeusedfortheactivity?
3. Oftheassetsavailableforeachactivity,whichisthebest
investment?
4. Ofthebestinvestmentsforallworthwhileactivities,in
whichonesshouldthecompanyinvest?

18. NPV:Ranksprojectsindescendingorderofmagnitude.
PI:Ranksprojectsindescendingorderofmagnitudeifa
positivecashflowproject.
IRR:Ranksprojectsindescendingorderofmagnitude.
Payback:Ranksprojectsinascendingorderofmagnitude.
ARR:Ranksprojectsindescendingorderofmagnitude.

19. Severaltechniquesshouldbeusedbecauseeachtechnique
providesvaluableanddifferentinformation.Ofpreferreduse
astheprimaryevaluatoristhenetpresentvaluein
conjunctionwiththepresentvalueindex,becausemanagement's
goalshouldbetomaximize,withinbudgetandrisk
constraints,thenetpresentvalueofthefirm.
116 Chapter14
CapitalBudgeting
20. Capitalrationingexistsbecauseafirmoftenfindsthatit
hastheopportunitytoinvestinmoreacceptableprojectsthan
ithasmoneyavailable.Projectsarefirstscreenedasto
desirabilityandthenrankedastoimpactoncompany
objectives.

21. Riskisdefinedasthelikelyvariabilityofthefuture
returnsofanasset.Aspectsofaprojectforwhichriskis
involvedare:
*Lifeoftheasset
*Amountofcashflows
*Timingofcashflows
*Salvagevalueoftheasset
*Taxrates
Whenriskisconsideredincapitalbudgetinganalysis,theNPV
ofaprojectislowered.

22. Sensitivityanalysisisusedtodeterminethelimitsofvalue
forinputvariables(e.g.,discountrate,cashflows,asset
life,etc.)beyondwhichtheproject'soutcomewillbe
significantlyaffected.Thisprocessgivesthedecisionmaker
anindicationofhowmuchroomthereisforerrorinestimates
forinputvariablesandwhichinputvariablesneedspecial
attention.

23. Postinvestmentauditsareperformedfortworeasons:to
obtainfeedbackonpastprojectsandtomakecertainthatthe
championsofproposedprojectssubmitrealisticnumbers
knowingtheirestimateswillultimatelybecomparedtoactual
numbers.Theseauditscanprovideinformationtocorrect
problemsandtoassesshowwellthecapitalinvestment
selectionprocessisworking.Thelargerthecapital
expenditure,themoreimportantitistoperform
postinvestmentaudits.Postinvestmentauditsareperformedat
thecompletionofaproject.

24. Thetimevalueofmoneyreferstotheconceptthatmoneyhas
timebasedearningspower.Moneycanbeloanedorinvestedto
earnanexpectedrateofreturn.Presentvalueisalwaysless
thanfuturevaluebecauseofthetimevalueofmoney.A
futurevaluemustbediscountedtodetermineitsequivalent
(butsmaller)presentvalue.Thediscountingprocessstrips
awaytheimputedrateofreturninfuturevalues,thus
resultinginsmallerpresentvalues.

25. Anannuityisacashflowthatisrepeatedinsuccessive
periods.Singlecashflowsoccuronlyinoneperiod.
 Chapter14 117
CapitalBudgeting
26. ARR=AverageannualprofitsAverageinvestment
Unliketherateusedtodiscountcashflowsortocompare
tothecostofcapitalrate,theARRisnotadiscountrateto
applytocashflows.Itismeasuredfromaccrualbased
accountinginformationandisnotintendedtobeassociated
withcashflows.

Exercises
27. a.3
b.10
c.2
d.9
e.5
f.8
g.6
h.4
i.1
j.7

28. a.9
b.4
c.7
d.3
e.6
f.5
g.10
h.2
i.8
j.1

29. a. Payback=$750,000$150,000peryear=5.00years

b. Year Amount CumulativeAmount

1 $75,000 $75,000
2 75,000 150,000
3 75,000 225,000
4 75,000 300,000
5 75,000 375,000
6 100,000 475,000
7 100,000 575,000
8 100,000675,000
9 100,000775,000

Payback=8+($75,000$100,000)years
=8.75years,or8yearsand9months
118 Chapter14
CapitalBudgeting
30. a. Year Amount CumulativeAmount
1 $5,000 $5,000
2 9,000 14,000
3 16,000 30,000
4 18,000 48,000
5 15,000 63,000
6 14,000 77,000
7 12,000 89,000

Payback=4years+($12,000$15,000)
=4.8years

b. Yes.Bachsshouldalsouseadiscountedcashflow
techniquefortworeasons:(1)totakeintoaccountthe
timevalueofmoneyand(2)toconsiderthosecashflows
thatoccurafterthepaybackperiod.

31. PointintimeCashflowsPVFactorPresentValue
0$(400,000)1.0000$(400,000)
170,0000.892962,503
270,0000.797255,804
385,0000.711860,503
485,0000.635554,018
585,0000.567448,229
686,4000.506643,770
786,4000.452439,087
886,4000.403934,897
962,0000.360622,357
1062,0000.322019,964
NPV$41,132

BasedontheNPV,thisisanacceptableinvestment.

32. a. Thecontributionmarginofeachpartis$28($50$22)
Contributionmarginperyear=$2850,000=$1,400,000
PointintimeCashflowsPVfactorPresentValue
0$(500,000)1.0000$(500,000)
18 (40,000)5.7466(229,864)
181,400,0005.74668,045,240
NPV$7,315,376

b. BasedontheNPV,thisisaveryacceptableinvestment.
 Chapter14 119
CapitalBudgeting
c. Otherconsiderationswouldincludewhetherthecompany
hasthenecessarycapacitytoproducetheadditional
output,thepossibilitythatthecustomerwoulddecideto
purchaseelsewhereorwouldnolongerhaveneedforthe
partsafterMachadoIndustrialhasmadeitsinvestment,
andwhetherthecompanyhasconsideredallofthecosts
thatwouldbeaffectedbythedecisiontoproducethenew
partespeciallylaborandoverhead.

33. PI=PVofcashinflowsPCofcashoutflows
=($6,000+$30,000)$30,000=1.20

34. a. PVofinflows$590,489($88,0006.7101)
PVofinvestment$500,000
PI=$590,489$500,000=1.18

b. TheOTAshouldaccepttheprojectbecauseitsPIis
greaterthan1.00.

c. Tobeacceptable,aprojectmustgenerateaPIofat
least1.

35. a. PV=discountfactorannualcashinflow
$140,000=discountfactor$28,180
Discountfactor=$140,000$28,180=4.968
TheIRRis12%

b. Yes.TheIRRonthisproposalisgreaterthanthefirm's
hurdlerateof10%.

c. $140,000=5.335Cashflow
Cashflow=$26,242

36. a. Year Amount CumulativeAmount

1 $14,000 $14,000
2 14,000 28,000
3 11,000 39,000
4 11,000 50,000
Payback=4years+(52,00050,000)$9,000
=4.22years

b. PointintimeCashflowsPVFactorPresentValue
0$(52,000)1.0000$(52,000)
1214,0001.735624,298
3411,0001.434315,777
569,0001.185410,669
67,5000.56454,234
NPV$2,978

c. PI=($52,000+$2,978)$52,000=1.06
120 Chapter14
CapitalBudgeting
37. a. InvestmentAnnualSavings=$2,300,000$300,000=
7.67years.

b. PointinTimeCashFlowsPVFactorPresentValue
0$(2,300,000)1.0000$(2,300,000)
111300,0006.49511,948,530
NPV$(351,470)

c. PI=$1,948,530$2,300,000=0.85

d. PV=discountfactorannualcashinflow
$2,300,000=discountfactor$300,000
discountfactor=$2,300,000$300,000=7.6667
discountfactorof7.6667correspondstoan IRR7%

38. a. Straightlinemethod
Annualdepreciation=$1,000,0005years
=$200,000peryear
Taxbenefit=$200,0000.35=$70,000
PV=$70,0003.7908=$265,356

b.
Acceleratedmethod
$1,000,0000.400.35.9091=$127,274.00
$600,0000.400.35.8265=69,426.00
$360,0000.400.35.7513=37,865.52
$216,0000.400.35.6830=20,653.92
$129,600*0.35.6209= 28,164.02
Total$283,383.46
*
Inthefinalyear,theremainingundepreciatedcostis
expensed.

c. Thedepreciationbenefitcomputedinpart(b).exceedsthat
computedinpart(a).solelybecauseofthetimevalueof
money.Thedepreciationmethodinpart(b).allowsfor
fasterrecaptureofthecost;therefore,thereisless
discountingofthefuturecashflows.
 Chapter14 121
CapitalBudgeting
39. a.SLD=$40,000,0008years=$5,000,000peryear

BeforetaxCF $8,400,000
Lessdepreciation 5,000,000
BeforetaxNI$3,400,000
Lesstax(30%)1,020,000
NI $2,380,000
Adddepreciation 5,000,000
AftertaxCF $7,380,000

PointinTimeCashFlowsPVFactorPresentValue
0$(40,000,000)1.0000$(40,000,000)
187,380,0005.746642,409,908
NPV$2,409,908
Theprojectisacceptable.

b. Years1and2 Years38
BeforetaxCF $8,400,000 $8,400,000
LessDepreciation 9,200,000 3,600,000
BeforetaxNI $(800,000) $4,800,000
Tax(taxbenefit) (240,000) 1,440,000
AftertaxNI $(560,000) $3,360,000
AddDepreciation 9,200,000 3,600,000
AftertaxCF $8,640,000 $6,960,000

PointintimeCashflowsPVfactorPresentValue
0$(40,000,000)1.0000$(40,000,000)
128,640,0001.783315,407,712
386,960,0003.963327,584,568
NPV$2,992,280
Theprojectisacceptable.
122 Chapter14
CapitalBudgeting
c. Recomputationofpart(a):
BeforetaxCF $8,400,000
Lessdepreciation 5,000,000
NIBT $3,400,000
Lesstax(50%)1,700,000
NI $1,700,000
Adddepreciation 5,000,000
AftertaxCF $6,700,000

PointinTimeCashFlowsPVFactorPresentValue
0$(40,000,000)1.0000$(40,000,000)
186,700,0005.746638,502,220
NPV$(1,497,780)
Theprojectisnotacceptable.

Recomputationofpart(b):
Years1and2 Years38
BeforetaxCF $8,400,000 $8,400,000
LessDepreciation 9,200,000 3,600,000
NIBT $(800,000) $4,800,000
LessTax(taxbenefit)(400,000) 2,400,000
AftertaxNI $(400,000) $2,400,000
AddDepreciation 9,200,000 3,600,000
AftertaxCF $8,800,000 $6,000,000

PointinTimeCashFlowsPVFactorPresentValue
0$(40,000,000)1.0000$(40,000,000)
128,800,0001.783315,693,040
386,000,0003.963323,779,800
NPV$(527,160)
Theprojectisnotacceptable.

40. a. Tax:$25,000$8,000=$17,000
Financialaccounting:$25,000$15,000=$10,000

b. CFAT=Marketvaluenowminustaxes
=$17,000(($17,000$8,000).40)
=$13,400

c. CFAT=$4,000(($4,000$8,000).40)=$5,600
 Chapter14 123
CapitalBudgeting
41. a. FindtheratethatwillcausetheNPVsofthetwo
projectstobeequal.Bytrialanderror,the
indifferencerateisjustabove4%.Ata4%ratetheNPV
ofeachprojectiscomputedasfollows:

Project1:
NPV=(8.1109$85,000)$400,000
NPV=$289,427

Project2:
NPV=(8.1109$110,000)$600,000
NPV=$292,199

b. ThisrateisknownastheFisherrate.

c. Project1:
NPV=(5.6502$85,000)$400,000
NPV=$80,267

Project2:
NPV=(5.6502$110,000)$600,000
NPV=$21,522

Project1wouldbepreferredduetoitshigherNPV,

42. a. cashflowannuityfactor=$30,000
cashflow3.6048=$30,000
cashflow=$8,322

b. $30,000$8,322=3.6years

43. PVfactor$180,000=$400,000
PVfactor=$400,000$180,000=2.2222

Thisfactorfallsbetween1.7591(at2years)and2.5313(at3
years)inthetableusingthe9%column.Thus,thecashflow
wouldhavetopersistforover2yearsbutunder3years.

44. a. cashflowdiscountfactor=investment
cashflow7.1607=$1,200,000
cashflow=$167,581

b. cashflowdiscountfactor=investment
$193,723discountfactor=$1,200,000
discountfactor=6.1944
ThisPVfactorfor12periodscorrespondsto12%.
124 Chapter14
CapitalBudgeting
45. futurevaluediscountfactor=presentvalue
futurevalue.5674=$14,000
futurevalue=$24,674

46.Cost=$9,000+PV($1,200annuity)
=$9,000+($1,20030.1075)
=$45,129

47. a. PV=futurevaluediscountfactor
=$50,000.6302
=$31,510shouldbeinvestedtoachievethegoal

b. PV=futurevaluediscountfactor
=$200,000.3083
=$61,660wouldbeequivalenttoday

c. PV=futurevaluediscountfactor
=$60,000.3522
=$21,132

d. timeline
timet0t1t2t3t4t5
amount$210$210$210$210$210

Year1receipt:$210,000.9246=$194,166
Year2receipt:$210,000.8548=179,508
Year3receipt:$210,000.7903=165,963
Year4receipt:$210,000.7307=153,447
Year5receipt:$210,000.6756=141,876
Presentvalue$834,960
Discountfactorsbasedonsemiannualrateof4percent.

e. Year1receipt:$30,000.9259=$27,777
Year2receipt:$50,000.8573=42,865
Year3receipt:$60,000.7938=47,628
Year4receipt:$100,000.7350=73,500
Year5receipt:$100,000.6806=68,060
Year6receipt:$100,000.6302=63,020
Year7receipt:$100,000.5835=58,350
Year8receipt:$100,000.5403=54,030
Year9receipt:$70,000.5003=35,021
Year10receipt:$45,000.4632=20,844
Presentvalue$491,095

f. No.Usinganydiscountrateabove0,thepresentvalue
ofthefutureannualcashflowsiswellbelow$1,000,000.
Onlyifthefriendhassubstantialotherassetswouldshe
beamillionaire.
 Chapter14 125
CapitalBudgeting
48. a. Changeinnetincome=$250,000($500,0005)
=$150,000
ARR=$150,000($500,0002)=60%

Payback=$500,000$250,000peryear=2years

b. Yes.Theequipmentinvestmentmeetsallinvestment
criteria.Thepaybackislessthan5yearsandthe
accountingrateofreturnexceeds18%.

49. a. Annualcashreceipts$16,000
Cashexpenses(2,000)
Netcashflowbeforetaxes$14,000
Depreciation8,333
Incomebeforetax$5,667
Taxes(1,983)
Netincome$3,684
Depreciation8,333
Annualaftertaxcashflow$12,017

b. Payback=$50,000$12,017peryear=4.16years

c. ARR=$3,684($50,0002)=14.74%

50. a. Beforetaxcashflow $25,000

Depreciation($60,0005) (12,000)
Incomebeforetax $13,000
Tax(28%) (3,640)
Netincome $9,360
Depreciation 12,000
Annualaftertaxcashflow $21,360

b. PointintimeCashflowsPVfactorPresentValue
0$(60,000)1.0000$(60,000)
15$21,3603.790880,971
NPV$20,971
c. Fromparta.accountingincome=$9,360

d. ARR=$9,360(($60,000+$0)2)=31.2%

Payback=$60,000$21,360=2.81years
126 Chapter14
CapitalBudgeting
51. a. Payback=$750,000$250,000annually=3years

b. Oneoftheothercostsavingsmaycomeintheformof
improvedquality.Byadoptingthehighertechnology,
fewerdefectsshouldoccur.Additionally,thecompany
maybeabletoloweritscostsbecauseofitsenhanced
flexibilitytoswitchproductionfromonejobtoanother.
Additionalcostsmaycomeintheformofmaintenanceand
repairsaswellastrainingcoststoupgradeskillsof
workerstooperatethenewequipment.

52. Someofthefactorsthatwouldweighinfavorofproceeding
with theinvestmentasplannedincludethese:
Thecostsavingswillbereceivednowinsteadoflater.
Anylearningcurveeffectswillbeenjoyedearlier.
Anyqualityeffectsonoperationswillberecognizedsooner.
Thereducedmaintenancecostbenefitwilloccurnowrather
thanlater.
Demandforservicesmayaccelerateunexpectedly.
Delaysininstallingtheequipmentmayresultinpricehikes
thatcouldbeavoidediftheequipmentisinstalledon
schedule.

Thefactorsthatmightweighinfavorofdelayinginvestment
includethese:
Riskassociatedwiththenewinvestmentmayincreasebecause
ofthelikelihoodthatdemandwillnotpickupinthenear
future.
Possiblepricereductionsmightberealizedbydelaying
acquisitionoftheequipment.Pricereductionsaremore
likelyoncomputerizedequipment.
Possiblelayoffsofemployeescanbedeferred.
Moretimeisnowavailabletoevaluatealternative
technologiesthatmayhaveemergedorwillemergesoon.
Thecompanyshouldprotectitscashflowinlightofa
local,stagnatingeconomy.
 Chapter14 127
CapitalBudgeting
53. AcompanysR&Dprogramisthemajorsourceofdistant,future
cashflows.ItisfromtheR&Deffortthatnewproductsare
identifiedanddeveloped.WithoutasuccessfulR&Dprogram,
thestreamoffuturecashflowswilldryup.Similarly,the
presentproductsandservicesofferedbyafirmare
attributabletopastR&Dprograms.Hence,thelinkageis
establishedbetweenR&Dactivity,andpresentandfuturecash
flows.
Itisnotsurprisingthatmuchlongtermplanningshould
beconcentratedontheR&Dactivity.Managingtheinvestment
inR&Dactivitiesisthemainmethodavailabletomanagersto
balancecurrentandpresentcashflows,aswellaspresentand
futuregrowth.R&Disexpensedwhenincurredandthisreduces
currentearnings.Thisoftentendstodepressstockprices.

54.Thecapitalbudgetinteractswiththecashbudgetinthat
acquisitionofcapitalitemsrepresentsauseofcash.The
capitalbudgetalsointeractswiththestatementofcashflows
investingactivitiessection.Further,thecapitalbudget
impactsdepreciationexpenseonthebudgetedincomestatement,
andassetsonthebudgetedbalancesheet.Indirectly,the
capitalbudgetinteractswithotherlinesontheincome
statementbecausethevariousprojectsincludedinthecapital
budgetwillinfluenceavarietyofexpensesincludinglabor,
overhead,administrationandmarketing.

55.Noresponseprovided.

56. Themarketmustbeexpectinganenormousincreaseinfuture
cashflowsrelativetocurrentcashflows.Ifthetotalvalue
ofthesharesisviewedasthepresentvalueofthefuture
cashflowsaccruingtotheequityholders,theonlypossible
explanationfortheincrediblyhighvalueofthestockisthat
investorsexpectfuturecashflowstobemanytimesthelevel
ofcurrentcashflows.

57. Ifthevalueofashareofstockisviewedasthepresent
valueofthefuturecashflowsthatwillaccruetothatshare
ofstock,thenanychangeinthediscountrateappliedby
investorswouldaffecttheshareprice.Ifinterestrates
moveupanddown,itisreasonabletoexpectstockpricesto
moveinverselytothechangeininterestratesbecausethe
changeintheprevailinginterestratesrepresentsachangein
thediscountrateappliedbyinvestors.
128 Chapter14
CapitalBudgeting
58. Thecapitalbudgetisakeycontroltoolfora.comfirm.Few
.comfirmshaveturnedaprofityet.Theyareveryearlyin
theprocessofdevelopingproductsandservicestodeliver
overtheInternetandthisprocessrequiressubstantial
capitalinvestment.Consequently,theirinvestingactivities,
managedbythecapitalbudgetingprocess,arethefocusof
muchmanagerialtimeandtalent.Onlyifthesefirmsinvest
intherightprojectswilltheeventualsuccessofthefirmbe
realized.

Problems

59. a.($000somitted)
t0 t1 t2t3t4t5t6t7t8
Investment90.0
NewCM24.0024.024.024.024.0024.0024.0024.00
Oper.costs0.06.507.27.27.27.959.4510.0011.25
Ann.savings90.017.5016.816.816.816.0514.5514.0012.75

b. Year CashSavings CumulativeSavings

1 $17,500 $17,500
2 16,800 34,300
3 16,800 51,100
4 16,800 67,900
5 16,050 83,950
Payback=5+(($90,000$83,950)$14,550)=5.42years

c. TimeCashFlowPVFactorfor10%PresentValue
0 $(90,000) 1.0000 $(90,000)
1 17,500 .9091 15,909
2 16,800 .8265 13,885
3 16,800 .7513 12,622
4 16,800 .6830 11,474
5 16,050 .6209 9,965
6 14,550 .5645 8,213
7 14,000 .5132 7,185
8 12,750 .4665 5,948
NPV $(4,799)

60. a. Time:t0t1t2t3t4t5t6t7
Amount:($31,000)$6,800$7,100$7,300$7,000$7,000$7,100$7,200

b.YearCashFlowCumulative
Year1$6,800$6,800
Year27,10013,900
Year37,30021,200
Year47,00028,200

Payback=4years+(($31,000$28,200)$7,000)=4.40years
 Chapter14 129
CapitalBudgeting
c.
CashflowDiscountPresent
DescriptionTimeAmountFactorValue
Purchasethecart0($31,000)1.0000($31,000)
Costsavingst16,800.89296,072
Costsavingst27,100.79725,660
Costsavingst37,300.71185,196
Costsavingst47,000.63554,448
Costsavingst57,000.56743,972
Costsavingst67,100.50663,597
Costsavingst77,200.45243,257
NPV$1,202

61. a. Paybackperiod=$64,000($25,000$4,500)=3.12
years;theprojectdoesmeetthepaybackcriterion.

b. Discountfactor=Investmentannualcashflow
=$64,000$20,500=3.1220
Discountfactorof3.1220indicatesIRR>10.5%
whichisanunacceptableIRR.TheactualIRRis10.71%.

62. a. Year Cashflow PVfactor PV

0 $(2,500,000) 1.0000 $(2,500,000)
17419,500 5.03302,111,344
7200,000.5470109,400
NPV $(279,256)

b. No,theNPVisnegative;thereforethisisan
unacceptableproject.

c. PI=($2,111,344+$109,400)$2,500,000
=0.89

d. Thecompanyshouldconsiderthequalityofthework
performedbythemachineversusthequalityofthework
performedbytheindividuals;thereliabilityofthe
manualprocessversusthereliabilityofthemechanical
process;andperhapsmostimportantly,theeffecton
workermoraleandtheethicalconsiderationsin
displacing14workers.
130 Chapter14
CapitalBudgeting
63. a. Theincrementalcostofthenewmachine:$290,000$6,000
=$284,000

CashflowDiscountPresent
DescriptionTimeAmountFactorValue
Incrementalcostt0$(284,000)1.0000 $(284,000)
Costsavingst1t760,0004.9676 298,056
NPV $14,056
PI=$298,056$284,000=1.05

Yes,themachineshouldbepurchasedbecausetheNPV>0
andthePI>1.

b. Payback=$284,00060,000peryear=4.73years

c. Netinvestmentannualannuity=discountfactorofIRR
$284,00060,000=4.7333

Discountfactorof4.7333isbetween13.0and13.5%
Usinginterpolation,theactualrateis13.40%

64. a. Computationofnetannualcashflow:
Increaseinrevenues$172,000
Increaseincashexpenses(75,000)
Increaseinpretaxcashflow$97,000
LessDepreciation(39,000)
Incomebeforetax$58,000
Incometaxes(30percent)(17,400)
Netincome$40,600
AddDepreciation39,000
Aftertaxcashflow$79,600

CashFlowDiscountPresent
DescriptionTimeAmountFactorValue
Initialcostt0$(780,000)1.0000 $(780,000)
Annualcashflowt1t2079,6007.9633 633,879
NPV $(146,121)

b. No,thisisnotanacceptableinvestment.Thenet
presentvalueisnotclosetothecutoffvalueof$0.
 Chapter14 131
CapitalBudgeting
c. Minimumannualcashflowdiscountfactor=
$780,000
Minimumannualcashflow7.9633=$780,000
Minimumannualcashflow=$97,949

Aftertaxcashflowincrease=Minimumcashflow
Actualcashflow
Aftertaxcashflowincrease=$97,949$79,600
Aftertaxcashflowincrease=$18,349

Increaseinrevenues=Aftertaxcashflowincrease(1
taxrate)
Increaseinrevenues=$18,3490.70
Increaseinrevenues=$26,213

65. a. Cashflowaftertax(CFAT):
YearPretaxCFDepreciationTaxCFAT
1$52,000$32,000$6,000$46,000
259,00051,2002,34056,660
359,00030,4008,58050,420
451,00024,0008,10042,900
543,00022,4006,18036,820

Timeline:
t0t1t2t3t4t5
$(160,000)$46,000$56,660$50,420$42,900$36,820

b. YearNetCashFlowCumulativeCashFlow
1$46,000$46,000
256,660102,660
350,420153,080
Payback=3years+(($160,000153,080)$42,900)
=3.16years.

Netpresentvalue:
TimeAmountDiscountFactorPresentValue
Year0$(160,000)1.0000$(160,000)
Year1$46,000.925942,591
Year256,660.857348,575
Year350,420.793840,023
Year442,900.735031,532
Year536,820.680625,060
NPV$27,781

Profitabilityindex=($160,000+$27,781)$160,000=
1.17

IRR,isbetween14.5%and15%.Usingacomputer,theIRR
isfoundtobe14.68%.
132 Chapter14
CapitalBudgeting
66. a. MapleCommercialPlaza:
t0t1t10t10
$(800,000)$210,000$400,000

HighTower:
t0t1t10t10
$(3,400,000)$830,000$1,500,000

b. MapleCommercialPlaza:
Calculationofannualcashflow:
Pretaxcostsavings$210,000
Depreciation($800,00025)(32,000)
Pretaxincome$178,000
Taxes(40percent)(71,200)
Aftertaxincome$106,800
Depreciation32,000
Aftertaxcashflow$138,800

t0t1t10t10
$(800,000)$138,800$432,000*
*
Includes$32,000fromtaxlossonsale
(0.40($400,000$480,000))

HighTower:
Calculationofannualcashflow:
Pretaxcostsavings$830,000
Depreciation($3,400,00025)(136,000)
Pretaxincome$694,000
Taxes(277,600)
Aftertaxincome$416,400
Depreciation136,000
Aftertaxcashflow$552,400

t0t1t10t10
$(3,400,000)$552,400$1,716,000*
*
Includes$216,000fromtaxlossonsale
(0.40($1,500,000$2,040,000))
 Chapter14 133
CapitalBudgeting
c. AftertaxNPV,MapleCommercialPlaza:
AmountDiscountFactor PresentValue
Year0$(800,000)1.0000$(800,000)
Year110138,8005.8892817,421
Year10432,000.3522152,150
NPV$169,571

AftertaxNPV,Hightower:
AmountDiscountFactor PresentValue
Year0$(3,400,000)1.0000$(3,400,000)
Year110552,4005.88923,253,194
Year101,716,000.3522604,375
NPV$457,569
BasedontheNPVcriterion,Hightoweristhepreferred
investment

d. AftertaxNPV,Hightower:
AmountDiscountfactorPresentValue
Year0$(3,400,000) 1.0000 $(3,400,000)
Year110180,400 5.8892 1,062,412
Year110372,000* 4.1925 1,559,610
Year101,716,000.3522 604,375
NPV $(173,603)
*
Rentalportionofcashflow=$620,000(1taxrate)
=$620,0000.60
=$372,000

Underthiscircumstance,MapleCommercialPlazaisthe
preferredinvestment.
134 Chapter14
CapitalBudgeting
67. a. ProjectA
Year CashFlow PVFactor PV
0 $(96,000) 1.0000 $(96,000)
16 25,600 4.1114 105,252
NPV $9,252

PI=$105,252$96,000=1.10

IRR:Discountfactorfor6periodsis$96,000$25,600=
3.7500,whichyieldsarateofjustunder15.5%.

ProjectB
Year CashFlow PVFactor PV
0 $(160,000) 1.0000 $(160,000)
110 30,400 5.6502 171,766
NPV $11,766

PI=$171,766$160,000=1.07

IRR:Discountfactorfor6periodsis$160,000$30,400
=5.2631,whichyieldsarateofabout13.75%.

b. Althoughthemethodsgiveconflictingresults,theNPVof
BisgreaterthanthatofAandthisisprobablythebest
indicationforchoice.AlthoughtheIRRforProjectAis
higher,thereinvestmentassumptionofthatmethodis
lessattainable.EventhoughthePIofProjectAis
slightlyhigher,itsNPVislessandusuallydollarsare
thedecidingcriterionwhenratesareclose.

c. ProjectA'sIRRis15.5%andProjectB'sis13.75%.Above
13.75%,ProjectBwillhaveanegativeNPV.At12%,
ProjectA'sNPVis$9,252andProjectB'sis$11,766.By
repeatedtrials,theFisherrate(therateatwhichthe
NPVsareequal)isestimatedtobebetween12.50%and
13.0%.Byprogrammablecalculator,therateisfoundto
be12.64%.
 Chapter14 135
CapitalBudgeting
68. a. Projectname NPV PVI IRR
Filmstudios $3,578,8461.1813.03%
Cameras&equipment1,067,9201.3318.62
Landinvestment 2,250,6281.4519.69
Motionpicture#1 1,040,2761.0612.26
Motionpicture#2 1,026,0081.0914.22
Motionpicture#3 3,197,3631.4021.34
Corporateaircraft 518,9161.2218.15

b. Rankingaccordingto:
NPV PVI IRR
1.FilmStudios Landinvestment MP#3
2.MP#3 MP#3 LandInvestment
3.LandInvest. Camera&Equip. Camera&Equip.
4.Cam.&Equip. Corp.Aircraft Corp.Aircraft
5.MP#1FilmStudio MP#2
6.MP#2 MP#2 FilmStudios
7.Corp.aircraftMP#1 MP#1

c. Suggestedpurchases NPV
1.MP#3@$8,000,000$3,197,363
2.Landinvest.@$5,000,0002,250,628
3.Cam.&Equip.@$3,200,0001,067,920
4.Corp.Aircraft@$2,400,000518,916
TotalNPV $7,034,827

69. a. Depreciationperyear=$2,000,00014=$142,857

Beforetaxcashflows=[3000.80($75$10)50]
$100,000
=$680,000peryear

BeforetaxCF $680,000
LessDepreciation (142,857)
Incomebeforetax $537,143
Lesstax(35%) (188,000)
Netincome $349,143
AddDepreciation 142,857
Aftertaxcashflow $492,000
PVof14yr.annuityof$492,000@13% $3,100,830
Lesscost (2,000,000)
NPV $1,100,830

b. Itexceedsthehighestrateprovidedinthetable.By
computeritis23.29%.

c. Cashflowdiscountfactor=$2,000,000
Cashflow(6.3025)=$2,000,000
Cashflow =$317,334
136 Chapter14
CapitalBudgeting
d. 6years

e. $217,425aftertaxCF
[($217,425$142,857)0.65]+$142,857+$100,000=
$357,577beforetaxCF($357,577300)$65=19rooms
(roundedup)

70. a. YearRevenueVCFCNetCashFlow
14$125,000$75,000$20,000$30,000
58175,000105,00020,00050,000
910100,00060,00020,00020,000

Year CashFlow PVFactor PV

0 $(145,000) 1.0000$(145,000)
14 30,000 3.169995,097
58 50,000 2.1651108,255
910 20,000 .809616,192
10 10,000 .38553,855
NPV$78,399

b. YearRevenueVCFCNetCashFlow
14$120,000$78,000$15,000$27,000
58200,000130,00017,50052,500
910103,00066,95025,00011,050

Year Cashflow PVFactor PV

0 $(137,500) 1.0000$(137,500)
14 27,000 3.169985,587
58 52,500 2.1651113,668
910 11,050 .80968,946
10 23,500 .38559,059
NPV$79,760

c. Thebiggestfactorsaretheincreasedlevelofvariable
costs,theadditionalworkingcapital,thelower
initialrevenues,andthelowercostofproduction
equipment.
 Chapter14 137
CapitalBudgeting
71. a. Year NetIncome
1 $(107,500)
2 (40,000)
3 5,500
4 88,000
5 240,000
6 240,000
7 72,000
8 (42,000)
$456,000

Averageannualincome=$456,0008=$57,000
AverageInvestment=(Cost+Salvage)2
=($1,600,000+$0)2=$800,000
ARR=$57,000$800,000=7.125%

b. Cash Cash Net Cumulative

YearReceipts Expenses Inflows CashFlows
1 $750,000 $657,500 $92,500$92,500
2 800,000 640,000 160,000 252,500
3 930,000 724,500 205,500 458,000
4 1,280,000 992,000 288,000 746,000
5 1,600,000 1,160,000 440,000 1,186,000
6 1,600,000 1,160,000 440,000 1,626,000

Payback=5+(($1,600,000$1,186,000)$440,000)years
=5.94years

c. Year Cashflow PVfactor PV

0 $(1,600,000) 1.0000 $(1,600,000)
1 92,500 .8929 82,593
2 160,000 .7972 127,552
3 205,500 .7118 146,275
4 288,000 .6355 183,024
5 440,000 .5674 249,656
6 440,000 .5066 222,904
7 272,000 .4524 123,053
8 158,000 .4039 63,816
NPV $(401,127)
138 Chapter14
CapitalBudgeting
72. a. Initialcost:t0=$(730,000)+$170,000=$(560,000)
Annualcashflow:
Additionalrevenue($1.20110,000)$132,000
Laborsavings30,000
Otheroperatingsavings($192,000$80,000)112,000
Total $274,000

NPV=$(560,000)+($274,0006.1446)=$1,123,620

b. Discountfactor=$560,000$274,000=2.0438
TheIRRexceedsnumbersreportedinthepresentvalue
appendix.Bycomputer,theIRRisfoundtobe47.96%.

c. $560,000$274,000=2.04years

d. ARR=($274,000$31,000)(($560,000+$0)2)
=86.79%

e. Incrementalrevenue($132,00010years)$1,320,000
Laborcostsavings($30,00010years)300,000
Savingsinothercosts($112,00010years)1,120,000
Lessincrementalcost(560,000)
Incrementalprofit$2,180,000

Becausetheincrementalprofitisgreaterthan$0,the
firmshouldbuythenewequipment.
 Chapter14 139
CapitalBudgeting
Cases

73.Note:Studentsmayhaveslightlydifferentanswers.TheCMA
solutionusesonlytwodigitpresentvaluefactors.
a. PresentValueAnalysis(using6%)
Initial
Outlay20032004200520062007NPV
Internal
Financing
Outlay($1,000,000)
Depr.
tax
shield$160,000$96,000$57,600$43,200$43,200
NetCF($1,000,000)$160,000$96,000$57,600$43,200$43,200
PVfactors1.000.940.890.840.790.75
NPV ($1,000,000)$150,400$85,440$48,384$34,128$32,400$(649,248)

Bank
Loan
Outlay ($100,000)
Loan
payment ($237,420)($237,420)($237,420)($237,420)($237,420)
Interest
taxshield 36,00030,10323,61716,4828,638
Depr.
taxshield $160,000$96,000$57,600$43,200$43,200
NetCF($100,000)($41,420)($111,317)($156,203)($177,738)($185,582)
PVfactors1.000.940.890.840.790.75
NPV($100,000)($38,935)($99,072)($131,211)($140,413)($139,187)$(648,818)

Lease
Outlay($50,000)
Taxshield
onoutlay $20,000
Payments
netoftax
($220,000
60%)($132,000)($132,000)($132,000)($132,000)($132,000)
NCF($50,000)($112,000)($132,000)($132,000)($132,000)($132,000)
PVfactors1.000.940.890.840.790.75
NPV($50,000)($105,280)($117,480)($110,880)($104,280)($99,000)$(586,920)

NPVforinternalfinancing=$(649,248)
NPVforbankloan=$(648,818)
NPVforlease=$(586,920)
140 Chapter14
CapitalBudgeting
Supportingcalculations
Depreciationtaxshield
Year DepreciationRateTaxshield
1 $1,000,0000.40=$400,0000.40=$160,000
2 ($1,000,000$400,000)0.40=240,0000.40=96,000
3 ($1,000,000$640,000)0.40=144,0000.40=57,600
4 ($1,000,000$784,000)0.50=108,0000.40=43,200
5 ($1,000,000$784,000)0.50=108,0000.40=43,200

Interesttaxshield
Year Interest Rate Taxshield
1 $90,000 0.40 $36,000
2 75,258 0.40 30,103
3 59,042 0.40 23,617
4 41,204 0.40 16,482
5 21,596 0.40 8,638

1. Metrohealthshouldemploythecostofdebtofsix
percent(whichrepresentstheaftertaxeffectofthe
tenpercentincrementalborrowingrate)asadiscount
rateincalculatingthenetpresentvalueforallthree
financingalternatives.
Investmentdecisions(acceptversusreject)and
financingdecisionsshouldbeseparated.Costof
capitalorhurdleratesapplytoinvestmentdecisions
butnottofinancingdecisions.Thisapplicationisa
financingdecision.Incrementalcostofdebtisthe
basicrateusedfordiscountinginfinancingdecisions
becausetheassumptionmadeisthatthefirmwouldhave
noidlecashavailableforfundingandwouldhaveto
borrowfromanoutsidelendinginstitutionatthe
incrementalborrowingrate(10percentinthiscase).

2. Thefinancingalternativemostadvantageousto
Metrohealthisleasing.Thisalternativehasthelowest
netpresentvalue($586,920)whencomparedtotheother
twoalternatives.
 Chapter14 141
CapitalBudgeting
b. SomequalitativefactorsPaulMondenshouldincludefor
managementconsiderationbeforedecidingonthefinancing
alternativesare:
Thedifferentialimpactfromonefinancingmethodversus
anotherforequipmentacquisitionsduetovarioushealth
care,thirdpartypayor,reimbursementscenarios(the
federalgovernmentwithDRGreimbursementorinsurance
companyreimbursement).
Thetechnologyoftheequipmentalongwiththeriskof
technologicalobsolescence.Ifmajortechnological
advancesareexpected,thepreferredqualitativechoice
wouldbeleasingfromalessorwhowouldabsorbanyloss
duetoequipmentobsolescence.
Themaintenanceagreementincludedintheoperating
lease.
(CMAadapted)

74. a. Incrementalannualaftertaxcashflows:
Purchase Year0
Purchaseofnewequipment $(300,000)
Onetimeproductionexpense
netoftax($30,000.6) (18,000)
Saleofoldequipment
netoftax($5,000.6) 3,000
Totalinitialcashoutflow $(315,000)

AnnualOperations
Year1Year2Year3Year4
Cashoperating
savings$90,000$150,000$150,000$150,000
Lesstaxeffect(40%)(36,000)(60,000)(60,000)(60,000)
Cashsavings
aftertax$54,000$90,000$90,000$90,000
Depr.taxshield
(seesched.below)48,00036,00024,00012,000
Aftertaxoperating
cashflows$102,000$126,000$114,000$102,000

DepreciationSchedule
Depreciablebase:$300,000
Life:fouryearlimit
Method:Sumoftheyears'digits
Year Rate Depreciation Depr.Shield
1 4/10 $120,000 $48,000
2 3/10 90,000 36,000
3 2/10 60,000 24,000
4 1/10 30,000 12,000
142 Chapter14
CapitalBudgeting
b. ThecompanyshouldaccepttheproposalsincetheNPVis
positive.

Year CashFlow12%PVFactorPV
0 $(315,000) 1.0000 $(315,000)
1 102,000 .8929 91,076
2 126,000.7972 100,447
3 114,000 .7118 81,145
4102,000 .6355 64,821
NPV $22,489
(CMA)

75. a.Thebenefitsofapostcompletionauditprogramforcapital
expenditureprojectsincludethese:
Thecomparisonofactualresultswithprojectedresults
tovalidatethataprojectismeetingexpected
performanceortotakecorrectiveactionorterminatea
projectnotachievingexpectedperformance.
Anevaluationoftheaccuracyofprojectionsfrom
differentdepartments.
Theimprovementoffuturecapitalprojectrevenueand
costestimatesthroughanalyzingvariationsbetween
expectedandactualresultsfrompreviousprojectsand
themotivationaleffectonpersonnelarisingfromthe
knowledgethatapostinvestmentauditwillbedone.

b. Practicaldifficultiesthatwouldbeencounteredin
collectingandaccumulatinginformationinclude:
Isolatingtheincrementalchangescausedbyonecapital
projectfromalltheotherfactorsthatchangeina
dynamicmanufacturingand/ormarketingenvironment.
Identifyingtheimpactofinflationonallcostsinthe
capitalprojectjustification.
Updatingoftheoriginalproposalforapprovalof
changesthatmayhaveoccurredaftertheinitial
approval.
Havingasufficientlysophisticatedinformation
accumulationsystemtomeasureactualcostsincurredby
thecapitalproject.
Allocatingsufficientadministrativetimeandexpenses
forthepostcompletionaudit.
(CMAadapted)
 Chapter14 143
CapitalBudgeting
RealityCheck

76. a. Itisnoeasierforahealthcareconcernthananyother
businesstoinvestincapitalassetswhendoingsoisnot
justifiedonfinancialgrounds.Theproblemdescribedin
thearticlewouldseemtodescribeafailureofthe
informationsystemsofhealthcareproviderstofairly
captureallrelevantfinancialdimensionsoflongterm
strategicinvestments.Itisunreasonabletothinkthat
benefitssuchasimprovingqualityofcareorpatient
satisfactionhavenofinancialreturn.

b. Asanaccountantwithahealthcareprovider,youcould
identifynonfinancialbenefitssuchasthosedescribed
inparta.and,ifappropriate,assignvaluestothem.
Thekeycontributionyouwouldmakeistoprovidea
rigorousinvestmentanalysisthatincludesnotonlythose
costsandbenefitsusuallycapturedbyaccounting
systems,buttoaddotherbenefitsthatmaybemissed
becausethefinancialimpactisindirect(e.g.,increased
consumersatisfaction)ratherthandirect.

77. a. Forlaborintensiveoperations,laborcostandquality
wouldbesubstantialconsiderationsinlocatingnew
investments.Havingskilledlaboravailableata
competitivecostwoulddeterminethelikelihoodthatthe
newinvestmentwouldbeprofitable.

b. Inadditiontolaborcostandquality,firmswouldalso
considerthesefactors:
Politicalrisksofthealternativeinvestmentlocations
Nearnesstosuppliersandmarkets
Taxratesofthealternativelocations
Incentivesofferedbylocalgovernments
Locationofcompetitors

78. a. Whenshortruneconomicconditionsbecomedifficult,
companiesmustbeverycarefulwhencuttingcoststo
protectprofits.Inparticular,cuttingspendingon
training,researchanddevelopment,andcustomerservice
willsurelyhaveadeleteriouseffectonproductand
servicequality.Alternatively,cuttingadvertising
costsandothermarketingcostsmayhavemuchlesseffect
onproductquality.
144 Chapter14
CapitalBudgeting
b. Anycostcuttingmeasuresthataffectemployeeand
managerialtrainingorresearchanddevelopmentwillhave
longtermimplications.Incuttingtheseactivities,the
firmisessentiallyminingfutureprofitabilityto
protectcurrentprofitability.Theconsequencewillbe
lowerfutureprofits,fewerproductinnovations,and
underdevelopedhumanresources.

79. a. Managersbeartheburdenofmaximizingthewealthof
theirinvestors.Totheextentthatholdingassets(as
opposedtosellingthem)resultsindiminishedwealth,
themanagersarefailingintheirobligationtothe
shareholders.Managersmayhaveincentivestohold
nonperformingassetsiftheircompensationandincentives
arerelatedtothesizeofthefirm.Evenso,managers
haveanethicalobligationtopursuethemaximizationof
investorwealthsubjecttoethicaltreatmentofother
stakeholders.Thisobligationisnolessbindingmerely
becauseitconflictswiththemanagerspersonal
incentives.

b. Spinoffsmayresultinthefiringofworkersorthe
downgradingoftheirjobs.Managershavea
responsibilitytoseethatworkerswhoareinvolvedin
spinoffsaretreatedethically.Disaffectedworkers
shouldbegivenallthesupportservicesnecessaryto
findcomparablealternativeemployment.Ifpossible,
workersshouldbegivenopportunitiestotransferto
otheroperationsofthecompany.Otherwise,workers
shouldbeprovidedwithemploymentcounselingand
trainingnecessarytofindingequivalentemploymentwith
anotherfirm.

80. a. Aleaseisoftenfoundappealingbyconsumersbecauseit
resultsinalowermonthlypaymentinmanyinstancesthan
themonthlypaymentthatisrequiredtopurchaseacar.
Thisallowstheconsumereithertoenjoyalowermonthly
paymentor,forthesamemonthlypaymentrequiredto
amortizethecostofonevehicle,payasimilarmonthly
amountforamoreexpensivecar.

b. Yes.Aconsumershouldbeprovidedwithallnecessary
informationtomakeafaircomparisonbetweenthelease
andpurchasealternative.

c. Asanaccountant,youcouldprovideafinancial
comparisonoftheleaseandpurchasealternatives.Using
adiscountedcashflowapproach,youcouldcomparethe
presentvalueofpurchasingthevehicletothepresent
valueofleasingthevehicle.