Question : 93. Capital budgeting Golden Flights, Inc. considering buying some specialized machinery : 1229652

93. Capital budgeting
Golden Flights, Inc. is considering buying some specialized machinery which would enable the company to obtain a six-year government contract for the design and engineering of a futuristic plane. The machinery costs $975,000 and must be destroyed for security reasons at the end of the six-year contract period. The estimated annual operating results of the project are as follows:
  
All revenue from the contract and all expenses (except depreciation) will be received or paid in cash in the same period as recognized for accounting purposes. You are to compute the following three factors for this project:
(a) Payback period: __________ years
(b) Return on average investment: ___________%
(c) Net present value of the investment in this machinery, discounted at an annual rate of 12% (an annuity table shows that the present value of $1 received annually for six years discounted at 12% is 4.111): $___________

94. Capital budgeting

Carry-Along is debating whether or not to invest in new equipment to manufacture a line of high-quality luggage. The new equipment would cost $850,000, with an estimated four-year life and no salvage value. The estimated annual operating results with the new equipment are as follows:
  
All revenue from the new luggage line and all expenses (except depreciation) will be received or paid in cash in the same period as recognized for accounting purposes. You are to compute the following for the investment in the new equipment to produce the new luggage line:
(a) Annual cash flow: $___________
(b) Payback period: __________ years
(c) Return on average investment: ___________%
(d) Total present value of the expected future annual cash flows, discounted at an annual rate of 12% (an annuity table shows that the present value of $1 received annually for four years discounted at 12% is 3.037): $___________
(e) Net present value of the proposed investment: $___________

95. Capital budgeting

Flynn Corporation is debating whether to purchase a new computerized production system. The system will cost $450,000, and have an estimated 10-year life with a salvage value of $70,000. The estimated operating results from the new production system are as follows:
  
All revenue and expenses other than depreciation will be received and paid in cash. Compute the following for this proposal:
(a) Annual net cash flow: $___________
(b) Payback period: __________ years
(c) Return on average investment: ___________%
(d) Net present value, discounted at an annual rate of 6% (present value of $1 due in 10 years, discounted at 6%, is 0.558; present value of $1 received annually for 10 years, discounted at 6%, is 7.360): $___________

96. Capital budgeting

Mason Co. is evaluating two alternative investment proposals. Below are data for each proposal:
  
The following information was taken from present value tables:
  
All revenue and expenses other than depreciation will be received and paid in cash. The company uses a discount rate of 12% in evaluating all capital investments.
Compute the following for each proposal (round payback period to the nearest tenth of a year and round return on average investment to the nearest tenth of a percent):
  
(f) Based on your analysis, which proposal appears to be the best investment?

97. The shortcomings of the payback method

What are the major shortcomings of relying too heavily upon the payback period in evaluating capital investment decisions?