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Exam 24: Capital Budgeting and Investment Analysis

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Question 31

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The time value of money is considered when calculating the payback period of an investment.

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B) False

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Question 32

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Capital budgeting decisions are not affected by return on investment considerations.

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B) False

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Question 33

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A company is trying to decide which of two new product lines to introduce in the coming year. The predicted revenue and cost data for each product line follows: $\begin{array}{lrr}&\text { Product A }&\text { Product B }\\\text { Sales } & \$ 80,000 & \$ 96,000 \\\text { Direct materials } & 3,000 & 6,000 \\\text { Direct labor } & 30,000 & 45,000 \\\text { Other cash operating expenses } & 7,500 & 9,000\\\\\text { New equipment costs } & 75,000 & 100,000 \\\text { Estimated useful life (no salvage) } & 5 \text { years } & 5 \text { years }\end{array}$ The company has a 30% tax rate, it uses the straight-line depreciation method, and it predicts that cash flows will be spread evenly throughout each year. Calculate each product's payback period. If the company requires a payback period of three years or less, which, if either, product should be chosen?

The internal rate of return equals the rate that yields a net present value of zero for an investment.

Peng Corporation is considering the purchase of new equipment costing $30,000. The projected annual after-tax net income from the equipment is $1,200, after deducting $10,000 for depreciation. The revenue is to be received at the end of each year. The machine has a useful life of 4 years and no salvage value. Peng requires a 12% return on its investments. The factors for the present value of $1 for different periods follow: $\begin{array} { l r } \text { Periods } & \text { 12 Percent } \\1 & 0.8929 \\2 & 0.7972 \\3 & 0.7118 \\4 & 0.6355\end{array}$ Calculate the break-even time for this equipment.

Bower Co. is reviewing a capital investment of $50,000. This project's projected cash flows over a five-year period are estimated at $20,000 each year. Required: (a) Calculate the payback period. (b) Calculate the break-even time. Assume a 12% hurdle rate and use the table below: $\begin{array}{ll}&\text { Present }\\&\text { Value }\\\text { Periods }&\text { of } 1 \text { at } 12 \%\\1 & 0.8929 \\2 & 0.7972 \\3 & 0.7118 \\4 & 0.6355 \\5 & 0.5674\end{array}$ (c) Using the results in (a) and (b) make a recommendation for the project.

A company is considering purchasing a machine for $600,000. The machine is expected to generate a net after-tax income of $15,000 per year. Depreciation expense would be $60,000. What is the payback period for this machine?

A company is trying to decide which of two new product lines to introduce in the coming year. The company requires a 12% return on investment. The predicted revenue and cost data for each product line follows: The company has a 30% tax rate and it uses the straight-line depreciation method. The present value of an annuity of 1 for 5 years at 12% is 3.6048. Compute the net present value for each piece of equipment under each of the two product lines. Which, if either of these two investments is acceptable?

The __________________________ is the rate that yields a net present value of zero for an investment.

A company has a decision to make between two investment alternatives. The company requires a 10% return on investment. Predicted data is provided below: $\begin{array}{lrr}&\text { Investment Y }&\text { Investment Z }\\\text { Projected after-tax net income } & \$ 40,000 & \$ 42,000 \\\text { Investment costs } & \$ 600,000 & \$ 675,000 \\\text { Estimated life } & 6 \text { years } & 6 \text { years }\end{array}$ The present value of an annuity for 6 years at 10% is 4.3553. This company uses straight-line depreciation. Required: (a) Calculate the net present value for each investment. (b) Which investment should this company select? Explain.

Capital budgeting decisions usually involve analysis of:

Use of the internal rate of return method cannot be used with uneven cash flows.

The internal rate of return method is not subject to the limitations of the net present value method when comparing projects with different amounts invested because:

A company is considering the purchase of a new machine for $128,000. Management predicts that the machine can produce sales of $32,000 each year for the next 8 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $7,500 per year plus depreciation of $10,800 per year. The company's tax rate is 38%. What is the payback period for the new machine?

A given project requires a $30,000 investment and is expected to generate end-of-period annual cash inflows as follows: $\begin{array} { c c c c } \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Total } \\\hline \$ 12,000 & \$ 8,000 & \$ 10,000 & \$ 30,000\end{array}$ Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below. $\begin{array} { c c c } \begin{array} { c } \mathrm { i } = 10 \% \\\mathrm { n } = 1\end{array} & \begin{array} { c } \mathrm { i } = 10 \% \\\mathrm { n } = 2\end{array} & \begin{array} { c } \mathrm { i } = 10 \% \\\mathrm { n } = 3\end{array} \\\hline .9091 & .8264 & .7513\end{array}$

Which methods of evaluating a capital investment project use cash flows as a measurement basis?

Saxon Manufacturing is considering purchasing two machines. Each machine costs $9,000 and will produce cash flows as follows: $\begin{array}{rrr}\text { End of } & \text { Machine }\\\text { Year } &A&B\\1 & \$ 5,000 & \$ 1,000 \\2 & 4,000 & 2,000 \\3 & 2,000 & 11,000\end{array}$ Saxon Manufacturing uses the net present value method to make the decision, and it requires a 15% annual return on its investments. The present value factors of 1 at 15% are: 1 year, 0.8696; 2 years, 0.7561; 3 years, 0.6575. Which machine should Saxon purchase?

Capital budgeting decisions are generally based on:

Holder Manufacturing is considering purchasing two machines. Each machine costs $8,000 and will produce cash flows as follows: $\begin{array}{rrr}\text { End of } & \text { Machine }\\\text { Year } &A&B\\1 & \$ 5,000 & \$ 1,000 \\2 & 4,000 & 2,000 \\3 & 2,000 & 11,000\end{array}$ Holder Manufacturing uses the net present value method to make the decision, and it requires a 15% annual return on its investments. The present value factors of 1 at 15% are: 1 year, 0.8696; 2 years, 0.7561; 3 years, 0.6575. Which machine should Holder purchase?

A company purchases a machine for $62,000. The machine has an expected life of 15 years and no salvage value. The company anticipates a yearly net income of $15,000 after taxes of 29% to be received uniformly throughout each year. What is the accounting rate of return?