Capital Budgeting Decisions

Chapter 14
Capital Budgeting Decisions
True/False
1. Thepresentvalueofagivensumtobereceivedinfiveyears
F willbeexactlytwiceasgreatasthepresentvalueofanequal
Medium sumtobereceivedintenyears.
2. Anincreaseinthediscountratewillresultinanincreasein
F thepresentvalueofagivencashflow.
Medium
3. Thepresentvalueofacashflowdecreasesasitmovesfurther
T intothefuture.
Easy
4. Whenthenetpresentvaluemethodisused,theinternalrateof
F returnisthediscountrateusedtocomputethenetpresentvalue
Medium ofaproject.
5. Ifnetpresentvalueisnegative,theninterpolationisneededin
F ordertomakeaproposedinvestmentacceptable.
Medium
6. Thenetpresentvaluemethodassumesthatcashflowsfroma
T projectareimmediatelyreinvestedatarateofreturnequalto
Medium thediscountrate.
7. Whenusinginternalrateofreturntoevaluateinvestment
F projects,iftheinternalrateofreturnislessthanthe
Easy requiredrateofreturn,theprojectshouldbeaccepted.
8. Theinternalrateofreturnforaprojectisthediscountrate
T thatmakesthenetpresentvalueoftheprojectequaltozero.
Easy
9. Incomparingtwoinvestmentalternatives,thedifferencebetween
T thenetpresentvaluesofthetwoalternativesobtainedusingthe
Medium totalcostapproachwillbethesameasthenetpresentvalue
obtainedusingtheincrementalcostapproach.
10. Thepaybackperiodisthelengthoftimeittakesforan
T investmenttorecoupitsowninitialcostoutofthecash
Easy receiptsitgenerates.
ManagerialAccounting,9/e 5
11. Projectswithshorterpaybackperiodsarealwaysmoreprofitable
F thanprojectswithlongerpaybackperiods.
Medium
12. Thepaybackmethodofmakingcapitalbudgetingdecisionsgives
F fullconsiderationtothetimevalueofmoney.
Easy
13. Ifnewequipmentisreplacingoldequipment,anysalvagereceived
F fromsaleoftheoldequipmentshouldnotbeconsideredin
Easy computingthepaybackperiodofthenewequipment.
14. Onestrengthofthesimplerateofreturnmethodisthatittakes
F intoaccountthetimevalueofmoneyincomputingthereturnon
Easy aninvestmentproject.
15. Thepreferenceruleforrankingprojectsbytheprofitability
T indexis:thehighertheprofitabilityindex,themoredesirable
Easy theproject.
Multiple Choice
16. Anincreaseinthediscountrate:
C a.willincreasethepresentvalueoffuturecashflows.
Medium b.willhavenoeffectonnetpresentvalue.
c.willreducethepresentvalueoffuturecashflows.
d.isonemethodofcompensatingforreducedrisk.
17. SupposeaninvestmenthascashinflowsofRdollarsattheendof
B eachyearfortwoyears.Thepresentvalueofthesecashinflows
Medium usinga12%discountratewillbe:
a.greaterthanundera10%discountrate.
b.lessthanundera10%discountrate.
c.equaltothatundera10%discountrate.
d.sometimesgreaterthanundera10%discountrateand
sometimesless;itdependsonR.
18. Thenetpresentvalueandinternalrateofreturnmethodsof
B capitalbudgetingaresuperiortothepaybackmethodinthat
Medium they:
CPAadapted a.areeasiertoimplement.
b.considerthetimevalueofmoney.
c.requirelessinput.
d.reflecttheeffectsofdepreciationandincometaxes.
6 ManagerialAccounting,9/e
19. Howarethefollowingusedinthecalculationofthenet
C presentvalueofaproposedproject?Ignoreincometax
Medium considerations.
CPA
adapted DepreciationexpenseSalvagevalue
a.IncludeInclude
b.IncludeExclude
c.ExcludeInclude
d.ExcludeExclude
20. Thenetpresentvaluemethodtakesintoaccount:
D
Medium CashFlowOverTimeValue
CPA LifeofProjectofMoney
adapted a.NoYes
b.NoNo
c.YesNo
d.YesYes
21. Thenetpresentvaluemethodofcapitalbudgetingassumesthat
C cashflowsarereinvestedat:
Easy a.theinternalrateofreturnontheproject.
CMA b.therateofreturnonthecompany'sdebt.
adapted c.thediscountrateusedintheanalysis.
d.azerorateofreturn.
22. Someinvestmentprojectsrequirethatacompanyexpandits
C workingcapitaltoservicethegreatervolumeofbusinessthat
Medium willbegenerated.Underthenetpresentvaluemethod,the
investmentofworkingcapitalshouldbetreatedas:
a.aninitialcashoutflowforwhichnodiscountingis
necessary.
b.afuturecashinflowforwhichdiscountingisnecessary.
c.bothaninitialcashoutflowforwhichnodiscountingis
necessaryandafuturecashinflowforwhichdiscountingis
necessary.
d.irrelevanttothenetpresentvalueanalysis.
23. (Ignoreincometaxesinthisproblem.)Howisdepreciation
A handledbythefollowingcapitalbudgetingtechniques?
Medium
CMA InternalSimple
adapted RateofReturnRateofReturnPayback
a.ExcludedIncludedExcluded
b.IncludedExcludedIncluded
c.ExcludedExcludedIncluded
d.IncludedIncludedExcluded
24. Whichofthefollowingcapitalbudgetingtechniquesconsider(s)
B cashflowovertheentirelifeoftheproject?
Easy
CPA InternalrateofreturnPayback
adapted a.YesYes
b.YesNo
c.NoYes
d.NoNo
25. Aweaknessoftheinternalrateofreturnmethodforscreening
C investmentprojectsisthatit:
Medium a.doesnotconsiderthetimevalueofmoney.
CMA b.implicitlyassumesthatthecompanyisabletoreinvestcash
adapted flowsfromtheprojectatthecompany'sdiscountrate.
c.implicitlyassumesthatthecompanyisabletoreinvestcash
flowsfromtheprojectattheinternalrateofreturn.
d.doesnottakeintoaccountallofthecashflowsfroma
project.
26. Ifthenetpresentvalueofaprojectiszerobasedona
A discountrateofsixteenpercent,thenthetimeadjustedrate
Medium ofreturn:
a.isequaltosixteenpercent.
b.islessthansixteenpercent.
c.isgreaterthansixteenpercent.
d.cannotbedeterminedfromtheinformationgiven.
27. Thepaybackmethodmeasures:
A a.howquicklyinvestmentdollarsmayberecovered.
Easy b.thecashflowfromaninvestment.
CMAadapted c.theeconomiclifeofaninvestment.
d.theprofitabilityofaninvestment.
28. Aninvestmentprojectthatrequiresapresentinvestmentof
B $210,000willhavecashinflowsof"R"dollarseachyearfor
Medium thenextfiveyears.Theprojectwillterminateinfiveyears.
Considerthefollowingstatements(ignoreincometax
considerations):
I.If"R"islessthan$42,000,thepaybackperiodexceeds
thelifeoftheproject.
II.If"R"isgreaterthan$42,000,thepaybackperiodexceeds
thelifeoftheproject.
III.If"R"equals$42,000,thepaybackperiodequalsthelife
oftheproject.
Whichstatement(s)is(are)true?
a.OnlyIandII.
b.OnlyIandIII.
c.OnlyIIandIII.
d.I,II,andIII.
29. Whichoneofthefollowingstatementsaboutthepaybackmethod
A ofcapitalbudgetingiscorrect?
Easy a.Thepaybackmethoddoesnotconsiderthetimevalueof
CMA money.
adapted b.Thepaybackmethodconsiderscashflowsafterthepayback
hasbeenreached.
c.Thepaybackmethodusesdiscountedcashflowtechniques.
d.Thepaybackmethodwillleadtothesamedecisionasother
methodsofcapitalbudgeting.
30. Theevaluationofaninvestmenthavingunevencashflowsusing
B thepaybackmethod:
Medium a.cannotbedone.
b.canbedoneonlybymatchingcashinflowsandinvestment
outflowsonayearbyyearbasis.
c.willproductessentiallythesameresultsasthoseobtained
throughtheuseofdiscountedcashflowtechniques.
d.requirestheuseofasophisticatedcalculatororcomputer
software.
31. Thecapitalbudgetingmethodthatdividesaproject'sannual
B incrementalnetincomebytheinitialinvestmentisthe:
Medium a.internalrateofreturnmethod.
CMAadapted b.thesimple(oraccounting)rateofreturnmethod.
c.thepaybackmethod.
d.thenetpresentvaluemethod.
32. Whendetermininganetpresentvalueinaninflationary
B environment,adjustmentsshouldbemadeto:
Medium a.decreasethediscountrateonly.
CMA b.increasetheestimatedcashflowsandincreasethediscount
adapted rate.
c.increasetheestimatedcashflowsonly.
d.increasetheestimatedcashflowsanddecreasethediscount
rate.
33. (Ignoreincometaxesinthisproblem.)KiplingCompanyhas
B investedinaprojectthathasaneightyearlife.Itis
Hard expectedthattheannualcashinflowfromtheprojectwillbe
CPA $20,000.Assumingthattheprojecthasainternalrateof
adapted returnof12%,howmuchwastheinitialinvestmentinthe
project?
a.$160,000
b.$99,360
c.$80,800
d.$64,640
34. (Ignoreincometaxesinthisproblem.)WhiteCompany'srequired
D rateofreturnoncapitalbudgetingprojectsis12%.The
Medium companyisconsideringaninvestmentopportunitywhichwould
yieldacashflowof$10,000infiveyears.Whatisthemost
thatthecompanyshouldbewillingtoinvestinthisproject?
a.$36,050.
b.$2,774.
c.$17,637.
d.$5,670.
35. (Ignoreincometaxesinthisproblem.)Inordertoreceive
C $12,000attheendofthreeyearsand$10,000attheendof
Easy fiveyears,howmuchmustbeinvestednowifyoucanearn14%
rateofreturn?
a.$12,978.
b.$8,100.
c.$13,290.
d.$32,054.
36. (Ignoreincometaxesinthisproblem.)SueFallsisthe
C presidentofSports,Inc.Sheisconsideringbuyinganew
Hard machinethatwouldcost$14,125.Suehasdeterminedthatthe
newmachinepromisesainternalrateofreturnof12%,butSue
hasmisplacedthepaperwhichtellstheannualcostsavings
promisedbythenewmachine.Shedoesrememberthatthemachine
hasaprojectedlifeof10years.Basedonthesedata,the
annualcostsavingsare:
a.itisimpossibletodeterminefromthedatagiven.
b.$1,412.50.
c.$2,500.00.
d.$1,695.00.
37. (Ignoreincometaxesinthisproblem.)Thefollowing
C informationisavailableonanewpieceofequipment:
Hard
Costoftheequipment......$21,720
Annualcashinflows........$5,000
Internalrateofreturn...16%
Requiredrateofreturn...10%
Thelifeoftheequipmentisapproximately:
a.6years.
b.4.3years.
c.8years.
d.itisimpossibletodeterminefromthedatagiven.
38. (Ignoreincometaxesinthisproblem.)Aplannedfactory
C expansionprojecthasanestimatedinitialcostof$800,000.
Hard Usingadiscountrateof20%,thepresentvalueoffuturecost
CPAadapted savingsfromtheexpansionis$843,000.Toyieldexactlya20%
internalrateofreturn,theactualinvestmentcostcannot
exceedthe$800,000estimatebymorethan:
a.$160,000.
b.$20,000.
c.$43,000.
d.$1,075.
39. (Ignoreincometaxesinthisproblem.)HilltopCompanyinvested
D $100,000inatwoyearproject.Thecashflowwas$40,000for
Hard thefirstyear.Assumingthattheinternalrateofreturnwas
CPAadapted exactly12%,whatwasthecashflowforthesecondyearofthe
project?
a.$51,247.
b.$60,000.
c.$64,284.
d.$80,652.
40. (Ignoreincometaxesinthisproblem.)JoeFlubupisthe
C presidentofFlubup,Inc.Heisconsideringbuyinganew
Hard machinethatwouldcost$25,470.Joehasdeterminedthatthe
newmachinepromisesainternalrateofreturnof14%,butJoe
hasmisplacedthepaperwhichtellstheannualcostsavings
promisedbythenewmachine.Hedoesrememberthatthemachine
hasaprojectedlifeof12years.Basedonthesedata,the
annualcostsavingsare:
a.impossibletodeterminefromthedatagiven.
b.$2,122.50.
c.$4,500.00.
d.$4,650.00.
41. (Ignoreincometaxesinthisproblem.)TheBakerCompany
B purchasedapieceofequipmentwiththefollowingexpected
Hard results:

Usefullife...................7years
Yearlynetcashinflow........$50,000
Salvagevalue.................0
Internalrateofreturn.......20%
Discountrate.................16%
Theinitialcostoftheequipmentwas:
a.$300,100.
b.$180,250
c.$190,600.
d.Cannotbedeterminedfromtheinformationgiven.
42. (Ignoreincometaxesinthisproblem.)Highpoint,Inc.,is
B consideringinvestinginautomatedequipmentwithatenyear
Hard usefullife.ManagersatHighpointhaveestimatedthecash
flowsassociatedwiththetangiblecostsandbenefitsof
automation,buthavebeenunabletoestimatethecashflows
associatedwiththeintangiblebenefits.Usingthecompany's
10%discountrate,thenetpresentvalueofthecashflows
associatedwithjustthetangiblecostsandbenefitsisa
negative$184,350.Howlargewouldtheannualnetcashinflows
fromtheintangiblebenefitshavetobetomakethisa
financiallyacceptableinvestment?
a.$18,435.
b.$30,000.
c.$35,000.
d.$37,236.
43. (Ignoreincometaxesinthisproblem.)Giventhefollowing
B data:
Hard
Presentinvestmentrequired..$12,000
Netpresentvalue............$430
Annualcostsavings..........$?
Discountrate................12%
Lifeoftheproject..........10years
Basedonthedatagiven,theannualcostsavingswouldbe:
a.$1,630.00.
b.$2,200.00.
c.$2,123.89.
d.$2,553.89.
44. (Ignoreincometaxesinthisproblem.)Thefollowingdata
A pertaintoaninvestmentinequipment:
Medium
Investmentintheproject..........$10,000
Netannualcashinflows............2,400
Workingcapitalrequired...........5,000
Salvagevalueoftheequipment.....1,000
Lifeoftheproject................8years
Atthecompletionoftheproject,theworkingcapitalwillbe
releasedforuseelsewhere.Computethenetpresentvalueof
theproject,usingadiscountrateof10%:
a.$606.
b.$8,271.
c.($1,729).
d.$1,729.
45. (Ignoreincometaxesinthisproblem.)Apieceofequipmenthas
A acostof$20,000.Theequipmentwillprovidecostsavingsof
Medium $3,500eachyearfortenyears,afterwhichtimeitwillhavea
salvagevalueof$2,500.Ifthecompany'sdiscountrateis12%,
theequipment'snetpresentvalueis:
a.$580.
b.($225).
c.$17,500.
d.$2,275.
46. (Ignoreincometaxesinthisproblem.)ParksCompanyis
D consideringaninvestmentproposalinwhichaworkingcapital
Medium investmentof$10,000wouldberequired.Theinvestmentwould
providecashinflowsof$2,000peryearforsixyears.The
workingcapitalwouldbereleasedforuseelsewherewhenthe
projectiscompleted.Ifthecompany'sdiscountrateis10%,
theinvestment'snetpresentvalueis:
a.$1,290.
b.($1,290).
c.$2,000.
d.$4,350.
A pertaintoaninvestmentproposal:
Medium
Investmentintheproject(equipment)..$14,000
Netannualcashinflowspromised.......2,800
Workingcapitalrequired...............5,000
Salvagevalueoftheequipment.........1,000
Lifeoftheproject....................10years
Theworkingcapitalwouldbereleasedforuseelsewherewhen
theprojectiscompleted.Whatisthenetpresentvalueofthe
project,usingadiscountrateof8%?
a.$2,566.
b.($251).
c.$251.
d.$5,251.
48. (Ignoreincometaxesinthisproblem.)BostonCompanyis
C contemplatingthepurchaseofanewmachineonwhichthe
Medium followinginformationhasbeengathered:
Costofthemachine...............$38,900
Annualcashinflowsexpected......$10,000
Salvagevalue.....................$5,000
Lifeofthemachine...............6years
Thecompany'sdiscountrateis16%,andthemachinewillbe
depreciatedusingthestraightlinemethod.Giventhesedata,
themachinehasanetpresentvalueof:
a.$26,100.
b.$23,900.
c.$0.
d.+$26,100.
49. (Ignoreincometaxesinthisproblem.)BenzCompanyis
B consideringthepurchaseofamachinethatcosts$100,000and
Hard hasausefullifeof18years.Thecompany'srequireddiscount
rateis12%.Ifthemachine'snetpresentvalueis$5,850,then
theannualcashinflowsassociatedwiththemachinemustbe
(roundtothenearestwholedollar):
a.$42,413.
b.$14,600.
c.$13,760.
d.itisimpossibletodeterminefromthedatagiven.
50. (Ignoreincometaxesinthisproblem.)HornCorporationis
C consideringinvestinginafouryearproject.Cashinflowsfrom
Hard theprojectareexpectedtobeasfollows:Year1,$2,000;Year
CPAadapted 2,$2,200;Year3,$2,400;Year4,$2,600.Ifusingadiscount
rateof8%,theprojecthasapositivenetpresentvalueof
$500,whatwastheamountoftheoriginalinvestment?
a.$1,411.
b.$2,411.
c.$7,054.
d.$8,054.
51. (Ignoreincometaxesinthisproblem.)TheWhittonCompanyuses
B adiscountrateof16%.Thecompanyhasanopportunitytobuya
Medium machinenowfor$18,000thatwillyieldcashinflowsof$10,000
peryearforeachofthenextthreeyears.Themachinewould
havenosalvagevalue.Thenetpresentvalueofthismachineto
thenearestwholedollaris:
a.$22,460.
b.$4,460.
c.$(9,980).
d.$12,000.
D pertaintoaninvestment:
Medium
Costoftheinvestment........$18,955
Lifeoftheproject...........5years
Annualcostsavings...........$5,000
Estimatedsalvagevalue.......$1,000
Discountrate.................10%
Thenetpresentvalueoftheproposedinvestmentis:
a.$3,355.
b.($3,430).
c.$0.
d.$621.
D pertaintoaninvestmentproposal:
Medium
Costoftheinvestment..........$20,000
Annualcostsavings.............$5,000
Estimatedsalvagevalue.........$1,000
Lifeoftheproject.............8years
Discountrate...................16%
Thenetpresentvalueoftheproposedinvestmentis:
a.$1,720.
b.$6,064.
c.$2,154.
d.$2,025.
54. (Ignoreincometaxesinthisproblem.)StratfordCompany
C purchasedamachinewithanestimatedusefullifeofseven
Hard years.Themachinewillgeneratecashinflowsof$90,000each
yearoverthenextsevenyears.Ifthemachinehasnosalvage
valueattheendofsevenyears,andassumingthecompany's
discountrateis10%,whatisthepurchasepriceofthemachine
ifthenetpresentvalueoftheinvestmentis$170,000?
a.$221,950.
b.$170,000.
c.$268,120.
d.$438,120.
55. (Ignoreincometaxesinthisproblem.)SamWelleristhinking
C ofinvesting$70,000tostartabookstore.Samplansto
Medium withdraw$15,000fromthebusinessattheendofeachyearfor
thenextfiveyears.Attheendofthefifthyear,Samplansto
sellthebusinessfor$110,000cash.Ata12%discountrate,
whatisthenetpresentvalueoftheinvestment?
a.$54,075.
b.$62,370.
c.$46,445.
d.$70,000.
56. (Ignoreincometaxesinthisproblem.)Arthuroperatesapart
D timeautorepairservice.Heestimatesthatanewdiagnostic
Hard computersystemwillresultinincreasedcashinflowsof$2,100
inYear1,$3,200inYear2,and$4,000inYear3.IfArthur's
discountrateis10%,thenthemosthewouldbewillingtopay
forthenewcomputersystemwouldbe:
a.$6,652.
b.$6,984.
c.$7,747.
d.$7,556.
C pertaintoaninvestmentproposal:
Medium
Presentinvestmentrequired........$26,500
Annualcostsavings................$5,000
Projectedlifeoftheinvestment...10years
Projectedsalvagevalue............$0
Theinternalrateofreturn,interpolatedtothenearesttenth
ofapercent,wouldbe:
a.11.6%.
b.12.8%.
c.13.6%.
d.12.4%.
58. (Ignoreincometaxesinthisproblem.)Thefollowingdataare
A availableonaproposedinvestmentproject:
Medium
Initialinvestment.........$142,500
Annualcashinflows........$30,000
Lifeoftheinvestment.....8years
Requiredrateofreturn....10%
ofapercent,wouldbe:
a.13.3%.
b.12.1%.
c.15.3%.
d.12.7%.
C pertaintoaninvestmentproposal:
Medium
Presentinvestmentrequired........$14,000
Annualcostsavings................$2,500
Projectedlifeoftheinvestment...8years
Projectedsalvagevalue............$0
Requiredrateofreturn............6%
ofapercent,wouldbe:
a.6.7%.
b.9.3%.
c.8.7%.
d.7.3%.
60. (Ignoreincometaxesinthisproblem.)OverlandCompanyhas
A gatheredthefollowingdataonaproposedinvestmentproject:
Hard
Investmentindepreciableequipment....$150,000
Annualcashflows......................$40,000
Lifeoftheequipment..................10years
Salvagevalue..........................0
Discountrate..........................10%
Theinternalrateofreturnonthisinvestmentisclosestto:
a.23.4%.
b.25.4%.
c.22.7%
d.22.1%
61. (Ignoreincometaxesinthisproblem.)Thefollowing
A informationconcernsaproposedinvestment:
Medium
Investmentrequired........$14,150
Annualsavings.............$2,500
Lifeoftheproject........12years
Theinternalrateofreturnis(donotinterpolate):
a.14%.
b.12%.
c.10%.
d.5%.
62. (Ignoreincometaxesinthisproblem.)JarveyCompanyis
A studyingaprojectthatwouldhaveatenyearlifeandwould
Medium requirea$450,000investmentinequipmentthathasnosalvage
value.Theprojectwouldprovidenetincomeeachyearas
followsforthelifeoftheproject:
Sales............................$500,000
Lesscashvariableexpenses......200,000
Contributionmargin..............300,000
Lessfixedexpenses:
Fixedcashexpenses............$150,000
Depreciationexpenses..........45,000195,000
Netincome.......................$105,000
Thecompany'srequiredrateofreturnis12%.Whatisthe
paybackperiodforthisproject?
a.3years
b.2years
c.4.28years
d.9years
63. (Ignoreincometaxesinthisproblem.)BuyRitePharmacyhas
A purchasedasmallautofordeliveringprescriptions.Theauto
Medium waspurchasedfor$9,000andwillhavea6yearusefullifeand
a$3,000salvagevalue.Deliveringprescriptions(whichthe
pharmacyhasneverdonebefore)shouldincreasegrossrevenues
byatleast$5,000peryear.Thecostoftheseprescriptionsto
thepharmacywillbeabout$2,000peryear.Thepharmacy
depreciatesallassetsusingthestraightlinemethod.The
paybackperiodfortheautois:
a.3.0years.
b.1.8years.
c.2.0years.
d.1.2years.
64. (Ignoreincometaxesinthisproblem.)Acompanywith$800,000
C inoperatingassetsisconsideringthepurchaseofamachine
Easy thatcosts$75,000andwhichisexpectedtoreduceoperating
costsby$20,000eachyear.Thepaybackperiodforthismachine
inyearsisclosestto:
a.0.27years.
b.10.7years.
c.3.75years.
d.40years.
65. (Ignoreincometaxesinthisproblem.)TheHigginsCompanyhas
B justpurchasedapieceofequipmentatacostof$120,000.This
Easy equipmentwillreduceoperatingcostsby$40,000eachyearfor
thenexteightyears.Thisequipmentreplacesoldequipment
thatwassoldfor$8,000cash.Thenewequipmenthasapayback
periodof:
a.8.0years.
b.2.8years.
c.10.0years.
d.3.0years.
66. (Ignoreincometaxesinthisproblem.)TheKeegoCompanyis
D planninga$200,000equipmentinvestmentthathasanestimated
Medium fiveyearlifewithnoestimatedsalvagevalue.Thecompanyhas
CMA projectedthefollowingannualcashflowsfortheinvestment.
adapted
YearCashInflows
1$120,000
260,000
340,000
440,000
540,000
Total$300,000
Assumingthatthecashinflowsoccurevenlyovertheyear,the
paybackperiodfortheinvestmentis:
a.0.75years.
b.1.67years.
c.4.91years.
d.2.50years.
67. (Ignoreincometaxesinthisproblem.)DennyCorporationis
A consideringreplacingatechnologicallyobsoletemachinewitha
Hard newstateoftheartnumericallycontrolledmachine.Thenew
machinewouldcost$450,000andwouldhaveatenyearuseful
life.Unfortunately,thenewmachinewouldhavenosalvage
value.Thenewmachinewouldcost$20,000peryeartooperate
andmaintain,butwouldsave$100,000peryearinlaborand
othercosts.Theoldmachinecanbesoldnowforscrapfor
$50,000.Thesimplerateofreturnonthenewmachineis
closestto:
a.8.75%.
b.20.00%.
c.7.78%.
d.22.22%.
68. (Ignoreincometaxesinthisproblem.)TheJasonCompanyis
A consideringthepurchaseofamachinethatwillincrease
Medium revenuesby$32,000eachyear.Cashoutflowsforoperatingthis
machinewillbe$6,000eachyear.Thecostofthemachineis
$65,000.Itisexpectedtohaveausefullifeoffiveyears
withnosalvagevalue.Forthismachine,thesimplerateof
returnis:
a.20%.
b.40%.
c.49.2%.
d.9.2%.
69. PerkinsCompanyisconsideringseveralinvestmentproposals,as
A shownbelow:
Easy
InvestmentProposalo
ABCD
Investmentrequired...$80,000$100,000$60,000$75,000
Presentvalueoffuture
netcashflows......96,000150,00084,000120,000
Ranktheproposalsintermsofpreferenceusingthe
profitabilityindex:
a.D,B,C,A.
b.B,D,C,A.
c.B,D,A,C.
d.A,C,B,D.
70. Informationonfourinvestmentproposalsisgivenbelow:
C
Easy ProposalInvestmentNetPresentValue
1$50,000$30,000
260,00024,000
330,00015,000
445,0009,000
Ranktheproposalsintermsofpreferenceaccordingtothe
profitabilityindex:
a.3,4,1,2.
b.1,2,3,4.
c.1,3,2,4.
d.2,1,4,3.
Reference:141
(Ignoreincometaxesinthisproblem.)ShieldsCompanyhasgatheredthe
followingdataonaproposedinvestmentproject:
Investmentrequiredinequipment.....$400,000
Annualcashinflows..................$80,000
Salvagevalue........................$0
Lifeoftheinvestment...............10years
Discountrate........................10%
71. Thepaybackperiodfortheinvestmentisclosestto:
D a.0.2years.
Easy b.1.0years.
ReferTo: c.3.0years.
141 d.5.0years.
72. Thesimplerateofreturnontheinvestmentisclosestto:
B a.5%.
Medium b.10%.
ReferTo: c.15%.
141 d.20%.
73. Thenetpresentvalueonthisinvestmentisclosestto:
C a.$400,000.
Medium b.$80,000.
ReferTo: c.$91,600.
141 d.$76,750.
74. Theinternalrateofreturnontheinvestmentisclosestto:
C a.11%.
Medium b.13%.
ReferTo: c.15%.
141 d.17%.
Reference:142
(Ignoreincometaxesinthisproblem.)Bugle'sBagelBakeryisinvestigating
thepurchaseofanewbagelmakingmachine.Thismachinewouldprovidean
annualoperatingcostsavingsof$3,650foreachofthenext4years.In
addition,thisnewmachinewouldallowtheproductionofonenewtypeof
bagelthatwouldresultinselling1,500dozenmorebagelseachyear.The
companyearnsacontributionmarginof$0.90oneachdozenbagelssold.The
purchasepriceofthismachineis$13,450anditwillhavea4yearuseful
life.Bugle'sdiscountrateis14%.
75. Thetotalannualcashinflowfromthismachineforcapital
D budgetingpurposesis:
Medium a.$3,650.
ReferTo: b.$5,150.
142 c.$4,750.
d.$5,000.
76. Theinternalrateofreturnforthisinvestmentisclosestto:
C a.14%.
Medium b.16%.
ReferTo: c.18%.
142 d.20%.
77. Thenetpresentvalueofthisinvestmentisclosestto:
A a.$1,120.
Medium b.$6,550.
ReferTo: c.$13,450.
142 d.$20,000.
Reference:143
(Ignoreincometaxesinthisproblem.)TreadsCorporationisconsideringthe
replacementofanoldmachinethatiscurrentlybeingused.Theoldmachine
isfullydepreciatedbutcanbeusedbythecorporationforfivemoreyears.
IfTreadsdecidestoreplacetheoldmachine,PiccoCompanyhasofferedto
purchasetheoldmachinefor$60,000.Theoldmachinewouldhavenosalvage
valueinfiveyears.
ThenewmachinewouldbeacquiredfromHillcrestIndustriesfor$1,000,000
incash.Thenewmachinehasanexpectedusefullifeoffiveyearswithno
salvagevalue.Duetotheincreasedefficiencyofthenewmachine,estimated
annualcashsavingsof$300,000wouldbegenerated.
TreadsCorporationusesadiscountrateof12%.
78. Thenetpresentvalueoftheprojectisclosestto:
C a.$171,000.
Medium b.$136,400.
ReferTo: c.$141,500.
143 d.$560,000.
79. Theinternalrateofreturnoftheprojectisclosestto:
C a.14%.
Medium b.16%.
ReferTo: c.18%.
143 d.20%.
Reference:144
(Ignoreincometaxesinthisproblem.)OrientalCompanyhasgatheredthe
followingdataonaproposedinvestmentproject:
Investmentindepreciableequipment.....$200,000
Annualnetcashflows...................$50,000
Lifeoftheequipment...................10years
Salvagevalue...........................0
Discountrate...........................10%
Thecompanyusesstraightlinedepreciationonallequipment.
80. Thepaybackperiodfortheinvestmentwouldbe:
D a.2.41years.
Medium b.0.25years.
ReferTo: c.10years.
144 d.4years.
81. Thesimplerateofreturnontheinvestmentwouldbe:
C a.10%.
Medium b.35%.
ReferTo: c.15%.
144 d.25%.
82. Thenetpresentvalueofthisinvestmentwouldbe:
B a.($14,350).
Medium b.$107,250.
ReferTo: c.$77,200.
144 d.$200,000.
Reference:145
(Ignoreincometaxesinthisproblem.)ApexCorp.isplanningtobuy
productionmachinerycosting$100,000.Thismachinery'sexpectedusefullife
isfiveyears,withnoresidualvalue.Apexusesadiscountrateof10%and
hascalculatedthefollowingdatapertainingtothepurchaseandoperation
ofthismachinery:
Estimated
annualnet
Yearcashinflow
1$60,000
230,000
320,000
420,000
520,000
83. Thepaybackperiodis:
A a.2.50years.
Medium b.2.75years.
CPA c.3.00years.
adapted d.5.00years.
ReferTo:
145
84. Thenetpresentvalueisclosestto:
A a.$20,400.
Medium b.$28,400.
CPA c.$80,000.
adapted d.$50,000.
ReferTo:
145
Reference:146
(Ignoreincometaxesinthisproblem.)TheFinneyCompanyisreviewingthe
possibilityofremodelingoneofitsshowroomsandbuyingsomenewequipment
toimprovesalesoperations.Theremodelingwouldcost$120,000nowandthe
usefullifeoftheprojectis10years.Additionalworkingcapitalneeded
immediatelyforthisprojectwouldbe$30,000;theworkingcapitalwouldbe
releasedforuseelsewhereattheendofthe10yearperiod.Theequipment
andothermaterialsusedintheprojectwouldhaveasalvagevalueof
$10,000in10years.Finney'sdiscountrateis16%.
85. Theimmediatecashoutflowrequiredforthisprojectwouldbe:
B a.$(120,000).
Easy b.$(150,000).
ReferTo: c.$(90,000).
146 d.$(130,000).
86. Whatwouldtheannualnetcashinflowsfromthisprojecthave
D tobeinordertojustifyinvestinginremodeling?
Hard a.$14,495
ReferTo: b.$35,842
146 c.$16,147
d.$29,158
Reference:147
(Ignoreincometaxesinthisproblem.)TheSawyerCompanyhas$80,000to
investandisconsideringtwodifferentprojects,XandY.Thefollowing
dataareavailableontheprojects:
ProjectXProjectY
Costofequipmentneedednow...$80,000
Workingcapitalrequirement....$80,000
Annualcashoperatinginflows..$23,000$18,000
Salvagevaluein5years.......$6,000
Bothprojectswillhaveausefullifeof5years;attheendof5years,the
workingcapitalwillbereleasedforuseelsewhere.Sawyer'sdiscountrate
is12%.
87. ThenetpresentvalueofprojectXis:
D a.$2,915.
Medium b.$(11,708).
ReferTo: c.$5,283.
147 d.$6,317.
88. ThenetpresentvalueofprojectYisclosestto:
B a.$15,110.
Medium b.$30,250.
ReferTo: c.$11,708.
147 d.$(11,708).
Reference:148
(Ignoreincometaxesinthisproblem.)TheBeckerCompanyisinterestedin
buyingapieceofequipmentthatitneeds.Thefollowingdatahavebeen
assembledconcerningthisequipment:
Costofrequiredequipment..........$250,000
Workingcapitalrequired............$100,000
Annualoperatingcashinflows........$80,000
Cashrepairatendof4years.......$40,000
Salvagevalueatendof6years.....$90,000
Thisequipmentisexpectedtohaveausefullifeof6years.Attheendof
thesixthyeartheworkingcapitalwouldbereleasedforuseelsewhere.The
company'sdiscountrateis10%.
89. Thepresentvalueofallfutureoperatingcashinflowsis
C closestto:
Easy a.$480,000.
ReferTo: b.$452,300.
148 c.$348,400.
d.$278,700.
90. Thepresentvalueofthenetcashflows(allcashinflowsless
B allcashoutflows)occurringduringyear4is:
Easy a.$40,000.
ReferTo: b.$27,320.
148 c.$54,640.
d.$42,790.
91. Thepresentvalueofthenetcashflows(allcashinflowsless
D allcashoutflows)occurringduringyear6isclosestto:
Medium a.$270,000.
148 c.$107,200.
d.$152,300.
Reference:149
(Ignoreincometaxesinthisproblem.)URCompanyisconsideringrebuilding
andsellingusedalternatorsforautomobiles.Thecompanyestimatesthatthe
netoperatingcashflows(saleslesscashoperatingexpenses)arisingfrom
therebuildingandsaleoftheusedalternatorswouldbeasfollows(numbers
inparenthesesindicateanoutflow):
Years110...$90,000
Year11........(20,000)
Year12........100,000
Inadditiontotheabovenetoperatingcashflows,URCompanywouldpurchase
productionequipmentcosting$200,000nowtouseintherebuildingofthe
alternators.Theequipmentwouldhavea12yearlifeanda$15,000salvage
value.Thecompany'sdiscountrateis10%.
92. Thepresentvalueofthenetoperatingcashflows(salesless
C cashoperatingexpenses)arisingfromtherebuildingandsale
Medium ofthealternators(roundedtothenearestdollar)is:
ReferTo: a.$582,735.
149 b.$596,735.
c.$577,950.
d.$591,950.
93. Thenetpresentvalueofallcashflowsassociatedwiththis
B investment(roundedtothenearestdollar)is:
Medium a.$377,950.
149 c.$392,950.
d.$362,950.
Reference:1410
(Ignoreincometaxesinthisproblem.)WestlandCollegehasatelephone
systemthatisinpoorcondition.Thesystemeithercanbeoverhauledor
replacedwithanewsystem.Thefollowingdatahavebeengatheredconcerning
thesetwoalternatives:
PresentProposedNew
SystemSystem

Purchasecostnew.......................$250,000$300,000
Accumulateddepreciation................$240,000
Overhaulcostsneedednow...............$230,000
Annualcashoperatingcosts.............$180,000$170,000
Salvagevaluenow.......................$160,000
Salvagevalueattheendof8years.....$152,000$165,000
Workingcapitalrequired................$200,000
WestlandCollegeusesa10%discountrateandthetotalcostapproachto
capitalbudgetinganalysis.Bothalternativesareexpectedtohaveauseful
lifeofeightyears.
94. Thenetpresentvalueofthealternativeofoverhaulingthe
B presentsystemis:
Hard a.$(1,279,316).
ReferTo: b.$(1,119,316).
1410 c.$801,284.
d.$(1,194,036).
95. Thenetpresentvalueofthealternativeofpurchasingthenew
A systemis:
Hard a.$(1,076,495).
ReferTo: b.$(1,236,495).
1410 c.$(1,169,895).
d.$(969,895).
Reference:1411
(Ignoreincometaxesinthisproblem.)LambertManufacturinghas$60,000to
investineitherProjectAorProjectB.Thefollowingdataareavailableon
theseprojects:
ProjectAProjectB
Costofequipmentneedednow..............$120,000$70,000
Workingcapitalinvestmentneedednow.....$50,000
Annualnetoperatingcashinflows.........$50,000$45,000
Salvagevalueofequipmentin6years.....$15,000
Bothprojectshaveausefullifeof6years.Attheendof6years,the
workingcapitalinvestmentwillbereleasedforuseelsewhere.Lambert's
discountrateis14%.
96. ThenetpresentvalueofProjectAisclosestto:
D a.$82,241.
Medium b.$67,610.
ReferTo: c.$74,450.
1411 d.$81,290.
97. ThenetpresentvalueofProjectBisclosestto:
A a.$77,805.
Medium b.$127,805.
ReferTo: c.$55,005.
1411 d.$105,005.
98. Whichofthefollowingstatementsis(are)correct?
C
Medium I.ProjectAisacceptableaccordingtothenetpresentvalue
ReferTo: method.
1411 II.ProjectAhasaninternalrateofreturngreaterthan14%.
a.OnlyI.
b.OnlyII.
c.BothIandII.
d.NeitherInorII.
Reference:1412
(Ignoreincometaxesinthisproblem.)FastFood,Inc.,haspurchasedanew
donutmaker.Itcost$16,000andhasanestimatedlifeof10years.The
followingannualdonutsalesandexpensesareprojected:
Sales.....................$22,000
Expenses:
Flour,etc.,required
inmakingdonuts...$10,000
Salaries...............6,000
Depreciation...........1,60017,600
Netincome................$4,400
99. Thepaybackperiodonthenewmachineisclosestto:
B a.5years.
Medium b.2.7years.
1412 d.1.4years.
100. Thesimplerateofreturnforthenewmachineisclosestto:
C a.20%.
Easy b.37.5%.
ReferTo: c.27.5%.
1412 d.80.0%.
Reference:1413
(Ignoreincometaxesinthisproblem.)PurvellCompanyhasjustacquireda
newmachine.Dataonthemachinefollow:
Purchasecost............$50,000
Annualcostsavings......15,000
Lifeofthemachine......8years
Thecompanyusesstraightlinedepreciationanda$5,000salvagevalue.(The
companyconsiderssalvagevalueinmakingdepreciationdeductions.)Assume
cashflowsoccuruniformlythroughoutayear.
101. Thepaybackperiodwouldbeclosestto:
A a.3.33years.
Easy b.3.0years.
1413 d.2.9years.
102. Thesimplerateofreturnwouldbeclosestto:
C a.30.0%.
Medium b.17.5%.
ReferTo: c.18.75%.
1413 d.12.5%.
Reference:1414
(Ignoreincometaxesinthisproblem.)HanleyCompanypurchasedamachine
for$125,000thatwillbedepreciatedonthestraightlinebasisovera
fiveyearperiodwithnosalvagevalue.Therelatedcashflowfrom
operationsisexpectedtobe$45,000ayear.Thesecashflowsfrom
operationsoccuruniformlythroughouttheyear.
103. Whatisthepaybackperiod?
C a.2.1years.
Easy b.2.3years.
CPA c.2.8years.
adapted d.4.2years.
ReferTo:
1414
104. Whatisthesimplerateofreturnontheinitialinvestment?
A a.16%.
Easy b.24%.
CPA c.28%.
adapted d.36%.
ReferTo:
1414
Essay
105. (Ignoreincometaxesinthisproblem.)PrinceCompanys
Medium requiredrateofreturnis10%.Thecompanyisconsideringthe
purchaseofthreemachines,asindicatedbelow.Considereach
machineindependently.
Required:
a.MachineAwillcost$25,00andhavealifeof15years.Its
salvagevaluewillbe$1,000,andcostsavingsareprojected
at$3,500peryear.Computethemachinesnetpresentvalue.
b.HowmuchwillPrinceCompanybewillingtopayforMachineB
ifthemachinepromisesannualcashinflowsof$5,000per
yearfor8years?
c.MachineChasaprojectedlifeof10years.Whatisthe
machine'sinternalrateofreturnifitcosts$30,000and
willsave$6,000annuallyincashoperatingcosts?
Interpolatetothenearesttenthofapercent.Wouldyou
recommendpurchase?Explain.
Answer:
a.10%Present
YearAmountFactorValue
Investmentrequirednow($25,000)1.000($25,000)
Annualcostsavings1153,5007.60626,621
Salvagevalue.....151,0000.239239
Netpresentvalue$1,860
b.10%Present
YearAmountFactorValue
Annualcashinflows18$5,0005.335$26,675
Sincethepresentvalueofthecashinflowsis$26,675,the
companyshouldbewillingtopayuptothisamounttoacquire
themachine.
c.InvestmentrequiredNetannualcashflow=Factorofthe
internalrateofreturn
$30,000%6,000=5.000
14%factor............5.2165.216
Truefactor...........5.000
16%factor............4.833
0.2160.383
14%+2%(0.2160.383)=15.1%
Themachineshouldbepurchased,sincetheinternalrateof
returnisgreaterthantherequiredrateofreturn.
106. Ignoreincometaxesinthisproblem.)Ursus,Inc.,is
Medium consideringaprojectthatwouldhaveatenyearlifeandwould
requirea$1,000,000investmentinequipment.Attheendoften
years,theprojectwouldterminateandtheequipmentwouldhave
nosalvagevalue.Theprojectwouldprovidenetincomeeach
yearasfollows:
Sales................................$2,000,000
Lessvariableexpenses...............1,400,000
Contributionmargin..................600,000
Lessfixedexpenses..................400,000
Netincome...........................$200,000
Alloftheaboveitems,exceptfordepreciationof$100,000a
year,representcashflows.Thedepreciationisincludedinthe
fixedexpenses.Thecompany'srequiredrateofreturnis12%.
Required:
a.Computetheproject'snetpresentvalue.
b.Computetheproject'sinternalrateofreturn,interpolating
tothenearesttenthofapercent.
c.Computetheproject'spaybackperiod.
d.Computetheproject'ssimplerateofreturn.
Answer:
a.Sincedepreciationistheonlynoncashitemontheincome
statement,thenetannualcashflowcanbecomputedbyadding
backdepreciationtonetincome.
Netincome.............$200,000
Depreciation...........100,000
Netannualcashflow...$300,000
12%Present
YearsAmountFactorValue
Initialinvestment..Now$(1,000,000)1.000$(1,000,000)
Netannualcash
flows.............110300,0005.6501,695,000
b.Theformulaforcomputingthefactoroftheinternalrateof
return(IRR)is:
InvestmentrequiredNetannualcashinflow=Factorofthe
IRR
$1,000,000$300,000=3.333
26%factor........3.4653.465
Truefactor.......3.333
28%factor........3.269
0.1320.196
26%+2%(0.1320.196)=27.3%
c.Theformulaforthepaybackperiodis:
InvestmentrequiredNetannualcashinflow=Payback
period
$1,000,000$300,000=3.33years
d.Theformulaforthesimplerateofreturnis:
NetincomeInitialinvestment=Simplerateofreturn
$200,000$1,000,000=20.0%
Medium concernaninvestmentproject:
Investmentinequipment...........$16,000
Netannualcashinflows...........$3,600
Workingcapitalrequired..........$4,500
Salvagevalueoftheequipment....$2,000
Lifeoftheproject...............12years
Discountrate.....................14%
Theworkingcapitalwillbereleasedforuseelsewhereatthe
conclusionoftheproject.
Required:
Computetheproject'snetpresentvalue.
Answer:
14%Present
ItemYearsAmountFactorValue
Investmentnow($16,000)1.000($16,000)
Annualcash
inflows...............1123,6005.66020,376
Workingcapital
required..............now(4,500)1.000(4,500)
Workingcapital
released..............124,5000.208936
Salvagevalue
equipment.............122,0000.208416
Netpresentvalue.......$1,228
108. (Ignoreincometaxesinthisproblem.)BradleyCompany's
Medium requiredrateofreturnis14%.Thecompanyhasanopportunity
tobetheexclusivedistributorofaverypopularconsumer
item.Nonewequipmentwouldbeneeded,butthecompanywould
havetouseonefourthofthespaceinawarehouseitowns.The
warehousecost$200,000new.Thewarehouseiscurrentlyhalf
emptyandtherearenootherplanstousetheemptyspace.In
addition,thecompanywouldhavetoinvest$100,000inworking
capitaltocarryinventoriesandaccountsreceivableforthe
newproductline.Thecompanywouldhavethedistributorship
foronly5years.Thedistributorshipwouldgeneratea$17,000
netannualcashinflow.
Required:
Whatisthenetpresentvalueoftheprojectatadiscountrate
of14%?Shouldtheprojectbeaccepted?
Answer:
14%Present
YearsAmountFactorValue
WorkingcapitalinvestmentNow$(100,000)1.000$(100,000)
Annualcashinflows......1517,0003.43358,361
Workingcapitalreleased5100,0000.51951,900
Netpresentvalue........$10,261
Yes,thedistributorshipshouldbeacceptedsincetheproject
hasapositivenetpresentvalue.
109. (Ignoreincometaxesinthisproblem.)MonsonCompanyis
Medium consideringthreeinvestmentopportunitieswithcashflowsas
describedbelow:
ProjectA:Cashinvestmentnow.....................$15,000
Cashinflowattheendof5years.......$21,000
Cashinflowattheendof8years.......$21,000
ProjectB:Cashinvestmentnow.....................$11,000
Annualcashoutflowfor5years.........$3,000
Additionalcashinflowattheend
of5years............................$21,000
ProjectC:Cashinvestmentnow.....................$21,000
Annualcashinflowfor4years..........$11,000
Cashoutflowattheendof3years......$5,000
Additionalcashinflowattheend
of4years............................$15,000
Required:
ComputethenetpresentvalueofeachprojectassumingMonson
Companyusesa12%discountrate.
Answer:
ProjectA:
12%Present
AmountFactorValue
Cashinvestmentnow..............($15,000)1.000($15,000)
Cashinflowattheendof5years$21,0000.567$11,907
Cashinflowattheendof8years$21,0000.404$8,484
Netpresentvalue................$5,391
ProjectB:
12%Present
AmountFactorValue
Annualcashoutflowfor5years..($3,000)3.605($10,815)
Additionalcashinflowatthe
endof5years...............$21,0000.567$11,907
Netpresentvalue................($9,908)
ProjectC:
12%Present
AmountFactorValue
Annualcashinflowfor4years...$11,0003.037$33,407
Cashoutflowattheendof
3years........................($5,000)0.712($3,560)
Additionalcashinflowatthe
endof4years.................$15,0000.636$9,540
Netpresentvalue................$18,387
110. (Ignoreincometaxesinthisproblem.)JimBinghamis
Medium consideringstartingasmallcateringbusiness.Hewouldneed
topurchaseadeliveryvanandvariousequipmentcosting
$125,000toequipthebusinessandanother$60,000for
inventoriesandotherworkingcapitalneeds.Rentforthe
buildingusedbythebusinesswillbe$35,000peryear.Jim's
marketingstudiesindicatethattheannualcashinflowfromthe
businesswillamountto$120,000.Inadditiontothebuilding
rent,annualcashoutflowforoperatingcostswillamountto
$40,000.Jimwantstooperatethecateringbusinessforonly
sixyears.Heestimatesthattheequipmentcouldbesoldat
thattimefor4%ofitsoriginalcost.Jimusesa16%discount
rate.
Required:
WouldyouadviseJimtomakethisinvestment?
Answer:
16%Present

DescriptionYearsAmountFactorValue
Van&equipment.....0($125,000)1.000($125,000)
Workingcapital.....0($60,000)1.000($60,000)
Buildingrent.......16($35,000)3.685($128,975)
Netannualcash
inflow............16$80,0003.685$294,800
Salvagevalue,
equipment.........6$5,0000.410$2,050
Releaseofworking
capital...........6$60,0000.410$24,600
111. (Ignoreincometaxesinthisproblem.)GeneralManufacturing
Medium Companyconsistsofseveraldivisions,oneofwhichisthe
TransportationDivision.Thecompanyhasdecidedtodisposeof
thisdivisionsinceitnolongerfitsthecompany'slongterm
strategy.Anofferof$9,000,000hasbeenreceivedfroma
prospectivebuyer.IfGeneralretainedthedivision,the
companywouldoperatethedivisionforonlynineyears,after
whichthedivisionwouldnolongerbeneededandwouldbesold
for$600,000.Ifthecompanyretainsthedivision,animmediate
investmentof$500,000wouldneedtobemadetoupdate
equipmenttocurrentstandards.Annualnetoperatingcashflows
wouldbe$1,805,000ifthedivisionisretained.Thecompanys
discountrateis12%.
Required:
Usingthenetpresentvaluemethod,determinewhetherGeneral
Manufacturingshouldacceptorrejecttheoffermadebythe
potentialbuyer.
Answer:
12%Present
YearExplanationAmountFactorValue
o
0Investmenttoupdateassets$(500,000)1.000$(500,000)
19Annualcashinflows.......1,805,0005.3289,617,040
9Sellingpricefor
thedivision............600,0000.361216,600
Netpresentvalue.........$9,333,640
Thesalespriceof$9,000,000islessthanthepresentvalueof
thecashflowsresultingfromretainingthedivision.General
thusshouldnotaccepttheoffer.
112. (Ignoreincometaxesinthisproblem.)MarkStevensis
Medium consideringopeningahobbyandcraftstore.Hewouldneed
$100,000toequipthebusinessandanother$40,000for
inventoriesandotherworkingcapitalneeds.Rentonthe
buildingusedbythebusinesswillbe$24,000peryear.Mark
estimatesthattheannualcashinflowfromthebusinesswill
amountto$90,000.Inadditiontobuildingrent,annualcash
outflowforoperatingcostswillamountto$30,000.Markplans
tooperatethebusinessforonlysixyears.Heestimatesthat
theequipmentandfurnishingscouldbesoldatthattimefor
10%oftheiroriginalcost.Markusesadiscountrateof16%.
Required:
WouldyouadviseMarktomakethisinvestment?Usethenet
presentvaluemethod.
Answer:
16%Present

o
Equipment...........0($100,000)1.000($100,000)
Workingcapital.....0($40,000)1.000($40,000)
Buildingrent.......16($24,000)3.685($88,440)
Netannualcash
inflow............16$60,0003.685$221,100
Salvagevalue,
equipment.........6$10,0000.410$4,100
Releaseofworking
capital...........6$40,0000.410$16,400
113. (Ignoreincometaxesinthisproblem.)VernonCompanyhasbeen
offereda7yearcontracttosupplyapartforthemilitary.
Medium Aftercarefulstudy,thecompanyhasdevelopedthefollowing
estimateddatarelatingtothecontract:
Costofequipmentneeded.............................$300,000
Workingcapitalneeded...............................$50,000
Annualcashreceiptsfromthedeliveryofparts,
lesscashoperatingcosts..........................$70,000
Salvagevalueofequipmentatterminationof
thecontract.......................................$5,000
Itisnotexpectedthatthecontractwouldbeextendedbeyond
theinitialcontractperiod.Thecompany'sdiscountrateis
10%.
Required:
Usethenetpresentvaluemethodtodetermineifthecontract
shouldbeaccepted.Roundallcomputationstothenearest
dollar.
Answer:
10%Present

o
Equipment...........0($300,000)1.000($300,000)
Workingcapital.....0($50,000)1.000($50,000)
Netannualcash
inflow............17$70,0004.868$340,760
Salvagevalue,
equipment.........7$5,0000.513$2,565
Releaseofworking
capital...........7$50,0000.513$25,650
114. (Ignoreincometaxesinthisproblem.)ABCompanyis
Hard consideringthepurchaseofamachinethatpromisestoreduce
operatingcostsbythesameamountforeveryyearofits6year
usefullife.Themachinewillcost$83,150andhasnosalvage
value.Themachinehasa20%internalrateofreturn.
Required:
Whatistheannualcostsavingspromisedbythemachine?
Answer:
InvestmentrequiredNetannualcashinflow=
Factoroftheinternalrateofreturn
$83,150Netannualcashinflow=3.326
$83,1503.326=Netannualcashinflow
=$25,000
115. (Ignoreincometaxesinthisproblem.)FerrisCompanyhasan
Easy oldmachinethatisfullydepreciatedbuthasacurrentsalvage
valueof$5,000.Thecompanywantstopurchaseanewmachine
thatwouldcost$60,000andhavea5yearusefullifeandzero
salvagevalue.Expectedchangesinannualrevenuesandexpenses
ifthenewmachineispurchasedare:
Increasedrevenues...............$63,000
Increasedexpenses:
Salaryofadditionaloperator..$20,000
Supplies.......................9,000
Depreciation...................12,000
Maintenance....................4,00045,000
Increasednetincome..............$18,000
Required:
a.Computethepaybackperiodonthenewequipment.
b.Computethesimplerateofreturnonthenewequipment.
Answer:
a.InvestmentrequiredNetannualcashinflow=Paybackperiod
$60,000$5,000)($18,000+$12,000)=1.83years(rounded)
b.IncrementalnetincomeInvestment=Simplerateofreturn
$18,000$55,000=32.7%(rounded)

Capital Budgeting Decisions

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Capital Budgeting Decisions

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Chapter 14

Capital Budgeting Decisions

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