ACC35 : MANAGERIAL ACCOUNTING 2nd Semester, AY 2010-2011 Finance and Accounting Department John Gokongwei School of Management

Ateneo de Manila University LONG RUN : CAPITAL BUDGETING DECISIONS Problems _____________________________________________________________________________________________________________

PROBLEM 1 Press Publishing Company hires students from the local university to collate pages on various printing jobs. This collating is all done by hand, at a cost of $60,000 per year. A collating machine has just come onto the market that could be used in place of the student help. The machine would cost $140,000 and have a 10-year useful life. It would require an operator at an annual cost of $18,000 and have annual maintenance costs of $7,000. New roller pads would be needed on the machine in five years at a total cost of $20,000. The salvage value of the machine in 10 years would be $40,000. For tax purposes, the company computes depreciation deductions assuming zero salvage value and uses straight-line depreciation. The collating machine would be depreciated over 10 years. Management requires a 14$ after-tax return on all equipment purchases. The company's tax rate is 30$. Required: 1. 2. Determine the before-tax net annual cost savings that the new collating machine will provide. Using the data from (1) above and other data from the exercise, compute the collating machine's net present value. (Round all dollar amounts to the nearest whole dollar.) Would you recommend that the machine be purchased?

PROBLEM 2 Kramer Corporation is considering two investment projects, each of which would require $50,000. Cost and cash flow data concerning the two projects are given below:

The high-speed photocopier would have a salvage value of $5,000 in eight years. For tax purposes, the company computes depreciation deductions assuming zero salvage value and uses straight-line depreciation. The photocopier would be depreciated over eight years. At the end of eight years, the investment in working capital would be released for use elsewhere. The company requires an after-tax return of 10$ on all investments. The tax rate is 30$. Required: Compute the net present value of each investment project. (Round to the nearest whole dollar.) PROBLEM 3 The Crescent Drilling Company owns the drilling rights to several tracts of land on which natural gas has been found. The amount of gas on some of the tracts is somewhat marginal, and the company is unsure whether it would be profitable to extract and sell the gas that these tracts contain. One such tract is tract 410, on which the following information has been gathered:

The natural gas in tract 410 would be exhausted after 10 years of extraction work. The equipment would have a useful life of 15 years, but it could be sold for only 15$ of its original cost when extraction was completed. For tax purposes, the company would depreciate the equipment over 10 years using straight-line depreciation and assuming zero salvage value. The tax rate is 30$, and the company's after-tax discount rate is 10$. The working capital would be released for use elsewhere at the completion of the project. Required: 1. 2. Compute the net present value of tract 410. Round all dollar amounts to the nearest whole dollar. Would you recommend that the investment project be undertaken?

PROBLEM 4 Atwood Company has an opportunity to produce and sell a revolutionary new smoke detector for homes. To determine whether this would be a profitable venture, the company has gathered the following data on probable costs and market potential: a. New equipment would have to be acquired to produce the smoke detector. The equipment would cost $100,000 and be usable for 12 years. After 12 years, it would have a salvage value equal to 10$ of the original

C. Andres Long run : Capital Budgeting Decisions

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000 to finance accounts receivable. administration.) The company's required rate of return is 20$. g. The replacement machine will have a market value of about $100. c. and sales would be $25 per unit. Comparative variable costs per unit of product are as follows: C.600 per year. b.000 now. b. To gain entry into the market. the company would have to advertise heavily in the early years of sales.000. To increase its productive capacity. Required: Compute the net cash inflow (cash receipts less yearly cash operating expenses) anticipated from sale of the smoke detectors for each year over the next 12 years. and straight-line depreciation on equipment would total $127. variable costs for production. The variable cost required to produce one unit of product using the model 5200 machine is given under the “general information” below. The smoke detectors would sell for $45 each. The model 5200 machine is more costly to maintain than the model 2600 machine. The variable cost required to produce one unit of product using the model 2600 machine is given under the “general information” below. Other fixed costs for salaries. To meet this demand.000. Straight-line depreciation is used by the company. The following general information is available on the two alternatives: a. Repairs and maintenance costs each year on a single model 2600 machine total $3. b. A new model 2600 machine costs $180. PROBLEM 5 Woolrich Company's market research division has projected a substantial increase in demand over the next several years for one of the company's products. The two machine models are not equally efficient.500 per year. the company is using a single model 2600 machine to manufacture this product. cost. Both the model 2600 machine and the model 5200 machine have a 10-year life from the time they are first used in production. Repairs and maintenance on a model 5200 machine and on a model 2600 machine used as standby would total $4. d. the company is considering two alternatives: Alternative 1. The following information is available on this alternative: a. e. c. The cost of a new model 5200 machine is $250. the company will need to produce units as follows: At present.b.000 four years ago. The company could purchase a model 5200 machine and use the old model 2600 machine as standby equipment. The old model 2600 machine will have to be replaced in six years at a cost of $200. The company could purchase another model 2600 machine that would operate along with the one it now owns. (Depreciation is based on cost less salvage value. and its present market value is $90. Its present book value is $99. This working capital would be released for use elsewhere after 12 years. maintenance. The scrap value of both machines is negligible and can be ignored. The model 2600 machine now in use was purchased for $165.000. Andres Long run : Capital Budgeting Decisions 2 of 3 Page . Alternative 2.000 when it is four years old. The advertising program follows: f. insurance. and day-to-day cash needs. An extensive marketing study projects sales in units over the next 12 years as follows: d. The model 5200 machine is a high-speed unit with double the capacity of the model 2600 machine.000. The following information is available on this alternative: a.000. inventories. c. Production and sales of the smoke detector would require a working capital investment of $40.

No other factory costs would change as a result of the decision between the two machines.c. Andres Long run : Capital Budgeting Decisions 3 of 3 Page . d. Woolrich Company uses an 18% discount rate. C. Required: Which alternative should the company choose? Use the net present value approach.

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