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Exam 11: Capital Budgeting and Investment Analysis

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Question 41

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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: $\begin{array}{l}\begin{array}{lll}& \underline { \text { Product A } }& \underline { \text { Product B } }\\ \text { Unit sales } &25,000 & 20,000 \\ \text {Unit sales } &\$ 30 & \$ 30\\\\\text { Direct materials } & \$ 15,000 & \$ 8,000 \\\text { Direct labor } & \$ 120,000 & \$ 80,000 \\\text { Other cash operating expenses } & \$ 30,000 & \$ 25,000\\\\\text { New equipment costs } & \$ 2,500,000 & \$ 1,500,000 \\\text { Estimated useful life (no salvage) } & 5 \text { years } & 5 \text { years }\end{array}\end{array}$ 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?

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_TB6311_00_TB6311_00_TB6311_00 *Annual d...

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Question 42

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A company is considering a five-year project.It plans to invest $60,000 now and forecasts cash flows of $16,200 for each year.The company requires a hurdle rate of 12%.Calculate the internal rate of return to determine whether it should accept this project.Selected factors for a present value of an annuity of 1 for five years are shown below: $\begin{array}{lc}\underline {\text { Interest }} &\underline {\text { Present Value of an Annuity of 1 }}\\ \underline{\text { Rate }}& \underline{\text { Factor }} \\{10 \%} &{3.7908}\\12 \% & 3.6048 \\14 \% & 34331\end{array}$

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Investment/Annual net cash flows = $60,0...

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Question 43

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An advantage of the break-even time (BET)method over the payback period method is that it recognizes the time value of money.

A company is considering a proposal to invest $30,000 in a project that would provide the following net cash flows: $\begin{array} { l l } \text { Year 1 } & \$ 6,500 \\\text { Year 2 } & 10,700 \\\text { Year 3 } & 15,000 \\\text { Year 4 } & 12,800\end{array}$ a.Compute the project's payback period. b.Compute the net present value of the project assuming a 10% discount rate with the following factors: PV factors for $1(yr.1: 0.9091; yr.2: 0.8264; yr.3:0 .7513; yr.4: 0.6830) c.Should the company invest in the machine? Why or why not?

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 eight 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 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?

After-tax net income divided by the annual average investment is the:

In using the internal rate of return method, management must consider a hurdle rate in making its decisions.What is a hurdle rate? What factors does management have to consider in selecting a hurdle rate?

The _____________________ is the simplest capital budgeting method studied in this chapter.

A company produces two boat models, Montauk and Orient.Both products are being considered for major investment projects next year.Relevant data follow: $\begin{array}{lll}&\underline{\text { Montauk }}& \underline{\text { Orient }}\\\text { New investment }& \$ 424,000 &\$ 380,000\\\text { Expected 3-year net cash flows: }\\\text { Year 1 } & 150,000 & 130,000 \\\text { Year 2 } & 160,000 & 130,000 \\\text { Year 3 } & 170,000 & 130,000\end{array}$ Required: Use the payback period to evaluate these two investment projects.

In calculating the rate of return on average investment, average investment should be calculated as (beginning book value + ending book value)/2.

A company is considering purchasing a machine for $21,000.The machine will generate an after-tax net income of $2,000 per year.Annual depreciation expense would be $1,500.What is the approximate accounting rate of return?

A company is considering purchasing a machine for $75,000.The machine is expected to generate a net after-tax income of $11,250 per year.Depreciation expense would be $7,500.What is the payback period for this machine?

Which one of the following methods considers the time value of money in evaluating alternative capital expenditures?

A company bought a machine that has an expected life of seven years and no salvage value.Management estimates that this machine will generate annual after-tax net income of $540.If the accounting rate of return is 12%, what was the purchase price of the machine?

The time value of money concept works on the principle that a dollar today is worth more than a dollar tomorrow.

A capital budgeting method that considers how quickly a project recovers costs is known as ______________________.An enhancement to this method that considers the time value of money is called _________________.

Presented below are terms preceded by letters (a)through (f)and followed by a list of definitions (1)through (6).Match the letter of the terms with the definitions.Use the space provided preceding each definition.

A company has a decision to make between two investment alternatives.The company requires a 10% return on investment.Predicted data is provided below: $\begin{array}{lrr}& \underline { \text { Investment Y } }& \underline { \text { Investment } Z }\\\text { Projected after-tax net income } & \$ 40,000 & \$ 42,000 \\\text { Investment costs } & \$ 600,000 & \$ 675,000 \\\text { Estimated life } & 6 \text { years } & 6 \text { years }\end{array}$ The present value of an annuity for six 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.

Presented below are terms preceded by letters (a) through (g) and followed by a list of definitions (1) through (7) .Match the letter of the term with the definition.Use the space provided preceding each definition -Annual after-tax net income divided by annual average investment.