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Exam 11: Capital Budgeting and Investment Analysis

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Question 61

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A company is planning to purchase a machine that will cost $24,000, have a six-year life, and be depreciated using the straight-line method with no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. $\begin{array} { l r r } \text { Sales }&&\$ 90,000\\ \text { Costs: }\\\text { Manufacturing } & \$ 52,000 \\ \text { Depreciation on machine } & 4,000 & \\ \text { Selling and administrative expenses } & \underline {30,000} & \underline { ( 86,000 ) } \\ \text { Income before taxes } & & \$ 4,000 \\ \text { Income tax } ( 50 \% ) && \underline { ( 2,000 ) } \\ \text { Net income } && \underline { \$ 2,000 } \end{array}$ -What is the accounting rate of return for this machine?

A) 33.3%
B) 16.7%
C) 50.0%
D) 8.3%
E) 4%

F) A) and D)
G) All of the above

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Question 62

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In business decision-making, managers typically examine the two fundamental factors of:

A) Risk and capital investment.
B) Risk and rate of return.
C) Capital investment and rate of return.
D) Risk and payback.
E) Payback and rate of return.

F) None of the above
G) A) and B)

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Question 63

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A company is considering the purchase of a new machine for $48,000.Management predicts that the machine can produce sales of $16,000 each year for the next 10 years.Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year.The company's tax rate is 40%.What is the approximate accounting rate of return for the machine?

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.

How can management evaluate the risk of an investment?

A company bought a machine that has an expected life of six years and no salvage value.Management estimates that this machine will generate annual after-tax net income of $700.If the accounting rate of return is 10%, what was the purchase price of the machine?

For each of the capital budgeting methods listed below, place an X in the correct column, indicating the measurement basis of each, the ability to make comparison among projects, and whether each method reflects or ignores the time value of money. $\begin{array}{c}\begin{array}{|c}\hline\text { } \\\text { }\\\hline\begin{array}{l}\\\\\\\\\hline \text { Payback period } \\\hline \text {Accounting rate of return } \\\hline \text { Net present value } \\\hline \text { Internal rate of return } \\\hline \end{array}\end{array}\begin{array}{|c|}\hline\text { Measurement } \\\text { Basis }\\\hline\begin{array}{c|c}\\\\ \text { Cash } & \text { Accrual } \\\text { Flows } & \text { Income } \\\hline & \\\hline & \\\hline & \\\hline & \\\hline\end{array}\end{array}\begin{array}{c|}\hline\text {Comparison among } \\\text { Projects }\\\hline\begin{array}{c|c}\\\\\text { Allows }&\text { Difficult to } \\\text { Comparison }&\text { Compare }\\\hline & \\\hline & \\\hline & \\\hline & \\\hline\end{array}\end{array}\begin{array}{c|}\hline\text { Time Value of } \\\text {Money }\\\hline\begin{array}{c|c}\text { Reflects } &\text { Ignores } \\\text { Time }&\text { Time } \\\text { Value of } &\text { Value of }\\\text { Money }&\text { Money }\\\hline & \\\hline & \\\hline & \\\hline & \\\hline\end{array}\end{array}\end{array}$

What is capital budgeting? Why are capital budgeting decisions often difficult and risky?

The _______________________________ is computed by dividing a project's after-tax net income by the average amount invested in it.

The accounting rate of return uses cash flows in its calculation.

The time expected to pass before the net cash flows from an investment would return its initial cost is called the:

A company purchases a machine for $1,000,000.The machine has an expected life of nine years and no salvage value.The company anticipates a yearly net income of $60,000 after taxes of 30% to be received uniformly throughout each year.What is the accounting rate of return?

Capital budgeting is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

Capital budgeting decisions are risky because the outcome is uncertain, large amounts are usually involved, the investment involves a long-term commitment, and the decision could be difficult or impossible to reverse.

The net cash flow of a particular investment project:

The following data concerns a proposed equipment purchase: $\begin{array}{lr}\text { Cost } & \$ 278,000 \\\text { Salvage value } & \$ 6,000 \\\text { Estimated useful life } & 8 \text { years } \\\text { Annual net cash flows } & \$ 46,360 \\\text { Depreciation method } & \text { Straight-line }\end{array}$ Assuming that net cash flows are received evenly throughout the year, the accounting rate of return is:

Briefly describe both the payback period method and the net present value method of comparing investment alternatives.

Neither the net present value nor the internal rate of return methods of evaluating investments consider the time value of money.

What is discounting?

Capital budgeting decisions are generally based on: