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Exam 11: Capital Budgeting Decisions

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Question 1

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Lebert, Inc., is considering the purchase of a machine that would cost $380,000 and would last for 7 years. At the end of 7 years, the machine would have a salvage value of $49,000. The machine would reduce labor and other costs by $96,000 per year. Additional working capital of $6,000 would be needed immediately. All of this working capital would be recovered at the end of the life of the machine. The company requires a minimum pretax return of 18% on all investment projects. The net present value of the proposed project is closest to:

A) $1,338
B) ($8,849)
C) ($14,048)
D) ($2,778)

E) All of the above
F) None of the above

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Question 2

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The required rate of return is the minimum rate of return that an investment project must yield to the acceptable.

A) True
B) False

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Question 3

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For capital budgeting decisions, the simple rate of return method is superior to the net present value method.

Buy-Rite Pharmacy has purchased a small auto for delivering prescriptions. The auto was purchased for $28,000 and will have a 6-year useful life and a $4,000 salvage value. Delivering prescriptions (which the pharmacy has never done before) should increase gross revenues by at least $32,000 per year. The cost of these prescriptions to the pharmacy will be about $25,000 per year. The pharmacy depreciates all assets using the straight-line method. The payback period for the auto is closest to:

Frick Road Paving Corporation is considering an investment in a curb-forming machine. The machine will cost $180,000, will last 10 years, and will have a $30,000 salvage value at the end of 10 years. The machine is expected to generate net cash inflows of $40,000 per year in each of the 10 years. Frick's discount rate is 10%. The net present value of the proposed investment is closest to:

The management of Mashiah Corporation is considering the purchase of a machine that would cost $290,000, would last for 6 years, and would have no salvage value. The machine would reduce labor and other costs by $102,000 per year. The company requires a minimum pretax return of 13% on all investment projects. The present value of the annual cost savings of $102,000 is closest to:

In capital budgeting computations, discounted cash flow methods:

Janes, Inc., is considering the purchase of a machine that would cost $400,000 and would last for 5 years, at the end of which, the machine would have a salvage value of $67,000. The machine would reduce labor and other costs by $109,000 per year. Additional working capital of $4,000 would be needed immediately, all of which would be recovered at the end of 5 years. The company requires a minimum pretax return of 12% on all investment projects. Required: Determine the net present value of the project. Show your work!

The basic premise of the payback method is that the more quickly the cost of an investment is recovered the more desirable is the investment.

Naomi Corporation has a capital budgeting project that has a negative net present value of $36,000. The life of this project is 6 years. Naomi's discount rate is 20%. By how much would the annual cash inflows from this project have to increase in order to have a positive net present value?

The Halsey Corporation is contemplating the purchase of new equipment that would require an initial investment of $125,000. The equipment would have a useful life of six years, with a salvage value of $29,000. This new equipment would be depreciated over its useful life by the straight-line method. It would replace existing equipment which is fully depreciated. The existing equipment has a salvage value now of $38,000. The anticipated annual revenues and expenses associated with the new equipment are: Assume cash flows occur uniformly throughout a year except for the initial investment and the salvage value at the end of the project. For this investment, the simple rate of return to the nearest tenth of a percent is:

Clairmont Corporation is considering the purchase of a machine that would cost $150,000 and would last for 5 years. At the end of 5 years, the machine would have a salvage value of $18,000. By reducing labor and other operating costs, the machine would provide annual cost savings of $37,000. The company requires a minimum pretax return of 12% on all investment projects. The net present value of the proposed project is closest to:

Westland College has a telephone system that is in poor condition. The system either can be overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives: Westland College uses a 10% discount rate and the total cost approach to net present value analysis. The working capital required under the new system would be released for use elsewhere at the conclusion of the project. Both alternatives are expected to have a useful life of eight years. The net present value of overhauling the present system is closest to:

In preference decision situations, a project with a lower net present value may be preferable to a project with a higher net present value.

The project profitability index is computed by dividing the present value of the cash inflows of the project by present value of the cash outflows of the project.

Dube Corporation is considering the following three investment projects: The profitability index of investment project E is closest to:

The following data concern an investment project: The working capital will be released for use elsewhere at the conclusion of the project. Required: Compute the project's net present value.

Hinck Corporation is investigating automating a process by purchasing a new machine for $520,000 that would have a 8 year useful life and no salvage value. By automating the process, the company would save $134,000 per year in cash operating costs. The company's current equipment would be sold for scrap now, yielding $22,000. The annual depreciation on the new machine would be $65,000. Required: Determine the simple rate of return on the investment to the nearest tenth of a percent. Show your work!

The project profitability index is used to compare the net present values of two investments that require different amounts of investment funds.

Baldock Inc. is considering the acquisition of a new machine that costs $420,000 and has a useful life of 5 years with no salvage value. The incremental net operating income and incremental net cash flows that would be produced by the machine are: Assume cash flows occur uniformly throughout a year except for the initial investment. If the discount rate is 12%, the net present value of the investment is closest to: