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Chapter 14 Capital Budgeting Decisions

True/False Questions

1. When cash flows are uneven and vary from year to year, the internal rate of return method is easier to use than the net present value method.

Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2 Level: Hard

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

Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,6 Level: Easy

3. Depreciation is included as a cash flow in capital budgeting decisions to ensure that the original cost of the asset is fully recovered.

Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium

4. Even when done properly, the total-cost and incremental-cost approaches to choosing between alternatives will sometimes yield different answers.

Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium

5. An increase in the expected salvage value at the end of a capital budgeting project will have no effect on the internal rate of return for that project.


6. The intangible benefits of automation cannot be estimated with any accuracy and therefore should be ignored in capital budgeting decisions.


7. When making preference decisions about competing investment proposals, the project profitability index is superior to the internal rate of return.

Ans: True AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium

Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition 14-7


8. The project profitability index is computed by dividing the net present value of the project by the investment required by the project.

Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy

9. In calculating the “investment required” for the project profitability index, the amount invested should be reduced by any salvage recovered from the sale of old equipment.

Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium

10. The payback method is most appropriate for projects whose cash flows extend far into the future.

Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Medium

11. When using the payback method, any cash flows for a project that occur after the payback period are not considered in computing the payback period for that project.

Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Medium

12. The present value of a given future cash flow will increase as the discount rate decreases.


13. If a company is operating at a profit, the cash inflow resulting from the depreciation tax shield is computed by multiplying the depreciation deduction by one minus the tax rate.

Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium

14. All cash inflows are taxable.

Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy

14-8 Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition


15. The after-tax benefit, or net cash inflow, realized from a particular taxable cash receipt can be obtained by multiplying the cash receipt by one minus the tax rate.

Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy

Multiple Choice Questions

16. Suture Corporation's discount rate is 12%. If Suture has a 5-year investment project that has a project profitability index of zero, this means that:A) the net present value of the project is equal to zero.B) the internal rate of return of the project is equal to the discount rate.C) the payback period of the project is equal to the project's useful life.D) both A and B above are true.

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2,4,5 Level: Hard

17. Amster Corporation has not yet decided on the required rate of return to use in its capital budgeting. This lack of information will prevent Amster from calculating a project's:

Payback Net Present Value Internal Rate of ReturnA) No No NoB) Yes Yes YesC) No Yes YesD) No Yes No

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2,5 Level: Medium Source: CMA, adapted

18. If income taxes are ignored, how is depreciation used in the following capital budgeting techniques?

Internal Rate of Return Net Present ValueA) Excluded ExcludedB) Excluded IncludedC) Included ExcludedD) Included Included

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2 Level: Medium Source: CPA, adapted



19. If the net present value of a project is zero based on a discount rate of 16%, then the internal rate of return is:A) equal to 16%.B) less than 16%.C) greater than 16%.D) cannot be determined from this data.

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2 Level: Medium

20. Three potential investment projects (A, B, and C) at Nit Corporation all require the same initial investment, have the same useful life (3 years), and have no expected salvage value. Expected net cash inflows from these three projects each year is as follows:

A B CYear 1......... $1,000 $2,000 $3,000Year 2......... $2,000 $2,000 $2,000Year 3......... $3,000 $2,000 $1,000

What can be determined from the information provided above?A) the net present value of project C will be the highest.B) the internal rate of return of projects A and C cannot be computed.C) the net present value and the internal rate of return will be the same for all three

projects.D) both A and B above.

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard

21. A project's net present value, ignoring income taxes, is affected by:A) the net book value of an asset that is replaced.B) the depreciation on an asset that is replaced.C) the depreciation to be taken on assets used directly on the project.D) proceeds from the sale of an asset that is replaced.

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy Source: CPA, adapted



22. A company has unlimited funds to invest at its discount rate. The company should invest in all projects having:A) an internal rate of return greater than zero.B) a net present value greater than zero.C) a simple rate of return greater than the discount rate.D) a payback period less than the project's estimated life.

Ans: B AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy Source: CMA, adapted

23. When the cash flows are the same every period after the initial investment in a project, the payback period is equal to:A) the net present value.B) the simple rate of return.C) the factor of the internal rate of return.D) the payback rate of return.

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2,5 Level: Hard Source: CMA, adapted

24. The internal rate of return method assumes that a project's cash flows are reinvested at the:A) internal rate of return.B) simple rate of return.C) required rate of return.D) payback rate of return.

Ans: A AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium Source: CMA, adapted

25. (Ignore income taxes in this problem.) Which of the following would be used in the calculation of the internal rate of return of an investment in new machinery to replace old machinery?A) The annual depreciation expense on the new machinery.B) The cost of an overhaul that would be needed on the old machinery in three

years.C) The salvage value of the old machinery in ten years.D) both B and C above.

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium



26. The project profitability index and the internal rate of return:A) will always result in the same preference ranking for investment projects.B) will sometimes result in different preference rankings for investment projects.C) are less dependable than the payback method in ranking investment projects.D) are less dependable than net present value in ranking investment projects.

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4,5 Level: Medium

27. Zonifugal Corporation needs to purchase a new conveyor system for its factory. Four different conveyor systems have been proposed. Which calculation would be the best one for Zonifugal to use to determine which system to purchase?A) payback periodB) simple rate of returnC) net present valueD) project profitability index


28. A preference decision:A) is concerned with whether a project clears the minimum required rate of return

hurdle.B) comes before the screening decision.C) is concerned with determining which of several acceptable alternatives is best.D) responses A, B, and C are all correct.

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy

29. In an equipment investment decision, which of the following amounts would be unaffected by a change in the tax rate?A) the present value of the initial investment in the equipment.B) the present value of the increase in working capital needed.C) the present value of the salvage value of the equipment.D) both A and B above.

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium



30. When evaluating a project, the portion of the fixed corporate headquarters expense that would be allocated to the project should be:A) included as a cash outflow on an after-tax basis by multiplying the expense by

one minus the tax rate.B) included as a cash outflow on an after-tax basis by multiplying the expense by

the tax rate.C) included as a cash outflow on a before-tax basis.D) ignored.

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Hard

31. (Ignore income taxes in this problem.) Given the following data:

Cost of equipment.............. $55,750Annual cash inflows........... $10,000Internal rate of return......... 16%

The life of the equipment must be:A) it is impossible to determine from the data givenB) 15 yearsC) 12.5 yearsD) 5.75 years

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Hard

Solution:The internal rate of return factor is 5.575, or $55,750 ÷ $10,000. In the table for the Present Value of an Annuity of $1 in Arrears, the factor of 5.575 can be found in the 16% column in the 15th row; 15 then represents the life of the equipment.



32. (Ignore income taxes in this problem.) Heap Company is considering an investment in a project that will have a two year life. The project will provide a 10% internal rate of return, and is expected to have a $40,000 cash inflow the first year and a $50,000 cash inflow in the second year. What investment is required in the project?A) $74,340B) $77,660C) $81,810D) $90,000

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2 Level: Hard Source: CMA, adapted

Solution:

Year(s) Amount 10% Factor PVCash inflow−1st year.......... 1 40,000 0.909 $36,360Cash inflow−2nd year.......... 2 50,000 0.826 41,300 Net present value................ $77,660

For the net present value of this project to be zero, the initial investment should be equal to the present value of the cash inflows, or $77,660.

33. (Ignore income taxes in this problem.) Congener Beverage Corporation is considering an investment in a capital budgeting project that has an internal rate of return of 20%. The only cash outflow for this project is the initial investment. The project is estimated to have an 8 year life and no salvage value. Cash inflows from this project are expected to be $100,000 per year in each of the 8 years. Congener's discount rate is 16%. What is the net present value of this project?A) $5,215B) $15,464C) $50,700D) $55,831

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2 Level: Hard



Solution:Internal rate of return factor = Initial investment ÷ Annual inflowsLook up the factor in the table Present Value of an Annuity of $1 in Arrears for 8 periods, 20% column; the factor is 3.837. Substituting into the above equation, 3.837 = Initial investment ÷ $100,000Initial investment = $383,700.

Year(s) Amount 16% Factor PVInitial investment............... Now ($383,700) 1.000 ($383,700)Annual net cash receipts.... 1-8 $100,000 4.344 434,400 Net present value................ $ 50,700

34. (Ignore income taxes in this problem.) The Able Company is considering buying a new donut maker. This machine will replace an old donut maker that still has a useful life of 2 years. The new machine will cost $2,500 a year to operate, as opposed to the old machine, which costs $2,700 per year to operate. Also, because of increased capacity, an additional 10,000 donuts a year can be produced. The company makes a contribution margin of $0.02 per donut. The old machine can be sold for $5,000 and the new machine costs $25,000. The incremental annual net cash inflows provided by the new machine would be:A) $200B) $400C) $5,200D) $5,400


Solution:

Operating cost savings per year ($2,700 − $2,500)........................ $200Additional contribution margin provided by the new donut maker

($0.02 × 10,000).......................................................................... 200 Incremental annual net cash inflows provided by new machine.... $400



35. (Ignore income taxes in this problem.) Given the following data:

Initial investment............... $80,000Annual cash inflow............ ?Salvage value..................... $0Net present value................ $13,600Life of the project............... 6 yearsDiscount rate...................... 16%

Based on the data given above, the annual cash inflow from the project after the initial investment is closest to:A) $50,116B) $21,710C) $25,400D) $38,376

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard

Solution:

First, set up table:Year(s) Amount 16% Factor PV

Initial investment............... Now $80,000 1.000 ($80,000)Annual cash inflows........... 1-6 ? 3.685 ? Net present value................ $13,600

Second, solve for the present value of the annual cash inflow:PV of annual cash inflow = $13,600 − (-$80,000) = $93,600Finally, solve for the annual cash inflow:Annual cash inflow × 3.685 = $93,600Annual cash inflow = $25,400



36. (Ignore income taxes in this problem.) Virginia Company invested in a four-year project. Virginia's discount rate is 10%. The cash inflows from this project are:

Year Cash Inflow1 $4,0002 $4,4003 $4,8004 $5,200

Assuming a positive net present value of $1,000, the amount of the original investment was closest to:A) $2,552B) $4,552C) $13,427D) $17,400

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard Source: CPA, adapted

Solution:

Net present value of cash inflows − Original investment = Net present value of projectOriginal investment = NPV of cash inflows − NPV of project= $14,427 − $1,000 = $13,427

Year(s) Amount 10% Factor PVYear 1 inflow............................... 1 $4,000 0.909 $ 3,636Year 2 inflow............................... 2 $4,400 0.826 3,634Year 3 inflow............................... 3 $4,800 0.751 3,605Year 4 inflow............................... 4 $5,200 0.683 3,552 Net present value of cash inflows $14,427



37. (Ignore income taxes in this problem.) Para Corporation is reviewing the following data relating to an energy saving investment proposal:

Initial investment............... $50,000Life of the project............... 5 yearsSalvage value..................... $10,000Annual cash savings........... ?

What annual cash savings would be needed in order to satisfy the company's 12% required rate of return (rounded to the nearest one hundred dollars)?A) $10,600B) $11,100C) $12,300D) $13,900

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard Source: CPA, adapted

Solution:

Years Amount 12% Factor Present ValueTotal investment................. Now ($50,000) 1.000 ($50,000)Annual cash savings........... 1-5 ? 3.605 ?Salvage value..................... 5 $10,000 0.567 5,670 Net present value................ $ 0

To solve for the present value of the annual cash savings:-$50,000 + PV of annual cash savings + $5,670 = $0PV of annual cash savings = $44,330To solve for the amount of the annual cash savings:Amount of annual cash savings × 3.605 = $44,330Amount of annual cash savings = $12,297, which rounds to $12,300



38. (Ignore income taxes in this problem.) Nevus Tattoo Parlor is considering a capital budgeting project. This project will initially require a $25,000 investment in equipment and a $3,000 working capital investment. The useful life of this project is 5 years with an expected salvage value of zero on the equipment. The working capital will be released at the end of the 5 years. The new system is expected to generate net cash inflows of $9,000 per year in each of the 5 years. Nevus' discount rate is 14%. The net present value of this project is closest to:A) $(3,088)B) $3,383C) $4,454D) $5,897

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium

Solution:

Year(s) Amount 14% Factor PVInitial investment............... Now ($25,000) 1.000 ($25,000)Working capital needed..... Now ($3,000) 1.000 ( 3,000)Annual cost savings........... 1-5 $9,000 3.433 30,897Working capital released.... 5 $3,000 0.519 1,557 Net present value................ $ 4,454



39. (Ignore income taxes in this problem.) The Malaise Prevention Agency is a non-profit organization that does all of its own informational printing. The printing press that Malaise currently is using needs a $20,000 overhaul. This will extend the useful life of the press by 8 years. As an alternative, Malaise could buy a brand new modern press for $45,000. The new press would also last 8 years. The annual operating expenses of the old press are $12,000. The annual operating expenses of the new press will only be $7,000. The old press is not expected to have a salvage value in 8 years. The new press is expected to have a $6,000 salvage value in 8 years. Malaise's discount rate is 14%. The net present value of the decision to buy the new press instead of overhauling the old press is closest to:A) $301B) $(301)C) $4,195D) $(46,089)


Solution:

Year(s) Amount 14% Factor PVInitial investment............... Now ($45,000) 1.000 ($45,000)Annual cost savings

($12,000 − $7,000)......... 1-8 $5,000 4.639 23,195Salvage value..................... 8 $6,000 0.351 2,106 Net present value of new

press................................ ($19,699)

Cost to overhaul old press................ $20,000NPV of new press............................. 19,699 NPV of new press vs. old press........ $ 301



40. (Ignore income taxes in this problem.) Nevland Corporation is considering the purchase of a machine that would cost $130,000 and would last for 6 years. At the end of 6 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 $44,000. The company requires a minimum pretax return of 19% on all investment projects. The net present value of the proposed project is closest to:A) $38,040B) $26,376C) $74,902D) $20,040

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy

Solution:

Year(s) Amount 19% Factor PVInitial investment............... Now ($130,000) 1.000 ($130,000)Annual cost savings........... 1-6 $44,000 3.410 150,040Salvage value..................... 6 $18,000 0.352 6,336 Net present value................ $ 26,376

41. (Ignore income taxes in this problem) The management of Penfold Corporation is considering the purchase of a machine that would cost $440,000, would last for 7 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 16% on all investment projects. The net present value of the proposed project is closest to:A) -$28,022B) $96,949C) -$79,196D) $274,000

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy

Solution:

Year(s) Amount 16% Factor PVInitial investment............... Now ($440,000) 1.000 ($440,000)Annual cost savings........... 1-7 $102,000 4.039 411,978 Net present value................ ($ 28,022)



42. (Ignore income taxes in this problem.) Dowlen, Inc., is considering the purchase of a machine that would cost $150,000 and would last for 6 years. At the end of 6 years, the machine would have a salvage value of $23,000. The machine would reduce labor and other costs by $36,000 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 12% on all investment projects. The net present value of the proposed project is closest to:A) $9,657B) -$2,004C) $6,699D) $13,223


Solution:

Year(s) Amount 12% Factor PVInitial investment............... Now ($150,000) 1.000 ($150,000)Working capital needed..... Now ($6,000) 1.000 (6,000)Annual cost savings........... 1-6 $36,000 4.111 147,996Working capital released.... 6 $6,000 0.507 3,042Salvage value..................... 6 $23,000 0.507 11,661 Net present value................ $ 6,699

43. (Ignore income taxes in this problem.) The Poteran Company is considering a machine that will save $3,000 a year in cash operating costs each year for the next six years. At the end of six years it would have no salvage value. If this machine costs $9,060 now, the machine's internal rate of return is closest to:A) 18%B) 20%C) 22%D) 24%


Solution:

Factor of the internal rate of return= Investment required ÷ Net annual cash inflow = $9,060 ÷ $3,000 = 3.020The factor of 3.020 for 6 years represents an internal rate of return of 24%.



44. (Ignore income taxes in this problem) The management of Elamin Corporation is considering the purchase of a machine that would cost $365,695 and would have a useful life of 9 years. The machine would have no salvage value. The machine would reduce labor and other operating costs by $61,000 per year. The internal rate of return on the investment in the new machine is closest to:A) 9%B) 11%C) 12%D) 10%


Solution:


45. (Ignore income taxes in this problem.) Bau Long-Haul, Inc., is considering the purchase of a tractor-trailer that would cost $281,656, would have a useful life of 7 years, and would have no salvage value. The tractor-trailer would be used in the company's hauling business, resulting in additional net cash inflows of $76,000 per year. The internal rate of return on the investment in the tractor-trailer is closest to:A) 19%B) 18%C) 21%D) 16%


Solution:




46. (Ignore income taxes in this problem.) Golab Roofing is considering the purchase of a crane that would cost $69,846, would have a useful life of 6 years, and would have no salvage value. The use of the crane would result in labor savings of $21,000 per year. The internal rate of return on the investment in the crane is closest to:A) 18%B) 20%C) 19%D) 17%


Solution:


47. (Ignore income taxes in this problem) Boe Corporation is investigating buying a small used aircraft for the use of its executives. The aircraft would have a useful life of 9 years. The company uses a discount rate of 10% in its capital budgeting. The net present value of the investment, excluding the salvage value of the aircraft, is -$439,527. Management is having difficulty estimating the salvage value of the aircraft. To the nearest whole dollar how large would the salvage value of the aircraft have to be to make the investment in the aircraft financially attractive?A) $439,527B) $43,953C) $4,395,270D) $1,036,620

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy

Solution:

Minimum salvage value= Negative net present value to the offset ÷ Present value factor= $439,527 ÷ 0.424 = $1,036,613 (answer is slightly off due to rounding)



48. (Ignore income taxes in this problem) The management of Byrge Corporation is investigating buying a small used aircraft to use in making airborne inspections of its above-ground pipelines. The aircraft would have a useful life of 8 years. The company uses a discount rate of 10% in its capital budgeting. The net present value of the investment, excluding the intangible benefits, is -$448,460. To the nearest whole dollar how large would the annual intangible benefit have to be to make the investment in the aircraft financially attractive?A) $44,846B) $56,058C) $84,060D) $448,460


Solution:

Minimum annual cash flows from the intangible benefits= Negative net present value to be offset ÷ Present value factor= $448,460 ÷ 5.335 = $84,060

49. (Ignore income taxes in this problem) The management of Osborn Corporation is investigating an investment in equipment that would have a useful life of 8 years. The company uses a discount rate of 12% in its capital budgeting. The net present value of the investment, excluding the annual cash inflow, is -$401,414. To the nearest whole dollar how large would the annual cash inflow have to be to make the investment in the equipment financially attractive?A) $48,170B) $50,177C) $80,800D) $401,414


Solution:

Minimum annual cash flows = Negative net present value to be offset ÷ Present value factor= $401,414 ÷ 4.968 = $80,800



50. (Ignore income taxes in this problem.) Croce, Inc., is investigating an investment in equipment that would have a useful life of 7 years. The company uses a discount rate of 8% in its capital budgeting. The net present value of the investment, excluding the salvage value, is -$515,967. To the nearest whole dollar how large would the salvage value of the equipment have to be to make the investment in the equipment financially attractive?A) $41,277B) $885,021C) $515,967D) $6,449,588


Solution:

Minimum salvage value= Negative net present value to the offset ÷ Present value factor= $515,967 ÷ 0.583 = $885,021

51. A project has an initial investment of $100,000 and a project profitability index of 0.15. The discount rate is 12%. The net present value of the project is closest to:A) $15,000B) $115,000C) $112,000D) $12,000

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium Source: CMA, adapted

Solution:

Project profitability index = Net present value ÷ Investment required0.15 = Net present value ÷ $100,000Net present value = $15,000



52. A company is pondering an investment project that has an internal rate of return which is equal to the company's discount rate. The project profitability index of this investment project is:A) 0.0B) 0.5C) 1.0D) 1.5

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium

53. (Ignore income taxes in this problem.) The management of Solar Corporation is considering the following three investment projects:

Project L Project M Project NInvestment required....................... $37,000 $55,000 $82,000Present value of cash inflows......... $38,480 $62,150 $90,200

Rank the projects according to the profitability index, from most profitable to least profitable.A) M,N,LB) L,N,MC) N,L,MD) N,M,L


Solution:

Project L Project M Project NInvestment required (a)......................... ($37,000) ($55,000) ($82,000)Present value of cash inflows............... 38,480 62,150 90,200 Net present value (b)............................. $ 1,480 $ 7,150 $ 8,200 Project profitability index (b) ÷ (a)....... 0.04 0.13 0.10Ranked by project profitability index... 3 1 2



54. (Ignore income taxes in this problem.) Trovato Corporation is considering a project that would require an investment of $48,000. No other cash outflows would be involved. The present value of the cash inflows would be $51,840. The profitability index of the project is closest to:A) 0.07B) 0.08C) 0.92D) 1.08


Solution:

Project QInvestment required (a)......................... ($48,000)Present value of cash inflows............... 51,840 Net present value (b)............................. $ 3,840 Project profitability index (b) ÷ (a)....... 0.08

55. (Ignore income taxes in this problem.) Ryner Corporation is considering three investment projects-S, T, and U. Project S would require an investment of $20,000, Project T of $69,000, and Project U of $83,000. No other cash outflows would be involved. The present value of the cash inflows would be $23,200 for Project S, $77,970 for Project T, and $94,620 for Project U. Rank the projects according to the profitability index, from most profitable to least profitable.A) U,T,SB) T,S,UC) U,S,TD) S,U,T


Solution:

Project S Project T Project UInvestment required (a)......................... ($20,000) ($69,000) ($83,000)Present value of cash inflows............... 23,200 77,970 94,620 Net present value (b)............................. $ 3,200 $ 8,970 $11,620Project profitability index (b) ÷ (a)....... 0.16 0.13 0.14Ranked by project profitability index... 1 3 2



56. (Ignore income taxes in this problem.) The management of Leitheiser Corporation is considering a project that would require an initial investment of $51,000. No other cash outflows would be required. The present value of the cash inflows would be $57,630. The profitability index of the project is closest to:A) 1.13B) 0.87C) 0.13D) 0.12


Solution:

Project QInvestment required (a)......................... ($51,000)Present value of cash inflows............... 57,630 Net present value (b)............................. $ 6,630 Project profitability index (b) ÷ (a)....... 0.13

57. (Ignore income taxes in this problem.) Olinick Corporation is considering a project that would require an investment of $343,000 and would last for 8 years. The incremental annual revenues and expenses generated by the project during those 8 years would be as follows:

Sales................................... $227,000Variable expenses.............. 52,000 Contribution margin........... 175,000 Fixed expenses:

Salaries............................ 27,000Rents............................... 41,000Depreciation.................... 40,000

Total fixed expenses.......... 108,000 Net operating income......... $ 67,000

The scrap value of the project's assets at the end of the project would be $23,000. The payback period of the project is closest to:A) 3.0 yearsB) 5.1 yearsC) 3.2 yearsD) 4.8 years




Solution:

Net annual cash flow = Net operating income + Depreciation= $67,000 + $40,000 = $107,000Payback period = Investment required ÷ Net annual cash flow= $343,000 ÷ $107,000 = 3.2 years

In this case the salvage value plays no part in the payback period since all of the investment is recovered before the end of the project.

58. (Ignore income taxes in this problem.) The management of Lanzilotta Corporation is considering a project that would require an investment of $263,000 and would last for 8 years. The annual net operating income from the project would be $66,000, which includes depreciation of $31,000. The scrap value of the project's assets at the end of the project would be $15,000. The payback period of the project is closest to:A) 3.8 yearsB) 2.6 yearsC) 2.7 yearsD) 4.0 years


Solution:Net annual cash flow = Net operating income + Depreciation= $66,000 + $31,000 = $97,000Payback period = Investment required ÷ Net annual cash flow= $263,000 ÷ $97,000 = 2.7 years




59. (Ignore income taxes in this problem.) Slomkowski Corporation is contemplating purchasing equipment that would increase sales revenues by $298,000 per year and cash operating expenses by $143,000 per year. The equipment would cost $712,000 and have a 8 year life with no salvage value. The annual depreciation would be $89,000. The simple rate of return on the investment is closest to:A) 9.3%B) 21.8%C) 22.1%D) 12.5%


Solution:

The simple rate of return is computed as follows:

Cost of machine, net of salvage value (a)........... $712,000Useful life (b)...................................................... 8 yearsAnnual depreciation (a) ÷ (b).............................. $89,000

Annual incremental revenue ($298,000 − $143,000)......................................................... $155,000

Less annual depreciation..................................... 89,000 Annual incremental net operating income.......... $ 66,000

Simple rate of return = Annual incremental net operating income ÷ Initial investment = $66,000 ÷ $712,000 = 9.3%

60. (Ignore income taxes in this problem.) The management of Plotnik Corporation is investigating purchasing equipment that would increase sales revenues by $269,000 per year and cash operating expenses by $156,000 per year. The equipment would cost $294,000 and have a 6 year life with no salvage value. The simple rate of return on the investment is closest to:A) 16.7%B) 38.4%C) 23.8%D) 21.8%




Solution:


Cost of machine, net of salvage value (a).......................... $294,000Useful life (b)..................................................................... 6 yearsAnnual depreciation (a) ÷ (b)............................................. $49,000

Annual incremental revenue ($269,000 − $156,000)........ $113,000Less annual depreciation.................................................... 49,000 Annual incremental net operating income......................... $ 64,000


61. (Ignore income taxes in this problem.) An expansion at Fey, Inc., would increase sales revenues by $150,000 per year and cash operating expenses by $47,000 per year. The initial investment would be for equipment that would cost $328,000 and have a 8 year life with no salvage value. The annual depreciation on the equipment would be $41,000. The simple rate of return on the investment is closest to:A) 41.3%B) 18.9%C) 12.5%D) 31.4%


Solution:


Annual incremental revenue ($150,000 − $47,000)............. $103,000Less annual depreciation....................................................... 41,000 Annual incremental net operating income............................ $ 62,000




62. (Ignore income taxes in this problem.) Crowl Corporation is investigating automating a process by purchasing a machine for $792,000 that would have a 9 year useful life and no salvage value. By automating the process, the company would save $132,000 per year in cash operating costs. The new machine would replace some old equipment that would be sold for scrap now, yielding $21,000. The annual depreciation on the new machine would be $88,000. The simple rate of return on the investment is closest to:A) 11.1%B) 16.7%C) 5.7%D) 5.6%


Solution:


Cost of machine, net of scrap (a) ($792,000 − $21,000).. $771,000

Annual cost savings.......................................................... $132,000Less annual depreciation.................................................. 88,000 Annual incremental net operating income........................ $ 44,000


63. (Ignore income taxes in this problem.) The management of Ro Corporation is investigating automating a process. Old equipment, with a current salvage value of $11,000, would be replaced by a new machine. The new machine would be purchased for $243,000 and would have a 9 year useful life and no salvage value. By automating the process, the company would save $69,000 per year in cash operating costs. The simple rate of return on the investment is closest to:A) 18.1%B) 11.1%C) 28.4%D) 17.3%




Solution:



Annual cost savings............................................ $69,000Less annual depreciation..................................... 27,000 Annual incremental net operating income.......... $42,000

Simple rate of return = Annual incremental net operating income ÷ Initial investment, less salvage value = $42,000 ÷ ($243,000 − $11,000) = 18.1%

64. (Ignore income taxes in this problem.) A company wants to have $20,000 at the end of a ten-year period by investing a single sum now. How much needs to be invested in order to have the desired sum in ten years, if the money can be invested at 12%?A) $3,254.68B) $3,539.82C) $6,440.00D) $7,720.00


Solution:

Factor from Present Value of $1 table, 12%, 10 years: 0.322$20,000 × 0.322 = $6,440.00



65. (Ignore income taxes in this problem.) At an interest rate of 14%, approximately how much would you need to invest today if you wanted to have $2,000,000 in 10 years?A) $383,436B) $540,000C) $740,741D) $1,043,200


Solution:

Factor from Present Value of $1 table, 14%, 10 years: 0.270$2,000,000 × 0.270 = $540,000

66. (Ignore income taxes in this problem.) How much would you have to invest today in the bank at an interest rate of 8% to have an annuity of $4,800 per year for 7 years, with nothing left in the bank at the end of the 7 years? Select the amount below that is closest to your answer.A) $33,600B) $2,798C) $24,989D) $31,111


Solution:

Factor from Present Value of an Annuity of $1 in Arrears Table, 8%, 7 years: 5.206$4,800 × 5.206 = $24,989



67. (Ignore income taxes in this problem.) You have deposited $24,764 in a special account that has a guaranteed interest rate. If you withdraw $4,300 at the end of each year for 9 years, you will completely exhaust the balance in the account. The guaranteed interest rate is closest to:A) 6%B) 10%C) 17%D) 56%


Solution:

$4,300 × Factor from PV of Annuity table = $24,764Factor from PV of Annuity table = 5.759Looking in Present Value of an Annuity of $1 in Arrears in the 9th row, 5.759 is found in the 10% column which is the guaranteed interest rate.

68. (Ignore income taxes in this problem.) You have deposited $7,620 in a special account that has a guaranteed interest rate of 19% per year. If you are willing to completely exhaust the account, what is the maximum amount that you could withdraw at the end of each of the next 7 years? Select the amount below that is closest to your answer.A) $1,295B) $2,056C) $2,219D) $1,089

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 7 Level: Medium

Solution:Factor from Present Value of an Annuity of $1 in Arrears table, 19%, 7 years: 3.706$7,620 ÷ 3.706 = $2,056



69. (Ignore income taxes in this problem.) Suddeth Corporation has entered into a 6 year lease for a building it will use as a warehouse. The annual payment under the lease will be $2,468. The first payment will be at the end of the current year and all subsequent payments will be made at year-ends. What is the present value of the lease payments if the discount rate is 5%?A) $12,528B) $14,103C) $14,808D) $11,050


Solution:

Factor from Present Value of an Annuity of $1 in Arrears table, 5%, 6 years: 5.076$2,468 × 5.076 = $12,528

70. (Ignore income taxes in this problem.) Domebo Corporation has entered into a 7 year lease for a piece of equipment. The annual payment under the lease will be $3,400, with payments being made at the beginning of each year. If the discount rate is 14%, the present value of the lease payments is closest to:A) $9,511B) $16,623C) $20,877D) $23,800


Solution:Annual payments made at the beginning of the year mean that the first lease payment would be paid immediately; the present value of the first lease payment is therefore $3,400. The next six lease payments for years 2-7 made at the beginning of each year is equivalent to six payments at the end of each year for years 1 through 6. The table for the Present Value of an Annuity of $1 in Arrears can be used to calculate the years 1-6.

Factor from Present Value of an Annuity of $1 in Arrears table, 14%, 6 years: 3.889($3,400 × 3.889) + $3,400 = $16,623



71. Wedge Corporation uses a discount rate of 14% and has a tax rate of 30%. The following cash flows occur in the last year of a 10-year equipment selection investment project:

Cost savings for the year............................ $180,000Working capital released............................ $120,000Salvage value from sale of equipment....... $25,000

At the end of the ten years when the equipment is sold, its net book value for tax purposes is zero. The total after-tax present value of the cash flows above is closest to:A) $45,765B) $48,465C) $61,425D) $71,145


Solution:

Years AmountTax

EffectNet cash inflow................... 10 $180,000 0.70Salvage value...................... 10 $25,000 0.70Working capital released.... 10 $120,000Net present value................

After-Tax Cash Flows

14% Factor

Present Value

Net annual cash inflow....... $126,000 0.270 $34,020Salvage value...................... $17,500 0.270 4,725Working capital released.... $120,000 0.270 32,400 Net present value................ $71,145



72. A company anticipates a taxable cash receipt of $80,000 in year 3 of a project. The company's tax rate is 30% and its discount rate is 10%. The present value of this future cash flow is closest to:A) $42,056B) $56,000C) $24,000D) $18,032

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium

Solution:

After-tax cash flow = Before-tax cash flow × (1 − Tax rate)= $80,000 × (1 − 0.30) = $56,000Present value factor from Present Value of $1: 0.751Present value = $56,000 × 0.751 = $42,056

73. A company anticipates a taxable cash expense of $30,000 in year 4 of a project. The company's tax rate is 30% and its discount rate is 14%. The present value of this future cash flow is closest to:A) $(21,000)B) $(5,329)C) $(9,000)D) $(12,432)


Solution:

After-tax cash flow = Before-tax cash flow × (1 − Tax rate)= $30,000 × (1 − 0.30) = $21,000Present value factor from Present Value of $1: 0.592Present value = $21,000 × 0.592 = $12,432



74. A company anticipates a depreciation deduction of $70,000 in year 4 of a project. The company's tax rate is 30% and its discount rate is 12%. The present value of the depreciation tax shield resulting from this deduction is closest to:A) $31,140B) $49,000C) $21,000D) $13,356


Solution:

Depreciation tax shield = $70,000 × 30% = $21,000Present value of depreciation shield = $21,000 × 0.636* = $13,356

*Factor from Present Value of $1 table, 12%, 4 years

75. A company needs an increase in working capital of $50,000 in a project that will last 4 years. The company's tax rate is 30% and its discount rate is 14%. The present value of the release of the working capital at the end of the project is closest to:A) $15,000B) $20,723C) $29,600D) $35,000

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium

Solution:

Present value of working capital release = $50,000 × 0.592* = $29,600

*Factor from Present Value of $1 table



76. Dunn Construction, Inc., has a large crane that cost $35,000 when purchased ten years ago. Depreciation taken to date totals $25,000. The crane can be sold now for $6,000. Assuming a tax rate of 40%, if the crane is sold the total after-tax cash inflow for capital budgeting purposes will be:A) $8,400B) $12,000C) $7,600D) $10,000

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Hard

Solution:

Sale proceeds....................................................... $ 6,000Less book value of crane ($35,000 − $25,000).... 10,000 Loss on sale of crane............................................ ($ 4,000)

Cash proceeds from sale...................................... $6,000Add tax benefit of loss ($4,000 × 0.40)............... 1,600 Total after-tax cash inflow from sale................... $7,600

77. If an investment of $90,000 made now has annual cash operating inflows of $5,000, and if the tax rate is 40%, then the after-tax cash operating inflow each year would be:A) $2,000B) $36,000C) $3,000D) $54,000

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy

Solution:

After-tax cash operating inflow = $5,000 × (1 – 0.40) = $3,000



78. If a company's income tax rate is 30% and its annual depreciation deduction is $80,000, then the annual tax savings from the depreciation tax shield is:A) $56,000B) $24,000C) $80,000D) $32,000

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy

Solution:

Annual tax savings from depreciation tax shield = $80,000 × 0.30 = $24,000

79. Garfield, Inc., is considering a ten-year investment project with forecasted cash revenues of $40,000 per year and forecasted cash expenses of $29,000 per year. The initial cost of the equipment for the project is $23,000. The salvage value of the equipment is $9,000 at the end of the ten years of the project. The net book value of the equipment for tax purposes will be zero at the end of the ten years. The project requires a working capital investment of $7,000 at its inception and another working capital infusion of $5,000 at the end of year five. All of this working capital would be released for use elsewhere at the end of the project. The company's tax rate is 40%. What is the after-tax net cash flow in the tenth year of the project?A) $32,000B) $24,000C) $20,000D) $11,000

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium Source: CMA, adapted



Solution:

Salvage sale proceeds......... $9,000Less book value.................. 0 Gain on sale........................ $9,000

Net after-tax cash flow in year 10:Gain on sale [$9,000 × (1 − 0.40)]....................................... $ 5,400Initial working capital.......................................................... 7,0005th year working capital........................................................ 5,000Net revenue per year [($40,000 − $29,000) × (1 − 0.40)].... 6,600 Net after-tax cash flow......................................................... $24,000

Use the following to answer questions 80-81:

The Golden Company is analyzing projects A, B, and C as possible investment opportunities. Each of these projects has a useful life of eight years. The following information has been obtained:

Project A Project B Project CInitial investment....................................... $250,000 $475,000 $380,000Present value of future net cash inflows.... $290,000 $503,000 $422,000Internal rate of return................................. 16% 20% 18%



80. Consider the following statements:

I. Project A is preferred to Project B according to a net present value ranking.II. Project A is preferred to Project B according to an internal rate of return

ranking.III. Project A is preferred to Project B according to a project profitability index

ranking.

Which is true?A) Only IB) Only IIC) Only I and IID) Only I and III

Ans: D AACSB: Analytic AICPA BB: Critical Thinking ACIPA FN: Decision Making AICPA FN: Reporting LO: 1,2,4 Level: Easy

Solution:

Project A Project B Project CInitial investment (a).................................. $250,000 $475,000 $380,000Present value of future net cash inflows.... $290,000 $503,000 $422,000Net present value (b).................................. $40,000 $28,000 $42,000Project profitability index (b) ÷ (a)............ 0.16 0.06 0.11Internal rate of return................................. 16% 20% 18%

81. Consider the following statements:

I. Project A has the highest ranking according to the project profitability index criterion.

II. Project B has the highest ranking according to the internal rate of return criterion.

III. Project C has the highest ranking according to the net present value criterion.

Which is true?A) Only IIB) Only I and IIIC) Only II and IIID) I, II and III

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2,4 Level: Easy



Solution:

Project A Project B Project CInitial investment (a).................................. $250,000 $475,000 $380,000Present value of future net cash inflows.... $290,000 $503,000 $422,000Net present value (b).................................. $40,000 $28,000 $42,000Project profitability index (b) ÷ (a)............ 0.16 0.06 0.11Internal rate of return................................. 16% 20% 18%


(Ignore income taxes in this problem.) Chee Company has gathered the following data on a proposed investment project:

Investment required in equipment............. $240,000Annual cash inflows................................... $50,000Salvage value............................................. $0Life of the investment................................ 8 yearsRequired rate of return............................... 10%

82. The payback period for the investment is closest to:A) 0.2 yearsB) 2.5 yearsC) 4.8 yearsD) 5.0 years


Solution:

Payback period = Investment required ÷ Annual cash inflows= $240,000 ÷ $50,000= 4.8 years



83. The simple rate of return on the investment is closest to:A) 12.5%B) 10.0%C) 20.8%D) 8.3%


Solution:

The simple rate of return is computed as follows:Cost of machine, net of salvage value (a). . $240,000Useful life (b)............................................. 8 yearsAnnual depreciation (a) ÷ (b)..................... $30,000

Annual cash inflows................................... $50,000Less annual depreciation............................ 30,000 Annual incremental net operating income. $20,000


84. The net present value on this investment is closest to:A) $160,000B) $240,024C) $58,800D) $26,750


Solution:

Year(s) Amount 10% Factor PVAnnual cash inflows..... 1-8 $50,000 5.335 $266,750Initial investment......... Now ($240,000) 1.000 ( 240,000 )Net present value.......... $ 26,750



85. The internal rate of return on the investment is closest to:A) 11%B) 13%C) 15%D) 17%


Solution:

Factor of the internal rate of return= Investment required ÷ Net annual cash inflow = $240,000 ÷ $50,000 = 4.800The factor of 4.800 for 8 years represents an internal rate of return of close to 13%.


(Ignore income taxes in this problem.) The Rapp Company is considering buying a new machine which will require an initial outlay of $15,000. The company estimates that over the next four years this machine would save $6,000 per year in cash operating expenses. At the end of four years, the machine would have no salvage value. The company's required rate of return is 14%.

86. The net present value of this investment is closest to:A) $(12,632)B) $17,484C) $2,484D) $3,612


Solution:

Year(s) Amount 14% Factor PVAnnual cost savings..... 1-4 $6,000 2.914 $17,484Initial investment......... Now ($15,000) 1.000 ( 15,000 )Net present value.......... $ 2,484



87. The machine's internal rate of return is closest to:A) 16%B) 18%C) 20%D) 22%


Solution:

Factor of the internal rate of return = Investment required ÷ Net annual cash inflow = $15,000 ÷ $6,000 = 2.500

The factor of 2.500 for 4 years represents an internal rate of return of almost 22%.


(Ignore income taxes in this problem.) Allo Foundation, a tax-exempt organization, invested $200,000 in cost-saving equipment. The equipment has a five-year useful life with no salvage value. Allo estimates that the annual cash savings from this project will amount to $65,000. On investments of this type, Allo's required rate of return is 12%.

88. The net present value of the project is closest to:A) $34,300B) $36,400C) $90,000D) $125,000

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium Source: CPA, adapted

Solution:




89. Allo's internal rate of return on this project is closest to:A) 13%B) 15%C) 17%D) 19%

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium Source: CPA, adapted

Solution:

Factor of the internal rate of return = Investment required ÷ Net annual cash inflow = $200,000 ÷ $65,000 = 3.077

The factor of 3.077 for 5 years represents an internal rate of return of almost 19%.


(Ignore income taxes in this problem.) Dumora Corporation is considering an investment project that will require an initial investment of $9,400 and will generate the following net cash inflows in each of the five years of its useful life:

Year 1 Year 2 Year 3 Year 4 Year 5Net cash inflows..... $1,000 $2,000 $4,000 $6,000 $5,000

Dumora’s discount rate is 16%.

90. Dumora's payback period for this investment project is closest to:A) 1.91 yearsB) 2.61 yearsC) 2.89 yearsD) 3.40 years




Solution:

AmountRemaining

BalanceInitial investment......... $9,400Year 1 cash inflow....... $1,000 $8,400Year 2 cash inflow....... $2,000 $6,400Year 3 cash inflow....... $4,000 $2,400

Year 4: $2,400 ÷ $6,000 = 0.4

Therefore, the payback period for this investment is 3.4 years.

91. Dumora's net present value for this investment project is closest to:A) $(832)B) $1,204C) $1,376D) $2,386


Solution:

Year(s) Amount 16% Factor PVCost savings−Year 1.... 1 $1,000 0.862 $ 862Cost savings−Year 2.... 2 $2,000 0.743 1,486Cost savings−Year 3.... 3 $4,000 0.641 2,564Cost savings−Year 4.... 4 $6,000 0.552 3,312Cost savings−Year 5.... 5 $5,000 0.476 2,380Initial investment......... Now ($9,400) 1.000 ( 9,400 )Net present value.......... $1,204




(Ignore income taxes in this problem.) Vandezande Inc. is considering the acquisition of a new machine that costs $370,000 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:

Incremental net operating income Incremental net cash flowsYear 1...... $54,000 $128,000Year 2...... $31,000 $105,000Year 3...... $52,000 $126,000Year 4...... $49,000 $123,000Year 5...... $48,000 $122,000

92. If the discount rate is 10%, the net present value of the investment is closest to:A) $370,000B) $457,479C) $234,000D) $87,479

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium Source: CMA, adapted

Solution:

Year(s) Amount 10% Factor PVInitial investment............... Now ($370,000) 1.000 ($370,000)Year 1 incremental net cash

inflow.............................. 1 $128,000 0.909 116,352Year 2 incremental net cash




inflow.............................. 5 $122,000 0.621 75,762 Net present value................ $ 87,479



93. The payback period of this investment, rounded off to the nearest tenth of a year, is closest to:A) 2.9 yearsB) 4.9 yearsC) 3.1 yearsD) 5.0 years

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Medium Source: CMA, adapted

Solution:

AmountRemaining

BalanceInitial investment......... $370,000Year 1 cash inflow....... $128,000 $242,000Year 2 cash inflow....... $105,000 $137,000Year 3 cash inflow....... $126,000 $11,000

Year 4: $11,000 ÷ $123,000 = 0.1 (rounded to nearest tenth)



(Ignore income taxes in this problem.) Oriol Inc. is considering the acquisition of equipment that costs $360,000 and has a useful life of 6 years with no salvage value. The incremental net cash flows that would be generated by the equipment are:

Incremental net cash flowsYear 1......... $115,000Year 2......... $138,000Year 3......... $95,000Year 4......... $91,000Year 5......... $133,000Year 6......... $134,000



94. If the discount rate is 19%, the net present value of the investment is closest to:A) $346,000B) $398,667C) $38,667D) $121,841

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy Source: CMA, adapted

Solution:

Year(s) Amount 19% Factor PVInitial investment............... Now ($360,000) 1.000 ($360,000)Year 1 incremental net cash






inflow.............................. 6 $134,000 0.352 47,168 Net present value................ $38,667

95. The payback period of this investment is closest to:A) 4.1 yearsB) 2.9 yearsC) 5.0 yearsD) 3.1 years

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Easy Source: CMA, adapted



Solution:

AmountRemaining

BalanceInitial investment......... $360,000Year 1 cash inflow....... $115,000 245,000Year 2 cash inflow....... 138,000 107,000Year 3 cash inflow....... 95,000 12,000

Year 4: $12,000 ÷ $91,000 = 0.1 (rounded to nearest tenth)



(Ignore income taxes in this problem.) Morrel University has a small shuttle bus that is in poor mechanical condition. The bus can be either overhauled now or replaced with a new shuttle bus. The following data have been gathered concerning these two alternatives:

Present Bus New BusPurchase cost new.......................... $32,000 $40,000Remaining net book value............. $21,000 —Major repair needed now............... $9,000 —Annual cash operating costs........... $12,000 $8,000Salvage value now......................... $10,000 —Trade-in value in seven years........ $2,000 $5,000

The University could continue to use the present bus for the next seven years. Whether the present bus is used or a new bus is purchased, the bus would be traded in for another bus at the end of seven years. The University uses a discount rate of 12% and the total cost approach to net present value analysis in evaluating its investment decisions.



96. If the new bus is purchased, the present value of the annual cash operating costs associated with this alternative is (rounded off to the nearest hundred dollars):A) $(54,800)B) $(36,500)C) $(16,200)D) $(42,800)


Solution:Year(s) Amount 12% Factor PV

Annual cash operating costs. 1-7 ($8,000) 4.564 ($36,512)

97. If the present bus is repaired, the present value of the annual cash operating costs associated with this alternative is (rounded off to the nearest hundred dollars):A) $(36,500)B) $(16,200)C) $(47,200)D) $(54,800)



Annual cash operating costs 1-7 ($12,000) 4.564 ($54,768)

98. If the present bus is repaired, the present value of the salvage received on sale of the bus seven years from now is:A) $(2,260)B) $2,260C) $904D) $(904)



Salvage value..................... 7 $2,000 0.452 $904




(Ignore income taxes in this problem.) Becker Billing Systems, Inc., has an antiquated high-capacity printer that needs to be upgraded. The system either can be overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives:

Overhaul Present System

Purchase New System

Purchase cost when new............. $300,000 $400,000Accumulated depreciation.......... $220,000 —Overhaul costs needed now........ $250,000 —Annual cash operating costs........ $120,000 $90,000Salvage value now...................... $90,000 —Salvage value in ten years........... $30,000 $80,000Working capital required............ — $50,000

The company uses a 10% discount rate and the total-cost approach to capital budgeting 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 ten years.

99. The net present value of the overhaul alternative (rounded to the nearest hundred dollars) is:A) $(750,300)B) $(725,800)C) $(975,800)D) $(987,400)

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard

Solution:

Year(s) Amount 10% Factor PVAnnual operating costs....... 1-10 ($120,000) 6.145 ($737,400)Overhaul costs.................... Now ($250,000) 1.000 (250,000)Salvage value..................... 10 $30,000 0.386 11,580 Net present value................ ($975,820)



100. The net present value of the new system alternative (rounded to the nearest hundred dollars) is:A) $(862,900)B) $(552,900)C) $(758,400)D) $(987,400)


Solution:

Year(s) Amount 10% Factor PVInitial investment............... Now ($400,000) 1.000 ($400,000)Annual operating costs....... 1-10 ($90,000) 6.145 (553,050)Salvage value−old equip.... Now $90,000 1.000 90,000Salvage value..................... 10 $80,000 0.386 30,880Working capital required. . . Now ($50,000) 1.000 (50,000)Working capital released.... 10 $50,000 0.386 19,300 Net present value................ ($862,870)


(Ignore income taxes in this problem.) Almendarez Corporation is considering the purchase of a machine that would cost $320,000 and would last for 7 years. At the end of 7 years, the machine would have a salvage value of $51,000. By reducing labor and other operating costs, the machine would provide annual cost savings of $72,000. The company requires a minimum pretax return of 18% on all investment projects.

101. The present value of the annual cost savings of $72,000 is closest to:A) $22,608B) $874,298C) $504,000D) $274,464


Solution:

Year(s) Amount 18% Factor PVAnnual cost savings........... 1-7 $72,000 3.812 $274,464



102. The net present value of the proposed project is closest to:A) -$29,522B) -$45,536C) $5,464D) -$94,042


Solution:

Year(s) Amount 18% Factor PVInitial investment............... Now ($320,000) 1.000 ($320,000)Annual cost savings........... 1-7 $72,000 3.812 274,464Salvage value..................... 7 $51,000 0.314 16,014 Net present value................ ($ 29,522 )


(Ignore income taxes in this problem.) The management of Opray Corporation is considering the purchase of a machine that would cost $360,000, would last for 7 years, and would have no salvage value. The machine would reduce labor and other costs by $78,000 per year. The company requires a minimum pretax return of 11% on all investment projects.

103. The present value of the annual cost savings of $78,000 is closest to:A) $763,064B) $177,027C) $546,000D) $367,536


Solution:

Year(s) Amount 11% Factor PVAnnual labor savings.......... 1-7 $78,000 4.712 $367,536



104. The net present value of the proposed project is closest to:A) $15,646B) $89,588C) $7,536D) $186,000


Solution:

Year(s) Amount 11% Factor PVInitial investment............... Now ($360,000) 1.000 ($360,000)Annual net cash receipts.... 1-7 $78,000 4.712 367,536 Net present value................ $ 7,536


(Ignore income taxes in this problem.) Paragas, Inc., is considering the purchase of a machine that would cost $370,000 and would last for 8 years. At the end of 8 years, the machine would have a salvage value of $52,000. The machine would reduce labor and other costs by $96,000 per year. Additional working capital of $4,000 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 19% on all investment projects.

105. The combined present value of the working capital needed at the beginning of the project and the working capital released at the end of the project is closest to:A) -$3,004B) $0C) -$12,080D) $11,816


Solution:

Year(s) Amount 19% Factor PVWorking capital required. . . Now ($4,000) 1.000 ($4,000)Working capital released.... 8 $4,000 0.249 996 Net present value................ ($3,004)



106. The net present value of the proposed project is closest to:A) $9,584B) $78,530C) $22,532D) $19,528


Solution:

Year(s) Amount 19% Factor PVInitial investment............... Now ($370,000) 1.000 ($370,000)Annual labor savings.......... 1-8 $96,000 3.954 379,584Working capital required. . . Now ($4,000) 1.000 (4,000)Working capital released.... 8 $4,000 0.249 996Salvage value..................... 8 $52,000 0.249 12,950 Net present value................ $ 19,530


(Ignore income taxes in this problem.) Undersymington Company has an opportunity to invest in a machine that would cost $28,000, and that would produce cost savings of $8,000 each year for the next five years.

107. If the machine has zero salvage value, then the internal rate of return is closest to:A) 10.4%B) 10.9%C) 12.8%D) 13.2%


Solution:

Factor of the internal rate of return= Investment required ÷ Net annual cash inflow = $28,000 ÷ $8,000 = 3.500.The factor of 3.500 for 5 years represents an internal rate of return of somewhat more than 13%, or 13.2%.



108. If the machine's salvage value at the end of the project is $4,000, then the internal rate of return is:A) less than 11%B) less than 12%, but greater than 11%C) less than 13%, but greater than 12%D) greater than 13%

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Hard

Solution:

Factor of the internal rate of return without considering salvage value= Investment required ÷ Net annual cash inflow = $28,000 ÷ $8,000 = 3.500.The factor of 3.500 for 5 years represents an internal rate of return of somewhat more than 13%, or 13.2%.

Since the IRR is more than 13% without considering the salvage value, adding in the present value of the salvage value will further increase the IRR.


(Ignore income taxes in this problem.) Cabe Corporation uses a discount rate of 18% in its capital budgeting. Partial analysis of an investment in automated equipment with a useful life of 7 years has thus far yielded a net present value of -$155,606. This analysis did not include any estimates of the intangible benefits of automating this process nor did it include any estimate of the salvage value of the equipment.

109. Ignoring any salvage value, to the nearest whole dollar how large would the additional cash flow per year from the intangible benefits have to be to make the investment in the automated equipment financially attractive?A) $40,820B) $22,229C) $28,009D) $155,606


Solution:




110. Ignoring any cash flows from intangible benefits, to the nearest whole dollar how large would the salvage value of the automated equipment have to be to make the investment in the automated equipment financially attractive?A) $495,561B) $28,009C) $155,606D) $864,478


Solution:



(Ignore income taxes in this problem.) The management of Hansley Corporation is investigating an investment in equipment that would have a useful life of 5 years. The company uses a discount rate of 18% in its capital budgeting. Good estimates are available for the initial investment and the annual cash operating outflows, but not for the annual cash inflows and the salvage value of the equipment. The net present value of the initial investment and the annual cash outflows is -$273,300.

111. Ignoring any salvage value, to the nearest whole dollar how large would the annual cash inflow have to be to make the investment in the equipment financially attractive?A) $54,660B) $49,194C) $87,400D) $273,300


Solution:




112. Ignoring the cash inflows, to the nearest whole dollar how large would the salvage value of the equipment have to be to make the investment in the equipment financially attractive?A) $625,400B) $1,518,333C) $273,300D) $49,194


Solution:



(Ignore income taxes in this problem.) Lem Corporation is investigating buying a small used aircraft for the use of its executives. The aircraft would have a useful life of 7 years. The company uses a discount rate of 11% in its capital budgeting. The net present value of the initial investment and the annual operating cash cost is -$317,966. Management is having difficulty estimating the annual benefit of having the aircraft and estimating the salvage value of the aircraft.

113. Ignoring the annual benefit, to the nearest whole dollar how large would the salvage value of the aircraft have to be to make the investment in the aircraft financially attractive?A) $2,890,600B) $317,966C) $34,976D) $659,680


Solution:




114. Ignoring any salvage value, to the nearest whole dollar how large would the annual benefit have to be to make the investment in the aircraft financially attractive?A) $67,480B) $317,966C) $34,976D) $45,424


Solution:



(Ignore income taxes in this problem.) Eddie Corporation is considering the following three investment projects:

Project C Project D Project EInvestment required....................... $36,000 $41,000 $85,000Present value of cash inflows......... $39,960 $47,560 $92,650

115. The profitability index of investment project D is closest to:A) 0.16B) 0.84C) 0.14D) 1.16


Solution:

Project DInvestment required (a)......................... ($41,000)Present value of cash inflows............... 47,560 Net present value (b)............................. $ 6,560 Project profitability index (b) ÷ (a)....... 0.16



116. Rank the projects according to the profitability index, from most profitable to least profitable.A) E,C,DB) E,D,CC) D,C,ED) C,E,D


Solution:

Project C Project D Project EInvestment required (a)......................... ($36,000) ($41,000) ($85,000)Present value of cash inflows............... 39,960 47,560 92,650 Net present value (b)............................. $ 3,960 $ 6,560 $ 7,650 Project profitability index (b) ÷ (a)....... 0.11 0.16 0.09Ranked by project profitability index... 2 1 3


(Ignore income taxes in this problem.) The management of Hibert Corporation is considering three investment projects-W, X, and Y. Project W would require an investment of $21,000, Project X of $66,000, and Project Y of $95,000. The present value of the cash inflows would be $22,470 for Project W, $73,920 for Project X, and $98,800 for Project Y.

117. The profitability index of investment project X is closest to:A) 0.11B) 0.88C) 1.12D) 0.12


Solution:

Project XInvestment required (a)......................... ($66,000)Present value of cash inflows............... 73,920 Net present value (b)............................. $ 7,920 Project profitability index (b) ÷ (a)....... 0.12



118. Rank the projects according to the profitability index, from most profitable to least profitable.A) Y,W,XB) X,Y,WC) X,W,YD) W,Y,X


Solution:

Project W Project X Project YInvestment required (a)......................... ($21,000) ($66,000) ($95,000)Present value of cash inflows............... 22,470 73,920 98,800 Net present value (b)............................. $ 1,470 $ 7,920 $ 3,800 Project profitability index (b) ÷ (a)....... 0.07 0.12 0.04Ranked by project profitability index... 2 1 3


(Appendix 14C) Gibboney Inc. has provided the following data to be used in evaluating a proposed investment project:

Initial investment............... $880,000Annual cash receipts.......... $660,000Life of the project............... 8 yearsAnnual cash expenses........ $330,000Salvage value..................... $88,000Tax rate.............................. 30%

For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 7 years. The company uses a discount rate of 12%.



119. When computing the net present value of the project, what are the annual after-tax cash receipts?A) $462,000B) $396,000C) $198,000D) $69,300


Solution:

Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)= $660,000 × (1 − 0.30) = $462,000

120. When computing the net present value of the project, what are the annual after-tax cash expenses?A) $429,000B) $242,000C) $99,000D) $231,000


Solution:

Annual after-tax cash expenses = Annual cash expenses × (1 − Tax rate)= $330,000 × (1 − 0.30)= $231,000



121. When computing the net present value of the project, what is the annual amount of the depreciation tax shield? In other words, by how much does the depreciation deduction reduce taxes each year in which the depreciation deduction is taken?A) $37,714B) $88,000C) $77,000D) $33,000


Solution:

Initial investment........................ $880,000Life in years................................ 7 yearsAnnual amount of depreciation... $125,714

Annual amount of depreciation tax shield = $125,714 × 0.30= $37,714

122. When computing the net present value of the project, what is the after-tax cash flow from the salvage value in the final year?A) $0B) $88,000C) $26,400D) $61,600


Solution:

Gain on sale (asset fully depreciated)..... $88,000× (1 − Tax rate)....................................... 0.70After-tax cash flow from salvage value. . $61,600





Solution:


Annual after-tax cash expenses = Annual cash expenses × (1 − Tax rate)= $330,000 × (1 − 0.30)= $231,000



Year(s) Amount 12% Factor PVInitial investment............... Now ($880,000) 1.000 ($ 880,000)Annual net cash receipts (after-tax) 1-8 $462,000 4.968 2,295,216Annual net cash expenses (after-tax) 1-8 ($231,000) 4.968 (1,147,608)Salvage value (after-tax).... 8 $61,600 0.404 24,886Annual depreciation tax shield 1-7 $37,714 4.564 172,127 Net present value................ $ 464,621




(Appendix 14C) Shufflebarger Inc. has provided the following data to be used in evaluating a proposed investment project:

Initial investment............... $280,000Annual cash receipts.......... $196,000Life of the project............... 6 yearsAnnual cash expenses........ $78,000Salvage value..................... $28,000

The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated over 5 years without any reduction for salvage value. The company uses a discount rate of 16%.



Solution:




125. When computing the net present value of the project, what are the annual after-tax cash expenses?A) $101,400B) $50,000C) $54,600D) $23,400


Solution:

Annual after-tax cash expenses = Annual cash expenses × (1 − Tax rate)= $78,000 × (1 − 0.30) = $54,600

126. When computing the net present value of the project, what is the annual amount of the depreciation tax shield? In other words, by how much does the depreciation deduction reduce taxes each year in which the depreciation deduction is taken?A) $16,800B) $39,200C) $14,000D) $32,667


Solution:





127. When computing the net present value of the project, what is the after-tax cash flow from the salvage value in the final year?A) $28,000B) $8,400C) $19,600D) $0


Solution:



(Appendix 14C) Valentin Inc. has provided the following data concerning an investment project that has been proposed:


The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated over 3 years without any reduction for salvage value. The company uses a discount rate of 10%.



128. When computing the net present value of the project, what is the after-tax cash flow from the salvage value in the final year?A) $13,500B) $45,000C) $0D) $31,500


Solution:




129. The net present value of the project is closest to:A) $39,881B) $59,442C) -$181,462D) -$161,901


Solution:


Initial investment.................................... $890,000Depreciable life in years......................... 3 yearsAnnual depreciation................................ $296,667× Tax rate................................................ 0.30Annual depreciation tax shield................ $89,000

Annual net cash inflows = Annual cash receipts − Annual cash expenses= $534,000 − $267,000= $267,000After-tax cash inflows = $267,000 × (1 − 0.30)= $186,900

Year(s) Amount 10% Factor PVInitial investment............... Now ($890,000) 1.000 ($890,000)Annual net cash inflows

(after-tax)........................ 1-5 $186,900 3.791 708,538Depreciation tax shield...... 1-3 $89,000 2.487 221,343Salvage value (after-tax).... 5 $31,500 0.621 19,562 Net present value................ $ 59,443




(Appendix 14C) Nunoz Inc. is considering an investment project that would require an initial investment of $250,000 and that would last for 9 years. The annual cash receipts from the project would be $175,000 and the annual cash expenses would be $79,000. The equipment used in the project could be sold at the end of the project for a salvage value of $13,000. The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated over 7 years without any reduction for salvage value. The company uses a discount rate of 10%.



Solution:






Solution:


Annual after-tax expenses = Annual expenses × (1 − Tax rate)= $79,000 × (1 − 0.30) = $55,300

Initial investment.................................... $250,000Depreciable life in years......................... 7 yearsAnnual depreciation................................ $35,714× Tax rate................................................ 0.30Annual depreciation tax shield................ $10,714


Year(s) Amount 10% Factor PVInitial investment............... Now ($250,000) 1.000 ($250,000)Annual cash receipts

(after-tax)........................ 1-9 $122,500 5.759 705,478Annual cash expenses

(after-tax)........................ 1-9 ($55,300) 5.759 (318,473)Depreciation tax shield 1-7 $10,714 4.868 52,156Salvage value..................... 9 $9,100 0.424 3,858 Net present value................ $193,019



Essay Questions

132. (Ignore income taxes in this problem.) Cooney Inc. has provided the following data concerning a proposed investment project:

Initial investment............... $160,000Life of the project............... 7 yearsAnnual net cash inflows..... $40,000Salvage value..................... $16,000

The company uses a discount rate of 17%.

Required:

Compute the net present value of the project.

Ans:

Year(s) Amount 17% Factor PVInitial investment............... Now ($160,000) 1.000 ($160,000)Annual net cash receipts.... 1-7 $40,000 3.922 156,880Salvage value..................... 7 $16,000 0.333 5,328 Net present value................ $ 2,208

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy



133. (Ignore income taxes in this problem.) Strausberg Inc. is considering investing in a project that would require an initial investment of $270,000. The life of the project would be 6 years. The annual net cash inflows from the project would be $81,000. The salvage value of the assets at the end of the project would be $27,000. The company uses a discount rate of 10%.

Required:


Ans:

Year(s) Amount 10% Factor PVInitial investment............... Now ($270,000) 1.000 ($270,000)Annual net cash receipts.... 1-6 $81,000 4.355 352,755Salvage value..................... 6 $27,000 0.564 15,228 Net present value................ $ 97,983


134. (Ignore income taxes in this problem.) Tiff Corporation has provided the following data concerning a proposed investment project:

Initial investment.................. $960,000Life of the project.................. 6 yearsWorking capital required...... $20,000Annual net cash inflows........ $288,000Salvage value........................ $144,000

The company uses a discount rate of 16%. The working capital would be released at the end of the project.

Required:




Ans:

Year(s) Amount 16% Factor PVInitial investment..................... Now ($960,000) 1.000 ($ 960,000)Annual net cash inflows........... 1-6 $288,000 3.685 1,061,280Working capital invested......... Now ($20,000) 1.000 (20,000)Working capital released.......... 6 $20,000 0.410 8,200Salvage value........................... 6 $144,000 0.410 59,040 Net present value...................... $ 148,520


135. (Ignore income taxes in this problem.) Mattice Corporation is considering investing $490,000 in a project. The life of the project would be 7 years. The project would require additional working capital of $34,000, which would be released for use elsewhere at the end of the project. The annual net cash inflows would be $123,000. The salvage value of the assets used in the project would be $49,000. The company uses a discount rate of 11%.

Required:


Ans:

Year(s) Amount 11% Factor PVInitial investment............... Now ($490,000) 1.000 ($490,000)Annual net cash inflows..... 1-7 $123,000 4.712 579,576Working capital invested. . . Now ($34,000) 1.000 (34,000)Working capital released.... 7 $34,000 0.482 16,388Salvage value..................... 7 $49,000 0.482 23,618 Net present value................ $ 95,582




136. (Ignore income taxes in this problem.) Wary Corporation is considering the purchase of a machine that would cost $240,000 and would last for 9 years. At the end of 9 years, the machine would have a salvage value of $29,000. The machine would reduce labor and other costs by $63,000 per year. The company requires a minimum pretax return of 19% on all investment projects.

Required:

Determine the net present value of the project. Show your work!

Ans:

Year(s) Amount 19% Factor PVAnnual cost savings..... 1-9 $63,000 4.163 $262,269Initial investment......... Now ($240,000) 1.000 (240,000)Salvage value............... 9 $29,000 0.209 6,061 Net present value.......... $ 28,330


137. (Ignore income taxes in this problem.) The management of Kinion Corporation is considering the purchase of a machine that would cost $170,000, would last for 7 years, and would have no salvage value. The machine would reduce labor and other costs by $50,000 per year. The company requires a minimum pretax return of 17% on all investment projects.

Required:


Ans:





138. (Ignore income taxes in this problem.) Joanette, Inc., is considering the purchase of a machine that would cost $240,000 and would last for 5 years, at the end of which, the machine would have a salvage value of $48,000. The machine would reduce labor and other costs by $62,000 per year. Additional working capital of $7,000 would be needed immediately, all of which would be recovered at the end of 5 years. The company requires a minimum pretax return of 17% on all investment projects.

Required:


Ans:

Year(s) Amount 17% Factor PVInitial investment............... Now ($240,000) 1.000 ($240,000)Working capital needed..... Now ($7,000) 1.000 (7,000)Annual cost savings........... 1-5 $62,000 3.199 198,338Working capital released.... 5 $7,000 0.456 3,192Salvage value..................... 5 $48,000 0.456 21,888 Net present value................ ($ 23,582 )


139. (Ignore income taxes in this problem.) The management of Harling Corporation is considering the purchase of a machine that would cost $90,504 and would have a useful life of 5 years. The machine would have no salvage value. The machine would reduce labor and other operating costs by $27,000 per year.

Required:

Determine the internal rate of return on the investment in the new machine. Show your work!

Ans:





140. (Ignore income taxes in this problem.) Maxcy Limos, Inc., is considering the purchase of a limousine that would cost $187,335, would have a useful life of 9 years, and would have no salvage value. The limousine would bring in cash inflows of $45,000 per year in excess of its cash operating costs.

Required:

Determine the internal rate of return on the investment in the new limousine. Show your work!

Ans:



141. (Ignore income taxes in this problem.) The management of Zachery Corporation is considering the purchase of a automated molding machine that would cost $203,255, would have a useful life of 5 years, and would have no salvage value. The automated molding machine would result in cash savings of $65,000 per year due to lower labor and other costs.

Required:

Determine the internal rate of return on the investment in the new automated molding machine. Show your work!

Ans:





142. (Ignore income taxes in this problem.) The management of an amusement park is considering purchasing a new ride for $60,000 that would have a useful life of 15 years and a salvage value of $8,000. The ride would require annual operating costs of $26,000 throughout its useful life. The company's discount rate is 10%. Management is unsure about how much additional ticket revenue the new ride would generate-particularly since customers pay a flat fee when they enter the park that entitles them to unlimited rides. Hopefully, the presence of the ride would attract new customers.

Required:

How much additional revenue would the ride have to generate per year to make it an attractive investment?

Ans:

Years Amount 10%Factor Present ValueCost of asset....................... Now $(60,000) 1.000 ($ 60,000)Annual operating costs....... 1-15 $(26,000) 7.606 ( 197,756)Salvage value..................... 15 $8,000 0.239 1,912 Net present value................ ($255,844)

$255,844 ÷ 7.606 = $33,637 additional revenue per year would be necessary to justify the investment. This much additional revenue would result in a zero net present value. Any less than this and the net present value would be negative. Any more than this and the net present value would be positive.

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Hard

143. (Ignore income taxes in this problem.) Devon Corporation uses a discount rate of 8% in its capital budgeting. Partial analysis of an investment in automated equipment with a useful life of 8 years has thus far yielded a net present value of -$496,541. This analysis did not include any estimates of the intangible benefits of automating this process nor did it include any estimate of the salvage value of the equipment.

Required:

a. Ignoring any salvage value, how large would the additional cash flow per year from the intangible benefits have to be to make the investment in the automated equipment financially attractive?

b. Ignoring any cash flows from intangible benefits, how large would the salvage value of the automated equipment have to be to make the investment in the automated equipment financially attractive?



Ans:a. Minimum annual cash flows from the intangible benefits

= Negative net present value to be offset ÷ Present value factor= $496,541 ÷ 5.747 = $86,400

b. Minimum salvage value= Negative net present value to the offset ÷ Present value factor= $496,541 ÷ 0.540 = $919,520


144. (Ignore income taxes in this problem.) The management of Crosson Corporation is investigating the purchase of a new satellite routing system with a useful life of 9 years. The company uses a discount rate of 17% in its capital budgeting. The net present value of the investment, excluding its intangible benefits, is -$173,055.

Required:

How large would the additional cash flow per year from the intangible benefits have to be to make the investment in the automated equipment financially attractive?

Ans:



145. (Ignore income taxes in this problem.) Chipps Corporation uses a discount rate of 9% in its capital budgeting. Management is considering an investment in telecommunications equipment with a useful life of 5 years. Excluding the salvage value of the equipment, the net present value of the investment in the equipment is -$530,985.

Required:

How large would the salvage value of the telecommunications equipment have to be to make the investment in the telecommunications equipment financially attractive?



Ans:Minimum salvage value= Negative net present value to the offset ÷ Present value factor= $530,985 ÷ 0.650 = $816,900


146. (Ignore income taxes in this problem.) Choudhury Corporation is considering the following three investment projects:

Project H Project I Project JInvestment required....................... $11,000 $53,000 $89,000Present value of cash inflows......... $12,980 $61,480 $96,120

Required:

Rank the investment projects using the project profitability index. Show your work

Ans:

Project H Project I Project JInvestment required (a)......................... ($11,000) ($53,000) ($89,000)Present value of cash inflows............... 12,980 61,480 96,120 Net present value (b)............................. $ 1,980 $ 8,480 $ 7,120 Project profitability index (b) ÷ (a)....... 0.18 0.16 0.08Ranked by project profitability index... 1 2 3


147. (Ignore income taxes in this problem.) The management of Winstead Corporation is considering the following three investment projects:

Project Q Project R Project SInvestment required....................... $14,000 $48,000 $74,000Present value of cash inflows......... $14,140 $54,720 $82,140

The only cash outflows are the initial investments in the projects.

Required:

Rank the investment projects using the project profitability index. Show your work



Ans:

Project Q Project R Project SInvestment required (a)......................... ($14,000) ($48,000) ($74,000)Present value of cash inflows............... 14,140 54,720 82,140 Net present value (b)............................. $ 140 $ 6,720 $ 8,140 Project profitability index (b) ÷ (a)....... 0.01 0.14 0.11Ranked by project profitability index... 3 1 2


148. (Ignore income taxes in this problem.) Hady Company is considering purchasing a machine that would cost $688,800 and have a useful life of 7 years. The machine would reduce cash operating costs by $118,759 per year. The machine would have no salvage value.

Required:

a. Compute the payback period for the machine.b. Compute the simple rate of return for the machine.

Ans:

a. Payback period = Investment required ÷ Net annual cash flow= $688,800 ÷ $118,759 = 5.80 years

b. The simple rate of return is computed as follows:

Cost of machine, net of salvage value (a)........ $688,800Useful life (b)................................................... 7 yearsAnnual depreciation (a) ÷ (b)........................... $98,400

Annual cost savings......................................... $118,759Less annual depreciation.................................. 98,400 Annual incremental net operating income....... $ 20,359


AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5,6 Level: Easy



149. (Ignore income taxes in this problem.) Ramson Company is considering purchasing a machine that would cost $756,000 and have a useful life of 8 years. The machine would reduce cash operating costs by $132,632 per year. The machine would have a salvage value of $151,200 at the end of the project.

Required:

a. Compute the payback period for the machine.b. Compute the simple rate of return for the machine.

Ans:

a. Payback period = Investment required ÷ Net annual cash flow= $756,000 ÷ $132,632 = 5.70 years


b. The simple rate of return is computed as follows:


Annual cost savings............................................ $132,632Less annual depreciation..................................... 75,600 Annual incremental net operating income.......... $ 57,032


AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5,6 Level: Medium



150. (Ignore income taxes in this problem.) Ostermeyer Corporation is considering a project that would require an initial investment of $247,000 and would last for 7 years. The incremental annual revenues and expenses for each of the 7 years would be as follows:

Sales................................... $198,000Variable expenses.............. 46,000 Contribution margin........... 152,000 Fixed expenses:

Salaries............................ 22,000Rents............................... 32,000Depreciation.................... 33,000

Total fixed expenses.......... 87,000 Net operating income......... $ 65,000

At the end of the project, the scrap value of the project's assets would be $16,000.

Required:

Determine the payback period of the project. Show your work!

Ans:

Net operating income................................. $65,000Add noncash deduction for depreciation. . . 33,000 Net annual cash inflow............................... $98,000

Payback period = Investment required ÷ Net annual cash inflow= $247,000 ÷ $98,000 = 2.52 years




151. (Ignore income taxes in this problem.) The management of Truelove Corporation is considering a project that would require an initial investment of $321,000 and would last for 7 years. The annual net operating income from the project would be $28,000, including depreciation of $42,000. At the end of the project, the scrap value of the project's assets would be $27,000.

Required:

Determine the payback period of the project. Show your work!

Ans:

Net operating income................................. $28,000Add noncash deduction for depreciation. . . 42,000 Net annual cash inflow............................... $70,000

Payback period = Investment required ÷ Net annual cash inflow= $321,000 ÷ $70,000 = 4.59 years


152. (Ignore income taxes in this problem.) Ducey Corporation is contemplating purchasing equipment that would increase sales revenues by $79,000 per year and cash operating expenses by $27,000 per year. The equipment would cost $150,000 and have a 6 year life with no salvage value. The annual depreciation would be $25,000.

Required:

Determine the simple rate of return on the investment to the nearest tenth of a percent. Show your work!

Ans:

Simple rate of return = Annual incremental net operating income ÷ Initial investment= [Incremental revenues − (Cash operating expenses + Depreciation)] ÷ Initial

investment=79,000 − ($27,000 + $25,000) ÷ $150,000= 27,000 ÷ $150,000 = 18.0%




153. (Ignore income taxes in this problem.) The management of Nixon Corporation is investigating purchasing equipment that would cost $518,000 and have a 7 year life with no salvage value. The equipment would allow an expansion of capacity that would increase sales revenues by $364,000 per year and cash operating expenses by $211,000 per year.

Required:


Ans:

Simple rate of return = Annual incremental net operating income ÷ Initial investment= [Incremental revenues − (Cash operating expenses + Depreciation)] ÷ Initial investment= 364,000 − ($211,000 + $74,000) ÷ $518,000= 79,000 ÷ $518,000 = 15.3%


154. (Ignore income taxes in this problem.) Russnak Corporation is investigating automating a process by purchasing a new machine for $198,000 that would have a 9 year useful life and no salvage value. By automating the process, the company would save $68,000 per year in cash operating costs. The company's current equipment would be sold for scrap now, yielding $18,000. The annual depreciation on the new machine would be $22,000.

Required:


Ans:

Simple rate of return = Annual incremental net operating income ÷ Initial investment= (Cost savings - Depreciation) ÷ Initial investment= ($68,000 − $22,000) ÷ ($198,000 − $18,000)= $46,000 ÷ $180,000 = 25.6%




155. (Ignore income taxes in this problem.) The management of Schenk Corporation is investigating automating a process by replacing old equipment by a new machine. The old equipment would be sold for scrap now for $13,000. The new machine would cost $648,000, would have a 9 year useful life, and would have no salvage value. By automating the process, the company would save $186,000 per year in cash operating costs.

Required:


Ans:

Depreciation on the new machine = $648,000 ÷ 9 = $72,000Simple rate of return = Annual incremental net operating income ÷ Initial investment= (Cost savings − Depreciation) ÷ Initial investment= ($186,000 − $72,000) ÷ ($648,000 - $13,000)= $114,000 ÷ $635,000 = 18.0%




156. A company is considering purchasing an asset for $70,000 that would have a useful life of 5 years and would have a salvage value of $12,000. For tax purposes, the entire original cost of the asset would be depreciated over 5 years using the straight-line method and the salvage value would be ignored. The asset would generate annual net cash inflows of $22,000 throughout its useful life. The project would require additional working capital of $8,000, which would be released at the end of the project. The company's tax rate is 40% and its discount rate is 9%.

Required:

What is the net present value of the asset?

Ans:

Years AmountTax

EffectCost of asset........................ Now ($70,000)Working capital needed...... Now ($8,000)Net annual cash inflows...... 1-5 $22,000 0.60Depreciation tax shield....... 1-5 $14,000 0.40Salvage value...................... 5 $12,000 0.60Working capital released.... 5 $8,000Net present value................


9% Factor

Present Value

Cost of asset........................ ($70,000) 1.000 ($70,000)Working capital needed...... ($8,000) 1.000 (8,000)Net annual cash inflows...... $13,200 3.890 51,348Depreciation tax shield....... $5,600 3.890 21,784Salvage value...................... $7,200 0.650 4,680Working capital released.... $8,000 0.650 5,200 Net present value................ $ 5,012

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium



157. Management is considering purchasing an asset for $40,000 that would have a useful life of 8 years and no salvage value. For tax purposes, the entire original cost of the asset would be depreciated over 8 years using the straight-line method. The asset would generate annual net cash inflows of $20,000 throughout its useful life. The project would require additional working capital of $5,000, which would be released at the end of the project. The company's tax rate is 40% and its discount rate is 12%.

Required:

What is the net present value of the asset?

Ans:

Years AmountTax

EffectCost of asset........................ Now ($40,000)Working capital needed...... Now ($5,000)Net annual cash inflows...... 1-8 $20,000 0.60Depreciation tax shield....... 1-8 $5,000 0.40Working capital released..... 8 $5,000Net present value.................

After-Tax Cash Flows 12%Factor

Present Value

Cost of asset........................ ($40,000) 1.000 ($40,000)Working capital needed...... ($5,000) 1.000 (5,000)Net annual cash inflows...... $12,000 4.968 59,616Depreciation tax shield....... $2,000 4.968 9,936Working capital released..... $5,000 0.404 2,020 Net present value................. $26,572




158. Belling Inc. has provided the following data concerning a proposed investment project:


The company's tax rate is 30%. For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 7 years. The company uses a discount rate of 14%.

Required:


Ans:

Annual cash receipts........................................ $126,000Annual cash expenses...................................... 50,000 Annual net cash receipts.................................. $ 76,000

Initial investment (a)........................................ $168,000Tax life (b)....................................................... 7 yearsAnnual depreciation deduction (a) ÷ (b).......... $24,000

Year(s) AmountTax

EffectAfter-Tax

Cash FlowsInitial investment........................... Now ($168,000) ($168,000)Annual net cash receipts................ 1-9 $76,000 0.70 $53,200Salvage value................................. 9 $8,000 0.70 $5,600Annual depreciation deductions..... 1-7 $24,000 0.30 $7,200


14% Factor PV

Initial investment........................... ($168,000) 1.000 ($168,000)Annual net cash receipts................ $53,200 4.946 263,127Salvage value................................. $5,600 0.308 1,725Annual depreciation deductions..... $7,200 4.288 30,874 Net present value............................ $127,726




159. Camel Inc. is considering a project that would require an initial investment of $210,000 and would have a useful life of 6 years. The annual cash receipts would be $126,000 and the annual cash expenses would be $57,000. The salvage value of the assets used in the project would be $32,000. The company's tax rate is 30%. For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 5 years. The company uses a discount rate of 10%.

Required:


Ans:

Annual cash receipts........................................ $126,000Annual cash expenses...................................... 57,000 Annual net cash receipts.................................. $ 69,000

Initial investment (a)........................................ $210,000Tax life (b)....................................................... 5 yearsAnnual depreciation deduction (a) ÷ (b).......... $42,000

Year(s) AmountTax

EffectAfter-Tax

Cash FlowsInitial investment........................... Now ($210,000) ($210,000)Annual net cash receipts................ 1-6 $69,000 0.70 $48,300Salvage value................................. 6 $32,000 0.70 $22,400Annual depreciation deductions..... 1-5 $42,000 0.30 $12,600


10% Factor PV

Initial investment........................... ($210,000) 1.000 ($210,000)Annual net cash receipts................ $48,300 4.355 210,347Salvage value................................. $22,400 0.564 12,634Annual depreciation deductions..... $12,600 3.791 47,767 Net present value............................ $ 60,747



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