Deck 14: Capital Expenditure Decisions

Question 1

If income taxes are ignored, which of the following choices correctly notes how a project's depreciation is treated under the net-present-value method and the internal-rate-of-return method? $\begin{array} { | l | l | l | l | } \hline & \text { Net Present Value } & & \text { Internal Rate of Return } \\\hline 1 & \text { Considered } & & \text { Considered } \\\hline 2 & \text { Considered }& & \text { Ignored } \\\hline 3 & \text { Ignored } & & \text { Considered } \\\hline 4 & \text { Ignored } & & \text { Ignored } \\\hline\end{array}$
$\begin{array}{|l|c|} 5 &\text {The correct answer depends on the depreciation } \\&\text { method (straight line or accelerated) that is used. }\\\hline\end{array}$

A)1
B)2
C)3
D)4
E)5

Answer 1

4

Question 2

The internal rate of return on an asset can be calculated:

A)if the return is greater than the hurdle rate.
B)if the asset's cash flows are identical to the future value of a series of cash flows.
C)if the future value of a series of cash flows can be arrived at by the annuity accumulation factor.
D)by finding a discount rate that yields a zero net present value.
E)by finding a discount rate that yields a positive net present value.

Answer 2

D

Question 3

Union Jack Company is considering the purchase of equipment that costs $60,000 and promises to reduce annual cash operating costs by $10,000 over each of the next five years. Which of the following is a proper way to evaluate this investment if the company desires a 10% return on all investments?

A)$60,000 vs. $10,000 x 5.
B)$60,000 vs. $60,000 x 0.621.
C)$60,000 vs. $60,000 x 3.791.
D)$60,000 vs. $10,000 x 3.791.
E)$60,000 x 0.909 vs. $10,000 x 3.791.

Answer 3

D

Question 4

The hurdle rate that is used in a net-present-value analysis is the same as the firm's:

A)payback period.
B)internal rate of return.
C)present value factor.
D)objective rate of return.
E)discount rate and minimum desired rate of return.

Question 5

The true economic yield produced by an asset is summarized by the asset's:

A)non-discounted cash flows.
B)net present value.
C)future value.
D)annuity discount factor.
E)internal rate of return.

Question 6

Bing and Associates Inc., which uses net present value to analyze investments, requires an 8% minimum rate of return. One of their entry level associates recently calculated a $200,000 machine's net present value to be $34,560, excluding the impact of straight-line depreciation. If Bing and Associates ignores income taxes and the machine is expected to have a four-year service life, the correct net present value of the machine would be:

A)$34,400
B)$34,560.
C)$163,250.
D)$200,000.
E)$365,600.

Question 7

A company that is using the internal rate of return (IRR) to evaluate projects should accept a project if its IRR:

A)is greater than the hurdle rate.
B)is greater than or equal to the firm's hurdle rate.
C)is greater than zero.
D)is less than the firm's cost of investment capital.
E)equates the present value of the project's cash inflows with the present value of the project's cash outflows.

Question 8

Winterwise Corporation is contemplating the purchase of $181,230 machine that is expected to produce annual savings in operating cash flow of $70,000 over the next four years. If Winterwise uses the internal rate of return (IRR) to evaluate new investments and the company has a hurdle rate of 16%, which of the following statements is correct?

A)The machine's IRR is less than 16%, and the machine should not be acquired.
B)The machine's IRR is approximately 20%, and the machine should not be acquired.
C)The machine's IRR is approximately 20%, and the machine should be acquired.
D)The machine's IRR is approximately 16%, and the machine should be acquired.
E)The Company's hurdle rate is approximately 20%, and the machine should not be acquired.

Question 9

A new machine that costs $79,860 is expected to save annual cash operating costs of $20,000 over each of the next five years. The machine's internal rate of return is:

A)approximately 4%.
B)approximately 6%.
C)approximately 8%.
D)approximately 10%.
E)approximately 12%.

Question 10

The mayor of Elizabethtown, Ontario is considering the purchase of a new computer system for the municipality's tax department. The system costs $75,000 and has an expected life of five years. The mayor estimates the following savings will result if the system is purchased: $\begin{array} { | c | r | r | } \hline \text { Year } && \text { Savings } \\\hline 1 & &\$ 20.000 \\\hline 2 & & 25.000 \\\hline 3 & & 30.000 \\\hline 4 & & 15.000 \\\hline 5 & & 12.000 \\\hline\end{array}$ A salesperson from a different computer company claims that his machine, which costs $85,000 and has an estimated service life of four years, will generate annual savings for Elizabethtown in the amount of $32,000. If the discount rate is 10%, the net present value of this system would be:

A)$1,080.
B)$23,175.
C)$63,512.
D)$101,440.
E)$133,279.

Question 11

Which of the following would not involve a capital-budgeting analysis?

A)The acquisition of new equipment.
B)The addition of a new product line.
C)The adoption of a new cost driver for overhead application.
D)The construction of a new distribution facility.
E)The decision of a pro football team to trade for and sign a star quarterback to a long-term contract.

Question 12

The internal-rate-of-return method assumes that project funds are reinvested at the:

A)hurdle rate.
B)rate of return earned on the project.
C)cost of debt capital.
D)cost of equity capital.
E)rate of earnings growth.

Question 13

Discounted-cash-flow analysis focuses primarily on:

A)the stability of cash flows.
B)the timing of cash flows.
C)the probability of cash flows.
D)the sensitivity of cash flows.
E)whether cash flows are increasing or decreasing.

Question 14

Capital-budgeting decisions primarily involve:

A)emergency situations.
B)long-term decisions.
C)short-term planning situations.
D)cash inflows and outflows in the current year.
E)planning for the acquisition of capital.

Question 15

A company's hurdle rate is generally influenced by:

A)the cost of capital.
B)the firm's depreciable assets.
C)whether management uses the net-present-value method or the internal-rate-of-return method.
D)project risk.
E)the cost of capital and the firm's depreciable assets.

Question 16

Which of the following items would complete the net-present-value method calculation?

A)A project's immediate cash flows.
B)A project's immediate cash flows, and cash flows during a project's life.
C)A project's immediate cash flows, cash flows during a project's life, and the time value of money.
D)Cash flows during a project's life, and the time value of money.
E)Cash flows during a project's life.

Question 17

The net-present-value method assumes that project funds are reinvested at the:

A)hurdle rate.
B)rate of return earned on the project.
C)cost of debt capital.
D)cost of equity capital.
E)internal rate of return.

Question 18

The mayor of Elizabethtown, Ontario is considering the purchase of a new computer system for the municipality's tax department. The system costs $75,000 and has an expected life of five years. The mayor estimates the following savings will result if the system is purchased: $\begin{array} { | c | r | r | } \hline \text { Year } && \text { Savings } \\\hline 1 & &\$ 20.000 \\\hline 2 & & 25.000 \\\hline 3 & & 30.000 \\\hline 4 & & 15.000 \\\hline 5 & & 12.000 \\\hline\end{array}$ If Elizabethtown uses a 10% discount rate for capital-budgeting decisions, the net present value of the computer system would be:

A)$489.
B)$4,079.
C)$11,658.
D)$63,342.
E)$79,057.

Question 19

The mayor of Elizabethtown, Ontario is considering the purchase of a new computer system for the municipality's tax department. The system costs $75,000 and has an expected life of five years. The mayor estimates the following savings will result if the system is purchased: $\begin{array} { | c | r | r | } \hline \text { Year } && \text { Savings } \\\hline 1 & &\$ 20.000 \\\hline 2 & & 25.000 \\\hline 3 & & 30.000 \\\hline 4 & & 15.000 \\\hline 5 & & 12.000 \\\hline\end{array}$ What can be said about the internal rate of return of Elizabethtown's new computer system if the net present value at 12% is positive?

A)The internal rate of return is greater than 12%.
B)The internal rate of return is between 10% and 12%.
C)The internal rate of return is less than 10%.
D)The internal rate of return must be less than 5%.
E)The internal rate of return is between 0 and 5%

Question 20

Capital budgeting tends to focus primarily on:

A)revenues.
B)costs.
C)cost centres.
D)programs or projects.
E)allocation tools.

Question 21

McClaren Inc. is considering a $400,000 investment in new equipment that is anticipated to produce the following net cash inflows: $\begin{array}{lr}\text { Year: } &\text { Net Cash} \\&\text { Inflows } \\1 & \$ 100,000 \\2 & 200,000 \\3 & 50,000 \\4 & 60,000 \\5 & 140,000\end{array}$ If cash flows occur evenly throughout a year, the equipment's payback period is:

A)2 years.
B)3 years.
C)3 years, 10 months.
D)4 years.
E)5 years.

Question 22

Blueteeth Incorporated plans to incur $306,000 of salaries expense and produce $560,000 of additional sales revenue if a capital project is implemented. Assuming a 23% tax rate, these two items collectively should appear in a capital budgeting analysis as:

A)a $195,580 inflow.
B)a $195,580 outflow.
C)a $254,000 inflow.
D)a $254,000 outflow.
E)$560,000 inflow.

Question 23

Reinhold Corporation has a $3,500,000 investment in equipment and is subject to a 20% income tax rate. Cash inflows are expected to average $320,000 before tax over the next few years; in contrast, average income before tax is anticipated to be $220,000. The company's accounting rate of return is:

A)5.00%.
B)6.30%.
C)7.30%.
D)9.10%
E)55%.

Question 24

Which of the following tools is sometimes used to rank investment proposals?

A)Profitability index.
B)Annuity index.
C)Project assessment guide.
D)Investment opportunity index.
E)Capital ranking index.

Question 25

Snaptile Company evaluates future projects by using the profitability index. The company is currently reviewing three projects similar in nature and must choose one of the following: $\begin{array} { l l l r } \text { Project } & \text { Initial Investment } && \begin{array} { l } \text { Present Value of Cash } \\\text { Inflows }\end{array} \\1 & \$ 400,000 && \$ 300,000 \\2 & 200,000 & & 320,000 \\3 & 350,000 & & 430,000\end{array}$ Which project should Snaptile select if the decision is based entirely on the profitability index?

A)Project 1 with a profitability index of 0.75.
B)Project 1 with a profitability index of 1.33.
C)Project 2 with a profitability index of 1.60.
D)Project 2 with a profitability index of 0.67.
E)Project 3 with a profitability index of 0.81.

Question 26

When income taxes are considered in capital budgeting, the cash flows related to a company's advertising expense would be correctly figured by taking the cash paid for advertising and:

A)adding the result of multiplying (advertising expense x tax rate).
B)adding the tax rate.
C)adding the result of multiplying [advertising expense x (1 - tax rate)].
D)subtracting the result of multiplying (advertising expense x tax rate).
E)subtracting the result of multiplying [advertising expense x (1 - tax rate)].

Question 27

When income taxes are considered in capital budgeting, the cash flows would be correctly figured by

A)adding the result of multiplying (depreciation expense x tax rate).
B)adding the result of multiplying [depreciation expense x (1 - tax rate)].
C)subtracting the result of multiplying (depreciation expense x tax rate).
D)subtracting the result of multiplying [depreciation expense x (1 - tax rate)].
E)doing nothing because there is no cash paid for depreciation.

Question 28

When a company is analyzing a capital project by a discounted-cash-flow approach and income taxes are being considered, depreciation:

A)should be ignored.
B)should be considered because it results in a tax savings.
C)should be considered because it is a fixed cost.
D)should be considered because it is a cash inflow.
E)should be considered because, like other expenses, it is a cash outlay related to operations.

Question 29

The systematic follow-up on a capital project to see how the project actually turns out is commonly known as:

A)capital budgeting assessment (CBA).
B)a post-audit.
C)control of capital expenditures (CCE).
D)overall cost performance.
E)the cost evaluation phase.

Question 30

The accounting rate of return focuses on the:

A)total accounting income over a project's life.
B)incremental accounting income over a project's life.
C)average cash flows over a project's life.
D)cash inflows from a project.
E)tax savings from a project.

Question 31

The payback period is best defined as:

A)initial investment ÷ annual after-tax cash inflow.
B)annual after-tax cash inflow ÷ initial investment.
C)initial investment ÷ useful life of investment.
D)(present value of the cash flows, exclusive of the initial investment) ÷ initial investment.
E)initial investment ÷ (present value of the cash flows, exclusive of the initial investment).

Question 32

Which of the following choices correctly depicts whether discounted cash flows are used by the method noted when evaluating long-term investments? $$\begin{array} { | l | c | c | c | c | c |c| } \hline & &\begin{array} { c } \text { Net } \\\text { Present Value }\end{array} & \begin{array} { c } \text { Internal Rate } \\\text { of Return }\end{array} & &\begin{array} { c } \text { Accounting } \\\text { Rate of Return }\end{array} \\\hline 1 && \text { No } & \text { No } & &\text { Yes } \\\hline 2 && \text { Yes } & \text { No } & &\text { Yes } \\\hline 3 && \text { Yes } & \text { No } & & \text { No } \\\hline 4 && \text { Yes } & \text { Yes } & & \text { No } \\\hline 5 && \text { Yes } & \text { Yes } & & \text { Yes } \\\hline\end{array}$$

A)1
B)2
C)3
D)4
E)5

Question 33

MacEwen Brothers Ltd., which is subject to an 18% income tax rate, is considering investing in a $300,000 asset that will result in the following over its five-year life: Average revenue: $805,000
Average operating expenses (excluding depreciation): $620,000
Average depreciation: $80,000
The accounting rate of return on the initial investment is:

A)28.70%.
B)35%.
C)61.67%.
D)86.96%.
E)88.33%

Question 34

Bleeker Corporation plans to generate $450,000 of sales revenue if the implementation of their planned capital project moves forward. Assuming a 28% tax rate, the sales revenue should be reflected in the analysis by a:

A)$126,000 inflow.
B)$324,000 inflow.
C)$324,000 outflow.
D)$450,000 inflow.
E)$450,000 outflow.

Question 35

Of the five expenses that follow, which one is most likely treated differently than the others when income taxes are considered in a discounted-cash-flow analysis?

A)Salaries expense.
B)Advertising expense.
C)Depreciation expense.
D)Utilities expense.
E)Office expense.

Question 36

A piece of equipment costs $50,000, and is expected to generate $2,500 of annual cash revenues and $500 of annual cash expenses. The disposal value at the end of the estimated 25-year life is $2,000. Ignoring income taxes, the payback period is:

A)20 years.
B)24 years.
C)24.75 years.
D)25 years.
E)99 years.

Question 37

If a proposal's profitability index is greater than one:

A)the net present value is negative.
B)the net present value is positive.
C)the net present value is zero.
D)the proposal should always be accepted.
E)the proposal should always be rejected.

Question 38

In Canada, the allowable deduction for depreciation expense in the calculation of taxable income is called:

A)depreciation expense.
B)the CCA tax shield.
C)the present value of the CCA tax shield.
D)capital cost allowance.
E)undepreciated capital cost.

Question 39

A company's after tax cash flows are not normally affected by:

A)revenues.
B)operating expenses.
C)gains on the sale of assets.
D)losses on the sale of assets.
E)the purchase of an asset.

Question 40

Landau Spandex Inc. ranks investments by using the profitability index (PI). The following data relate to Product A and Product B: $\begin{array} { l r r } & \text { Product A } & \text { Product B } \\\text { Initial investment } & \$ 900,000 & \$ 1,500,000 \\\text { Present value of inflows } & 800,000 & 2,000,000\end{array}$ Which Product would be more attractive as judged by its ranking, and why?

A)Product B because the PI is 0.89.
B)Product A because the PI is 0.89.
C)Product B because the PI is 1.33.
D)Product B because the PI is 0.75.
E)Product A because of its positive NPV.

Question 41

Regal Interiors is considering a $6.8 million asset investment that has a six-year service life and a $700,000 salvage value. The investment is expected to produce annual savings in cash operating costs of $904,000 and will require a $600,000 overhaul in year 5, which is fully deductible for tax purposes.
Regal uses the net-present-value method to analyze investments. Asset investments are depreciated by the straight-line method.
Required:
A. Ignoring income taxes, determine the (pre-discounted) cash-flow amounts that would be used in a net-present-value analysis for (1) the asset acquisition, (2) annual savings in cash operating costs, (3) annual straight-line depreciation, (4) the overhaul in year 5, and (5) disposal of the asset in year 6. Note cash outflows in parentheses.
B. Repeat requirement "A," assuming the company is subject to a 20% income tax rate.

Question 42

Cabbie Compartments Corporation is considering the use of accelerated depreciation rather than straight-line depreciation for a new asset acquisition. Which of the following choices correctly shows when the majority of depreciation would be taken (early or late in the asset's life), when most of the tax savings occur (early or late in the asset's life), and which depreciation method would have the higher present value? $\begin{array} { | l | l | l | l | l | } \hline & \begin{array} { c } \text { When Majority } \\\text { of Depreciation } \\\text { is Taken }\end{array} & \begin{array} { c } \text { When Majority } \\\text { of Tax Savings } \\\text { Occur }\end{array} & \begin{array} { c } \text { Depreciation Method } \\\text { With Higher Present } \\\text { Value }\end{array} \\\hline 1 & \text { Early in life } & \text { Early in life } & \text { Accelerated } \\\hline 2 & \text {Early in life } & \text { Early in life } & \text { Straight-line } \\\hline 3 & \text { Early in life } & \text { Late in life } & \text { Straight-line } \\\hline 4 & \text { Late in life } & \text { Late in life } & \text { Straight-line } \\\hline 5 & \text { Late in life } & \text { Early in life } & \text { Accelerated } \\\hline\end{array}$

A)1
B)2
C)3
D)4
E)5

Question 43

James Company has an asset that cost $5,000 and currently has accumulated depreciation of $2,000. Suppose the firm sold the asset for $2,500 and is subject to a 30% income tax rate. The net after-tax cash flow of the disposal is:

A)$2,100.
B)$2,350.
C)$2,500.
D)$2,650.
E)$3,200.

Question 44

Cranberry Cross Co. (CCC) is currently purchasing components from an outside supplier for $75 per unit. Because of supplier reliability problems, the company is considering producing the component internally in a currently idle manufacturing plant. Annual volume over the next six years is expected to total 200,000 units at variable manufacturing costs of $60 per unit.
CCC must acquire $60,000 of new equipment if it reopens the plant. The equipment has a five-year service life and a $10,000 salvage value, and will be depreciated by the straight-line method. Repairs and maintenance are expected to average $3,000 per year in years 3-5, and the equipment will be sold at the end of its life. The hurdle rate is 10%.
Required:
Use the net-present-value method (total-cost approach) and determine whether CCC should make or buy the component. Ignore income taxes.

Question 45

A machine was sold in December 2012 for $9,000. It was originally purchased in January 2010 for $15,000, and depreciation of $12,000 was recorded from the date of purchase through to the date of disposal. Assuming a 40% income tax rate, the after-tax cash inflow at the time of sale is:

A)$3,600.
B)$6,600.
C)$8,400.
D)$9,000.
E)$11,400.

Question 46

Pick Company received $18,000 cash from the sale of a machine that had a $13,000 book value. If the company is subject to a 30% income tax rate, the net cash flow to use in a discounted-cash-flow analysis would be:

A)$3,500.
B)$6,500.
C)$12,600.
D)$16,500.
E)$19,500.

Question 47

When a manager applies a net present value analysis using a just-in-time philosophy, they are least likely to encounter:

A)hurdle rates that are set too high.
B)time horizons that are set too short.
C)high uncertainties with respect to future operating cash flows.
D)biases with respect to small, incremental projects.
E)non value-added costs.

Question 48

Hunter Corporation will evaluate a potential investment in an advanced manufacturing system by use of the net-present-value (NPV) method. Which of the following system benefits is least likely to be omitted from the NPV analysis?

A)Savings in operating costs.
B)Greater flexibility in the production process.
C)Improved product quality.
D)Shorter manufacturing cycle time.
E)Ability to fill customer orders more quickly.

Question 49

A machine is expected to produce annual savings in cash operating costs of $400,000 for the next six years. If the company has a 10% after-tax hurdle rate and is subject to a 30% income tax rate, the correct discounted net cash flow would be:

A)$522,600.
B)$947,520.
C)$1,219,400.
D)$1,680,000.
E)$1,742,000.

Question 50

Forrester Inc. purchased a $150,000 machine that has a five-year life and no salvage value. The company uses straight-line depreciation on all asset acquisitions and is subject to a 20% tax rate. The proper cash flow to show in a discounted-cash-flow analysis as occurring at time 0 would be:

A)$(150,000).
B)$(120,000).
C)$(30,000).
D)$30,000.
E)$150,000.

Question 51

Custom Plastics plans to purchase $4.5 million of equipment in the not-too-distant future. The equipment will have a $600,000 salvage value and will be depreciated over a six-year service life by the straight-line method. Custom is subject to a 30% income tax rate.
The company's accountant is about to perform a net-present-value analysis, assuming a 10% after-tax hurdle rate.
Required:
A. Determine the discounted cash flows that would be reflected in the analysis in year 0 and year 1.
B. Determine the discounted cash flow that would be reflected in the analysis in year 6, assuming that Custom sells the equipment for only $450,000 because of a recent change in market conditions.

Question 52

James Company has an asset that cost $5,000 and currently has accumulated depreciation of $2,000. Suppose the firm sold the asset for $2,500 and is subject to a 30% income tax rate. The loss on disposal would be:

A)$350.
B)$500.
C)$650.
D)$2,500.
E)$5,000.

Question 53

Vandelay International is planning a project that is expected to last for six years and generate annual net cash inflows of $75,000. The project will require the purchase of a $280,000 machine, which is expected to have a salvage value of $10,000 at the end of the six-year period. In addition to annual operating costs, the machine will require a $50,000 overhaul at the end of the fourth year. The company presently has a 12% minimum desired rate of return.
Based on this information, accountant Division Manager prepared the following analysis: The Division Manager recommends that the project be rejected because it does not meet the company's minimum desired rate of return. Ignore income taxes.
Required:
A. What criticism(s) would you make of the accountant's evaluation?
B. Use the net-present-value method and determine whether the project should be accepted.
C. Based on your answer in requirement "B," is the internal rate of return greater or less than 12%? Explain.

Question 54

Consider the five items below that follow, which are related to independent investment opportunities.
Purchase price of a new machine: $850,000
Annual straight-line depreciation: $75,000
Annual savings in cash operating costs: $120,000
Advertising expenses related to a new marketing campaign in year 2: $35,000
Sale of an asset in year 6: Loss on sale, $60,000; proceeds received by seller, $23,000
Required:
Complete the following table, inserting the (pre-discounted) cash flow amounts that would be used in a net-present-value analysis. Column A should be completed based on the assumption of no income taxes; in contrast, Column B should be completed assuming the relevant company is subject to a 30% income tax rate. Be sure to note cash outflows in parentheses.

Question 55

On January 2, 2010, Marissa Foresta purchased 800 shares of Rushdie Publishing's common stock at $35 per share. The company paid a $1.50 dividend per share on December 28 of that year, and raised the amount by $0.50 per share for a distribution on December 28, 2011. Marissa sold her entire investment on December 30, 2012, generating a $5,000 gain on the sale of stock.
Required:
A. Prepare a dated listing of the cash inflows and outflows related to Marissa's stock investment. Ignore income taxes.
B. Assume that Marissa has a 10% hurdle rate for all investments. Rounding to the nearest dollar, compute the net present value of her investment in Rushdie and determine whether she achieved her 10% goal.

Question 56

Mick Greene Co. (MG) is considering the replacement of some equipment that has a book value equal to zero and a current market value of $4,600. One possible alternative is to invest in new equipment that costs $20,000. The new equipment has a three-year service life and an estimated salvage value of $5,000, will produce annual cash operating savings of $10,800, and will require a $4,500 overhaul in year 2. The company uses straight-line depreciation.
Required:
Prepare a net-present-value analysis of MG's replacement decision, assuming a 12% hurdle rate and no income taxes. Should the equipment be acquired? Note: Round calculations to the nearest dollar.

Question 57

A depreciation tax shield is a(n):

A)after-tax cash outflow.
B)increase in income tax.
C)non-cash factor.
D)reduction in income tax.
E)sporadic fluctuation in income tax.

Question 58

Worrell Industries is currently purchasing Part No. 456 from an outside supplier for $90 per unit. Because of supplier reliability problems, the company is considering producing the part internally in a currently idle manufacturing plant. Annual volume over the next five years is expected to total 400,000 units at variable manufacturing costs of $88 per unit.
Worrell must acquire $200,000 of new equipment if it reopens the plant. The equipment has a five-year service life and a $20,000 salvage value, and will be depreciated by the straight-line method. (Note: Worrell ignores salvage values in depreciation calculations.) Normal equipment maintenance is expected to total $12,000 in year 4, and the equipment will be sold at the end of its life.
Required:
Rounding to the nearest dollar, use the net-present-value method (total-cost approach) and a 12% after-tax hurdle rate to determine whether Worrell should make or buy Part No. 456. The company is subject to a 30% income tax rate.

Question 59

Pittsburg Township is studying a 500-acre site for a new community park. The new site is estimated to generate $50,000 in annual operating costs for 15 years. Other data are:
Purchase price per acre: $620
Site preparation costs: $70,000
Hurdle rate: 8%
Ignore income taxes.
Required:
A. Use the net-present-value method and determine whether the site should be acquired.
B. Determine the proposal's approximate internal rate of return.

Question 60

Gotham Corporation is considering the acquisition of a new machine that costs $149,040. The machine is expected to have a four-year service life and will produce annual savings in cash operating costs of $45,000. Gotham evaluates investments by using the internal rate of return and ignores income taxes.
Required:
A. Briefly define the internal rate of return.
B. What relationship holds true at the internal rate of return with respect to discounted cash inflows and discounted cash outflows? With respect to net present value?
C. Compute the machine's internal rate of return.

Question 61

A profitability index can be used to rank investment proposals.
Required:
A. Define the profitability index.
B. Two projects are under consideration. Project I has a net present value of $20,000 whereas project II has a net present value of $200,000. Which project is better? Explain. What weakness in a net-present-value analysis does the profitability index address?

Question 62

Lorax Corporation is considering the acquisition of a new machine that is expected to produce annual savings in cash operating costs of $30,000 before income taxes. The machine costs $100,000, has a useful life of five years, and no salvage value. Lorax uses straight-line depreciation on all assets, is subject to a 30% income tax rate, and has an after-tax hurdle rate of 8%.
Required:
A. Compute the machine's payback period.
B. Compute the machine's accounting rate of return on the initial investment.
C. Compute the machine's net present value.

Question 63

The payback method is a popular way to analyze investment proposals.
Required:
A. Explain how the payback period is determined. Generally speaking, from a payback perspective, which projects are viewed to be the most attractive?
B. Does the payback method take income taxes into consideration? Explain.
C. What are the deficiencies of the payback method?

Question 64

Impass Limited is considering the acquisition of a new machine that costs $402,000. The machine is expected to have a six-year service life and will produce annual savings in cash operating costs of $75,000. Impass uses straight-line depreciation, is subject to a 23% income tax rate, has an after-tax hurdle rate of 10%, and rounds calculations to the nearest dollar.
Required:
A. Determine the annual after-tax cash flows that result from acquisition of the machine.
B. Assuming that your answer in requirement "A" totalled $98,470, calculate the machine's:
1. Net present value. Is the machine an attractive investment? Why?
2. Internal rate of return. Is the machine an attractive investment? Why?
3. Payback period.

Question 65

You are reviewing some material that deals with investment analysis, preparing for your first day on the job at Franklin Enterprises. Consider the cash flows that follow.
1. The immediate payment required to purchase a $600,000 milling machine.
2. Straight-line depreciation of $20,000 in year 2 of a long-term investment.
3. Annual savings in cash operating costs of $50,000 over the next eight years.
4. Sale of a machine for $35,000 at the end of its six-year service life. The machine has a book value of $25,000.
5. A $6,000 equipment overhaul in year 5 that is fully deductible for income tax purposes.
Required:
Calculate the discounted cash flow that is appropriate for each of the preceding items. Assume a 10% after-tax hurdle rate and a 30% income tax rate, and round to the nearest dollar.

Question 66

Post-audits are an important part of capital budgeting.
Required:
A. What is a post-audit of a capital investment project?
B. What are the benefits of a post-audit?
C. A manager prepared an unsuccessful proposal for a capital project, as her firm decided not to fund and pursue the project. The manager observed, "The company's post-audit process will show that this project should have been funded." Comment on the manager's understanding of the post-audit process.

Question 67

Rocky & Road, which sells ice cream and frozen yoghurt, is considering a new site that will require a $4.2 million investment for land acquisition and construction costs. The following operating results are expected: Required:
A. If management requires a payback period of three years or less, should the new site be opened? Why?
B. Compute the accounting rate of return on the initial investment.
C. What significant limitation of payback and the accounting rate of return is overcome by the net-present-value method?

Question 68

An increased number of companies are investing in advanced manufacturing systems.
Required:
A. Many proposed advanced manufacturing systems have a negative net present value when discounted-cash-flow analysis is used. Explain several causes of this situation.
B. Two major benefits of advanced systems are greater flexibility in the manufacturing process and improvements in product quality. Explain how these benefits can create problems when performing discounted-cash-flow analysis.

Question 69

Both net present value (NPV) and the internal rate of return (IRR) have a reinvestment assumption.
Required:
A. State the assumption for each method.
B. One of the advantages of the NPV method is that users can adjust for risk considerations. Explain how this is done.

Question 70

Ivory Corporation is reviewing an investment proposal that has an initial cost of $52,500. An estimate of the investment's end-of-year book value, the yearly after-tax net cash inflows, and the yearly net income are presented in the schedule below. The investment's salvage value at the end of each year is equal to book value, and there will be no salvage value at the end of the investment's life. Ivory uses a 14% after-tax target rate of return for new investment proposals.
Required:
A. Calculate the project's payback period.
B. Calculate the accounting rate of return on the initial investment.
C. Calculate the proposal's net present value. Round to the nearest dollar.