Question 1

In a replacement decision, if an old asset sells below its book value

Accepted Answer

If an old asset sells below its book value, it means that the asset has depreciated more than expected, resulting in a loss. This loss should be recognized in the financial statements as an expense.

Question 2

Project X has a cost of $100,000 and provides the following annual earnings: year 1 $35,000; year 2 $25,000; year 3 $175,000; and year 4 $10,000. Under the payback method, in which year is the investment recouped?

Accepted Answer

$100,000 out, less year 1 (35,000), year 2 (25,000), and year 3 (175,000) means the payback point must have been reached in the third year of cash inflows.

Question 3

Technology Corp. is considering a $238,160 investment in a new marketing campaign that it anticipates will provide annual cash flows of $52,000 for the next five years. The firm has a 6% cost of capital. What should the analysis indicate to the firm's managers?

Accepted Answer

$238,160/52,000 = 4.580. Take that factor to table PV of annuity to find that 3% matches under n = 5.
Please note that this question can be solved by simple division and scanning the Present Value of an Annuity (Appendix D) because the cash inflows remain constant each period.

Question 4

A firm utilizes a strategy of capital rationing, which is currently $375,000 and is considering the following two projects: Project A has a cost of $335,000 and the following cash flows: year 1 $140,000; year 2 $150,000; and year 3 $100,000. Project B has a cost of $365,000 and the following cash flows: year 1 $220,000; year 2 $110,000; and year 3 $150,000. Using a 6% cost of capital, what is the internal rate of return of project B?

Accepted Answer

First, we need to calculate the present value of the cash flows for each project using the 6% cost of capital.

For project A: 
PV = $140,000/(1+0.06)^1 + $150,000/(1+0.06)^2 + $100,000/(1+0.06)^3 
PV = $249,162.12

For project B: 
PV = $220,000/(1+0.06)^1 + $110,000/(1+0.06)^2 + $150,000/(1+0.06)^3 
PV = $316,578.05

Since project B has a higher present value of cash flows than project A, it is the better investment choice.

To determine the internal rate of return (IRR) of project B, we can use trial and error by plugging in different discount rates until we get the present value of the cash flows to equal the cost of the investment. Alternatively, we can use Excel to calculate the IRR.

Using Excel: 
=IRR({-365000, 220000, 110000, 150000}) = 10.18%

Since the IRR of project B is higher than the cost of capital (6%), it is considered a good investment and the best choice.

Question 5

A firm utilizes a strategy of capital rationing, which is currently $375,000 and is considering the following two projects: Project A has a cost of $335,000 and the following cash flows: year 1 $140,000; year 2 $150,000; and year 3 $100,000. Project B has a cost of $365,000 and the following cash flows: year 1 $220,000; year 2 $110,000; and year 3 $150,000. Using a 6% cost of capital, what is the net present value of project A?

Accepted Answer

The answer of A firm utilizes a strategy of capital...

Question 6

Project XYZ has a cost of $200,000 and provides the following annual cash inflows: year 1 $35,000; year 2 $25,000; year 3 $175,000; and year 4 $10,000. What is the net present value of this investment, assuming the discount rate is 8%?

Accepted Answer

The answer of Project XYZ has a cost of $200,000...

Question 7

Firm X is considering the replacement of an old machine with one that has a purchase price of $70,000. The current market value of the old machine is $18,000 but the book value is $32,000. The firm's tax rate is 30%. What is the net cash outflow for the new machine after considering the sale of the old machine? Disregard the effect of depreciation of the new machine if acquired.

Accepted Answer

The net cash outflow is calculated as the purchase price of the new machine minus the after-tax proceeds from the sale of the old machine. The after-tax proceeds are the market value minus the tax on the gain (market value - book value). Gain = $18,000 - $32,000 = -$14,000 (a loss, so no tax). Net cash outflow = $70,000 - $18,000 = $52,000.

Question 8

All of the following is information required to create a net present value profile except for which one?

Accepted Answer

The other options (A, C, and D) are necessary components to create a net present value profile because they provide the NPV at different discount rates and the IRR, all of which are used to evaluate the profitability of an investment. The NPV at the risk-free rate is not necessary for creating a net present value profile because it is not typically used as a discount rate for evaluating investments.

Question 9

A firm is selling an old asset below book value in a replacement decision. As the firm's tax rate is raised, the net cash outflow (purchase price less proceeds from the sale of the old asset) would

Accepted Answer

If the asset is selling below book value, a

Quiz 12: The Capital Budgeting Decision