Question 1

How does the calculation of break-even time (BET differ from the calculation of payback period (PBP)?

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Question 2

You have evaluated three projects of similar investment amount and risk using the net present value (NPV method. How would you decide which one of the projects to select?

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Question 3

Poe Company is considering the purchase of new equipment costing $80,000. The projected net cash flows are $35,000 for the first two years and $30,000 for years three and four. The revenue is to be received at the end of each year. The machine has a useful life of 4 years and no salvage value. Poe requires a 10% return on its investments. The present value of $1 and present value of an annuity of $1 for different periods is presented below. Compute the net present value of the machine. $$\begin{array} { c c c } 
\text { Periods } & \text { Present Value } & \text { Presert Value of arl } \
 & \text { of } \$ 1 \text { at } 10 \% & \text { Arunuity of } \$ 1 \text { at } 10 \% \
1& 0.9091 & 0.9091 \
2 & 0.8264 & 1.7355 \
3 & 0.7514 & 2.4869 \
4 & 0.6830 & 3.1699
\end{array}$$

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Question 4

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

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Question 5

Identify at least three reasons for managers to favor the internal rate of return (IRR over other capital budgeting approaches.

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Question 6

What is one advantage and one disadvantage of using the accounting rate of return to evaluate investment alternatives?

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Question 7

A company is trying to decide which of two new product lines to introduce in the coming year. The predicted revenue and cost data for each product line follows:
 $\begin{array}{lcc}
&\underline{\text { Product A}} &\underline{\text {Product B }}\ 
\text { Sales } & \$ 80,000 & \$ 96,000 \
\text { Direct materials } & 3,000 & 6,000 \
\text { Direct labor } & 30,000 & 45,000 \
\text { Other cash operating expenses } & 7,500 & 9,000 \
\text { New equipment costs } & 75,000 & 100,000 \
\text { Estimated useful life (no salvage } & 5 \text { years } & 5 \text { years }
\end{array}$
 The company has a 30% tax rate, it uses the straight-line depreciation method, and it predicts that cash flows will be spread evenly throughout each year. Calculate each product's payback period. If the company requires a payback period of three years or less, which, if either, product should be chosen?

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Question 8

In using a capital budgeting method that takes the time value of money into consideration, management must consider a hurdle rate in making its decisions. What is a hurdle rate? What factors does management have to consider in selecting a hurdle rate?

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Question 9

For each of the capital budgeting methods listed below, place an X in the correct column, indicating the measurement basis of each, the ability to make comparison among projects, and whether each method reflects or ignores the time value of money.

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Question 10

Briefly describe the time value of money. Why is the time value of money important in capital budgeting?

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Question 11

A company is considering purchasing a machine for $85,000. The machine is expected to generate a net after-tax income of $11,250 per year. Depreciation expense would be $8,500. What is the payback period for this machine?

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Question 12

The process of analyzing alternative long-term investments and deciding which assets to acquire or sell is known as:

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The process of analyzing alternative long-term investments and deciding which assets to acquire or sell is known as capital budgeting. Options A, C, D, and E are related to other areas of managerial accounting and do not relate specifically to analyzing long-term investments.

Question 13

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

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Question 14

Capital budgeting is the process of analyzing:

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Capital budgeting involves analyzing long-term investments, such as purchasing new equipment, acquiring a new business, or building a new facility. It focuses on evaluating the future cash flows and potential risks and returns associated with these investments to determine whether they should be pursued.

Question 15

When the amount invested differs substantially across projects, NPV is of limited value for comparison purposes. You have evaluated three projects of substantially different investment amounts using the net present value (NPV method. How would you decide which one of the projects to select?

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Question 16

A company is considering a proposal to invest $40,000 in a project that would provide the following net cash flows:
Year 1 $ 6,500
Year 2 12,700
Year 3 15,000
Year 4 12,800
Compute the project's payback period.

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Question 17

When making capital budgeting decisions, companies usually prefer shorter payback periods. Explain why shorter payback periods are desirable.

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Question 18

Capital budgeting decisions are risky because all of the following are true except:

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The statement "They rarely produce net cash flows" is false. Capital budgeting decisions are made with the expectation of generating net positive cash flows over the long term.

Question 19

Nestor Company is considering the purchase of an asset for $100,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year. Compute the break-even time (BET) period for this investment. $$\begin{array} { | l | l | l | } 
\hline & \begin{array} { c } 
\text { Annual Net } \
\text { Cash Flows }
\end{array} & \begin{array} { c } 
\text { Present Value } \
\text { of } \$ 1 \text { at } \mathbf { 1 0 } \%
\end{array} \
\hline \text { Year 0 } & & 1.0000 \
\hline \text { Year 1 } & \$ 40,000 & .9091 \
\hline \text { Year 2 } & \$ 40,000 & .8264 \
\hline \text { Year 3 } & \$ 35,000 & .7513 \
\hline \text { Year 4 } & \$ 35,000 & .6830 \
\hline \text { Year 5 } & \$ 30,000 & .6209 \
\hline
\end{array}$$

Accepted Answer

The break-even time (BET) period is the time it takes for the present value of cash inflows to equal the initial investment. By calculating the cumulative present value of cash flows for each year and finding when it equals or exceeds $100,000, we find that it occurs between year 2 and year 3. Interpolating between these years gives approximately 3.17 years.

Question 20

Nebraska Co. is reviewing a capital investment of $100,000. This project's projected cash flows over a five-year period are estimated at $35,000 each year.
Required:
(a) Calculate the payback period.
(b) Calculate the break-even time. Assume a 12% hurdle rate and use the table below:
Present Value
Periods of 1 at 12%
1…… 0.8929
2…… 0.7972
3…… 0.7118
4…… 0.6355
5…… 0.5674
(c) Using the results in (a) and (b), make a recommendation for the project.

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Quiz 11: Capital Budgeting and Investment Analysis