285679315-Test-Bank-Chapter14-Capital-Budgeting.doc

Chapter 14

Capital Budgeting Decisions

True/False

"1. "The present value of a given sum to be received in five years "
"F "will be exactly twice as great as the present value of an "
"Medium "equal sum to be received in ten years. "
"2. "An increase in the discount rate will result in an increase in"
"F "the present value of a given cash flow. "
"Medium " "
"3. "The present value of a cash flow decreases as it moves further"
"T "into the future. "
"Easy " "
"4. "When the net present value method is used, the internal rate "
"F "of return is the discount rate used to compute the net present"
"Medium "value of a project. "
"5. "If net present value is negative, then interpolation is needed"
"F "in order to make a proposed investment acceptable. "
"Medium " "
"6. "The net present value method assumes that cash flows from a "
"T "project are immediately reinvested at a rate of return equal "
"Medium "to the discount rate. "
"7. "When using internal rate of return to evaluate investment "
"F "projects, if the internal rate of return is less than the "
"Easy "required rate of return, the project should be accepted. "
"8. "The internal rate of return for a project is the discount rate"
"T "that makes the net present value of the project equal to zero."
"Easy " "
"9. "In comparing two investment alternatives, the difference "
"T "between the net present values of the two alternatives "
"Medium "obtained using the total cost approach will be the same as the"
" "net present value obtained using the incremental cost "
" "approach. "
"10. "The payback period is the length of time it takes for an "
"T "investment to recoup its own initial cost out of the cash "
"Easy "receipts it generates. "

"11. "Projects with shorter payback periods are always more "
"F "profitable than projects with longer payback periods. "
"Medium " "
"12. "The payback method of making capital budgeting decisions gives"
"F "full consideration to the time value of money. "
"Easy " "
"13. "If new equipment is replacing old equipment, any salvage "
"F "received from sale of the old equipment should not be "
"Easy "considered in computing the payback period of the new "
" "equipment. "
"14. "One strength of the simple rate of return method is that it "
"F "takes into account the time value of money in computing the "
"Easy "return on an investment project. "
"15. "The preference rule for ranking projects by the profitability "
"T "index is: the higher the profitability index, the more "
"Easy "desirable the project. "

Multiple Choice

"16. "An increase in the discount rate: "
"C "a. will increase the present value of future cash flows. "
"Medium "b. will have no effect on net present value. "
" "c. will reduce the present value of future cash flows. "
" "d. is one method of compensating for reduced risk. "
"17. "Suppose an investment has cash inflows of R dollars at the end"
"B "of each year for two years. The present value of these cash "
"Medium "inflows using a 12% discount rate will be: "
" "a. greater than under a 10% discount rate. "
" "b. less than under a 10% discount rate. "
" "c. equal to that under a 10% discount rate. "
" "d. sometimes greater than under a 10% discount rate and "
" "sometimes less; it depends on R. "
"18. "The net present value and internal rate of return methods of "
"B "capital budgeting are superior to the payback method in that "
"Medium "they: "
"CPA adapted"a. are easier to implement. "
" "b. consider the time value of money. "
" "c. require less input. "
" "d. reflect the effects of depreciation and income taxes. "

"19. "How are the following used in the calculation of the net "
"C "present value of a proposed project? Ignore income tax "
"Medium "considerations. "
"CPA adapted" "
" "Depreciation expense Salvage value "
" "a. Include Include "
" "b. Include Exclude "
" "c. Exclude Include "
" "d. Exclude Exclude "
"20. "The net present value method takes into account: "
"D " "
"Medium "Cash Flow Over Time Value "
"CPA adapted"Life of Project of Money "
" "a. No Yes "
" "b. No No "
" "c. Yes No "
" "d. Yes Yes "
"21. "The net present value method of capital budgeting assumes that"
"C "cash flows are reinvested at: "
"Easy "a. the internal rate of return on the project. "
"CMA adapted"b. the rate of return on the company's debt. "
" "c. the discount rate used in the analysis. "
" "d. a zero rate of return. "
"22. "Some investment projects require that a company expand its "
"C "working capital to service the greater volume of business that"
"Medium "will be generated. Under the net present value method, the "
" "investment of working capital should be treated as: "
" "a. an initial cash outflow for which no discounting is "
" "necessary. "
" "b. a future cash inflow for which discounting is necessary. "
" "c. both an initial cash outflow for which no discounting is "
" "necessary and a future cash inflow for which discounting is "
" "necessary. "
" "d. irrelevant to the net present value analysis. "
"23. "(Ignore income taxes in this problem.) How is depreciation "
"A "handled by the following capital budgeting techniques? "
"Medium " "
"CMA adapted"Internal Simple "
" "Rate of Return Rate of Return Payback "
" "a. Excluded Included Excluded "
" "b. Included Excluded Included "
" "c. Excluded Excluded Included "
" "d. Included Included Excluded "

"24. "Which of the following capital budgeting techniques "
"B "consider(s) cash flow over the entire life of the project? "
"Easy " "
"CPA adapted"Internal rate of return Payback "
" "a. Yes Yes "
" "b. Yes No "
" "c. No Yes "
" "d. No No "
"25. "A weakness of the internal rate of return method for screening"
"C "investment projects is that it: "
"Medium "a. does not consider the time value of money. "
"CMA adapted"b. implicitly assumes that the company is able to reinvest "
" "cash flows from the project at the company's discount rate. "
" "c. implicitly assumes that the company is able to reinvest "
" "cash flows from the project at the internal rate of return. "
" "d. does not take into account all of the cash flows from a "
" "project. "
"26. "If the net present value of a project is zero based on a "
"A "discount rate of sixteen percent, then the time-adjusted rate "
"Medium "of return: "
" "a. is equal to sixteen percent. "
" "b. is less than sixteen percent. "
" "c. is greater than sixteen percent. "
" "d. cannot be determined from the information given. "
"27. "The payback method measures: "
"A "a. how quickly investment dollars may be recovered. "
"Easy "b. the cash flow from an investment. "
"CMA adapted"c. the economic life of an investment. "
" "d. the profitability of an investment. "
"28. "An investment project that requires a present investment of "
"B "$210,000 will have cash inflows of "R" dollars each year for "
"Medium "the next five years. The project will terminate in five years."
" "Consider the following statements (ignore income tax "
" "considerations): "
" " "
" "I. If "R" is less than $42,000, the payback period exceeds "
" "the life of the project. "
" "II. If "R" is greater than $42,000, the payback period exceeds"
" "the life of the project. "
" "III. If "R" equals $42,000, the payback period equals the life"
" "of the project. "
" " "
" "Which statement(s) is (are) true? "
" "a. Only I and II. "
" "b. Only I and III. "
" "c. Only II and III. "
" "d. I, II, and III. "

"29. "Which one of the following statements about the payback method"
"A "of capital budgeting is correct? "
"Easy "a. The payback method does not consider the time value of "
"CMA adapted"money. "
" "b. The payback method considers cash flows after the payback "
" "has been reached. "
" "c. The payback method uses discounted cash flow techniques. "
" "d. The payback method will lead to the same decision as other "
" "methods of capital budgeting. "
"30. "The evaluation of an investment having uneven cash flows using"
"B "the payback method: "
"Medium "a. cannot be done. "
" "b. can be done only by matching cash inflows and investment "
" "outflows on a year-by-year basis. "
" "c. will product essentially the same results as those obtained"
" "through the use of discounted cash flow techniques. "
" "d. requires the use of a sophisticated calculator or computer "
" "software. "
"31. "The capital budgeting method that divides a project's annual "
"B "incremental net income by the initial investment is the: "
"Medium "a. internal rate of return method. "
"CMA adapted"b. the simple ( or accounting) rate of return method. "
" "c. the payback method. "
" "d. the net present value method. "
"32. "When determining a net present value in an inflationary "
"B "environment, adjustments should be made to: "
"Medium "a. decrease the discount rate only. "
"CMA adapted"b. increase the estimated cash flows and increase the discount"
" "rate. "
" "c. increase the estimated cash flows only. "
" "d. increase the estimated cash flows and decrease the discount"
" "rate. "
"33. "(Ignore income taxes in this problem.) Kipling Company has "
"B "invested in a project that has an eight-year life. It is "
"Hard "expected that the annual cash inflow from the project will be "
"CPA adapted"$20,000. Assuming that the project has a internal rate of "
" "return of 12%, how much was the initial investment in the "
" "project? "
" "a. $160,000 "
" "b. $99,360 "
" "c. $80,800 "
" "d. $64,640 "

"34. "(Ignore income taxes in this problem.) White Company's "
"D "required rate of return on capital budgeting projects is 12%. "
"Medium "The company is considering an investment opportunity which "
" "would yield a cash flow of $10,000 in five years. What is the "
" "most that the company should be willing to invest in this "
" "project? "
" "a. $36,050. "
" "b. $2,774. "
" "c. $17,637. "
" "d. $5,670. "
"35. "(Ignore income taxes in this problem.) In order to receive "
"C "$12,000 at the end of three years and $10,000 at the end of "
"Easy "five years, how much must be invested now if you can earn 14% "
" "rate of return? "
" "a. $12,978. "
" "b. $8,100. "
" "c. $13,290. "
" "d. $32,054. "
"36. "(Ignore income taxes in this problem.) Sue Falls is the "
"C "president of Sports, Inc. She is considering buying a new "
"Hard "machine that would cost $14,125. Sue has determined that the "
" "new machine promises a internal rate of return of 12%, but Sue"
" "has misplaced the paper which tells the annual cost savings "
" "promised by the new machine. She does remember that the "
" "machine has a projected life of 10 years. Based on these data,"
" "the annual cost savings are: "
" "a. it is impossible to determine from the data given. "
" "b. $1,412.50. "
" "c. $2,500.00. "
" "d. $1,695.00. "
"37. "(Ignore income taxes in this problem.) The following "
"C "information is available on a new piece of equipment: "
"Hard " "
" "Cost of the equipment ...... $21,720 "
" "Annual cash inflows ........ $5,000 "
" "Internal rate of return ... 16% "
" "Required rate of return ... 10% "
" " "
" "The life of the equipment is approximately: "
" "a. 6 years. "
" "b. 4.3 years. "
" "c. 8 years. "
" "d. it is impossible to determine from the data given. "

"38. "(Ignore income taxes in this problem.) A planned factory "
"C "expansion project has an estimated initial cost of $800,000. "
"Hard "Using a discount rate of 20%, the present value of future cost"
"CPA adapted"savings from the expansion is $843,000. To yield exactly a 20%"
" "internal rate of return, the actual investment cost cannot "
" "exceed the $800,000 estimate by more than: "
" "a. $160,000. "
" "b. $20,000. "
" "c. $43,000. "
" "d. $1,075. "
"39. "(Ignore income taxes in this problem.) Hilltop Company "
"D "invested $100,000 in a two-year project. The cash flow was "
"Hard "$40,000 for the first year. Assuming that the internal rate of"
"CPA adapted"return was exactly 12%, what was the cash flow for the second "
" "year of the project? "
" "a. $51,247. "
" "b. $60,000. "
" "c. $64,284. "
" "d. $80,652. "
"40. "(Ignore income taxes in this problem.) Joe Flubup is the "
"C "president of Flubup, Inc. He is considering buying a new "
"Hard "machine that would cost $25,470. Joe has determined that the "
" "new machine promises a internal rate of return of 14%, but Joe"
" "has misplaced the paper which tells the annual cost savings "
" "promised by the new machine. He does remember that the machine"
" "has a projected life of 12 years. Based on these data, the "
" "annual cost savings are: "
" "a. impossible to determine from the data given. "
" "b. $2,122.50. "
" "c. $4,500.00. "
" "d. $4,650.00. "
"41. "(Ignore income taxes in this problem.) The Baker Company "
"B "purchased a piece of equipment with the following expected "
"Hard "results: "
" " "
" "Useful life ................... 7 years "
" "Yearly net cash inflow ........ $50,000 "
" "Salvage value ................. -0- "
" "Internal rate of return ....... 20% "
" "Discount rate ................. 16% "
" " "
" "The initial cost of the equipment was: "
" "a. $300,100. "
" "b. $180,250 "
" "c. $190,600. "
" "d. Cannot be determined from the information given. "

"42. "(Ignore income taxes in this problem.) Highpoint, Inc., is "
"B "considering investing in automated equipment with a ten-year "
"Hard "useful life. Managers at Highpoint have estimated the cash "
" "flows associated with the tangible costs and benefits of "
" "automation, but have been unable to estimate the cash flows "
" "associated with the intangible benefits. Using the company's "
" "10% discount rate, the net present value of the cash flows "
" "associated with just the tangible costs and benefits is a "
" "negative $184,350. How large would the annual net cash inflows"
" "from the intangible benefits have to be to make this a "
" "financially acceptable investment? "
" "a. $18,435. "
" "b. $30,000. "
" "c. $35,000. "
" "d. $37,236. "
"43. "(Ignore income taxes in this problem.) Given the following "
"B "data: "
"Hard " "
" "Present investment required .. $12,000 "
" "Net present value ............ $ 430 "
" "Annual cost savings .......... $ ? "
" "Discount rate ................ 12% "
" "Life of the project .......... 10 years "
" " "
" "Based on the data given, the annual cost savings would be: "
" "a. $1,630.00. "
" "b. $2,200.00. "
" "c. $2,123.89. "
" "d. $2,553.89. "
"44. "(Ignore income taxes in this problem.) The following data "
"A "pertain to an investment in equipment: "
"Medium " "
" "Investment in the project .......... $10,000 "
" "Net annual cash inflows ............ 2,400 "
" "Working capital required ........... 5,000 "
" "Salvage value of the equipment ..... 1,000 "
" "Life of the project ................ 8 years "
" " "
" "At the completion of the project, the working capital will be "
" "released for use elsewhere. Compute the net present value of "
" "the project, using a discount rate of 10%: "
" "a. $606. "
" "b. $8,271. "
" "c. ($1,729). "
" "d. $1,729. "

"45. "(Ignore income taxes in this problem.) A piece of equipment "
"A "has a cost of $20,000. The equipment will provide cost savings"
"Medium "of $3,500 each year for ten years, after which time it will "
" "have a salvage value of $2,500. If the company's discount rate"
" "is 12%, the equipment's net present value is: "
" "a. $580. "
" "b. ($225). "
" "c. $17,500. "
" "d. $2,275. "
"46. "(Ignore income taxes in this problem.) Parks Company is "
"D "considering an investment proposal in which a working capital "
"Medium "investment of $10,000 would be required. The investment would "
" "provide cash inflows of $2,000 per year for six years. The "
" "working capital would be released for use elsewhere when the "
" "project is completed. If the company's discount rate is 10%, "
" "the investment's net present value is: "
" "a. $1,290. "
" "b. ($1,290). "
" "c. $2,000. "
" "d. $4,350. "
"A "pertain to an investment proposal: "
"Medium " "
" "Investment in the project (equipment) .. $14,000 "
" "Net annual cash inflows promised ....... 2,800 "
" "Working capital required ............... 5,000 "
" "Salvage value of the equipment ......... 1,000 "
" "Life of the project .................... 10 years "
" " "
" "The working capital would be released for use elsewhere when "
" "the project is completed. What is the net present value of the"
" "project, using a discount rate of 8%? "
" "a. $2,566. "
" "b. ($251). "
" "c. $251. "
" "d. $5,251. "

"48. "(Ignore income taxes in this problem.) Boston Company is "
"C "contemplating the purchase of a new machine on which the "
"Medium "following information has been gathered: "
" " "
" "Cost of the machine ............... $38,900 "
" "Annual cash inflows expected ...... $10,000 "
" "Salvage value ..................... $ 5,000 "
" "Life of the machine ............... 6 years "
" " "
" "The company's discount rate is 16%, and the machine will be "
" "depreciated using the straight-line method. Given these data, "
" "the machine has a net present value of: "
" "a. -$26,100. "
" "b. -$23,900. "
" "c. $0. "
" "d. +$26,100. "
"49. "(Ignore income taxes in this problem.) Benz Company is "
"B "considering the purchase of a machine that costs $100,000 and "
"Hard "has a useful life of 18 years. The company's required discount"
" "rate is 12%. If the machine's net present value is $5,850, "
" "then the annual cash inflows associated with the machine must "
" "be (round to the nearest whole dollar): "
" "a. $42,413. "
" "b. $14,600. "
" "c. $13,760. "
" "d. it is impossible to determine from the data given. "
"50. "(Ignore income taxes in this problem.) Horn Corporation is "
"C "considering investing in a four-year project. Cash inflows "
"Hard "from the project are expected to be as follows: Year 1, "
"CPA adapted"$2,000; Year 2, $2,200; Year 3, $2,400; Year 4, $2,600. If "
" "using a discount rate of 8%, the project has a positive net "
" "present value of $500, what was the amount of the original "
" "investment? "
" "a. $1,411. "
" "b. $2,411. "
" "c. $7,054. "
" "d. $8,054. "
"51. "(Ignore income taxes in this problem.) The Whitton Company "
"B "uses a discount rate of 16%. The company has an opportunity to"
"Medium "buy a machine now for $18,000 that will yield cash inflows of "
" "$10,000 per year for each of the next three years. The machine"
" "would have no salvage value. The net present value of this "
" "machine to the nearest whole dollar is: "
" "a. $22,460. "
" "b. $4,460. "
" "c. $(9,980). "
" "d. $12,000. "

"D "pertain to an investment: "
"Medium " "
" "Cost of the investment ........ $18,955 "
" "Life of the project ........... 5 years "
" "Annual cost savings ........... $ 5,000 "
" "Estimated salvage value ....... $ 1,000 "
" "Discount rate ................. 10% "
" " "
" "The net present value of the proposed investment is: "
" "a. $3,355. "
" "b. ($3,430). "
" "c. $-0-. "
" "d. $621. "
"D "pertain to an investment proposal: "
"Medium " "
" "Cost of the investment .......... $20,000 "
" "Annual cost savings ............. $ 5,000 "
" "Estimated salvage value ......... $ 1,000 "
" "Life of the project ............. 8 years "
" "Discount rate ................... 16% "
" " "
" "The net present value of the proposed investment is: "
" "a. $1,720. "
" "b. $6,064. "
" "c. $2,154. "
" "d. $2,025. "
"54. "(Ignore income taxes in this problem.) Stratford Company "
"C "purchased a machine with an estimated useful life of seven "
"Hard "years. The machine will generate cash inflows of $90,000 each "
" "year over the next seven years. If the machine has no salvage "
" "value at the end of seven years, and assuming the company's "
" "discount rate is 10%, what is the purchase price of the "
" "machine if the net present value of the investment is "
" "$170,000? "
" "a. $221,950. "
" "b. $170,000. "
" "c. $268,120. "
" "d. $438,120. "
"55. "(Ignore income taxes in this problem.) Sam Weller is thinking "
"C "of investing $70,000 to start a bookstore. Sam plans to "
"Medium "withdraw $15,000 from the business at the end of each year for"
" "the next five years. At the end of the fifth year, Sam plans "
" "to sell the business for $110,000 cash. At a 12% discount "
" "rate, what is the net present value of the investment? "
" "a. $54,075. "
" "b. $62,370. "
" "c. $46,445. "
" "d. $70,000. "

"56. "(Ignore income taxes in this problem.) Arthur operates a "
"D "part-time auto repair service. He estimates that a new "
"Hard "diagnostic computer system will result in increased cash "
" "inflows of $2,100 in Year 1, $3,200 in Year 2, and $4,000 in "
" "Year 3. If Arthur's discount rate is 10%, then the most he "
" "would be willing to pay for the new computer system would be: "
" "a. $6,652. "
" "b. $6,984. "
" "c. $7,747. "
" "d. $7,556. "
"C "pertain to an investment proposal: "
"Medium " "
" "Present investment required ........ $26,500 "
" "Annual cost savings ................ $ 5,000 "
" "Projected life of the investment ... 10 years "
" "Projected salvage value ............ $ -0- "
" " "
" "The internal rate of return, interpolated to the nearest tenth"
" "of a percent, would be: "
" "a. 11.6%. "
" "b. 12.8%. "
" "c. 13.6%. "
" "d. 12.4%. "
"58. "(Ignore income taxes in this problem.) The following data are "
"A "available on a proposed investment project: "
"Medium " "
" "Initial investment ......... $142,500 "
" "Annual cash inflows ........ $30,000 "
" "Life of the investment ..... 8 years "
" "Required rate of return .... 10% "
" " "
" "a. 13.3%. "
" "b. 12.1%. "
" "c. 15.3%. "
" "d. 12.7%. "

"C "pertain to an investment proposal: "
"Medium " "
" "Present investment required ........ $14,000 "
" "Annual cost savings ................ $ 2,500 "
" "Projected life of the investment ... 8 years "
" "Projected salvage value ............ $ -0- "
" "Required rate of return ............ 6% "
" " "
" "a. 6.7%. "
" "b. 9.3%. "
" "c. 8.7%. "
" "d. 7.3%. "
"60. "(Ignore income taxes in this problem.) Overland Company has "
"A "gathered the following data on a proposed investment project: "
"Hard " "
" "Investment in depreciable equipment .... $150,000 "
" "Annual cash flows ...................... $ 40,000 "
" "Life of the equipment .................. 10 years "
" "Salvage value .......................... -0- "
" "Discount rate .......................... 10% "
" " "
" "The internal rate of return on this investment is closest to: "
" "a. 23.4%. "
" "b. 25.4%. "
" "c. 22.7% "
" "d. 22.1% "
"61. "(Ignore income taxes in this problem.) The following "
"A "information concerns a proposed investment: "
"Medium " "
" "Investment required ........ $14,150 "
" "Annual savings ............. $ 2,500 "
" "Life of the project ........ 12 years "
" " "
" "The internal rate of return is (do not interpolate): "
" "a. 14%. "
" "b. 12%. "
" "c. 10%. "
" "d. 5%. "

"62. "(Ignore income taxes in this problem.) Jarvey Company is "
"A "studying a project that would have a ten-year life and would "
"Medium "require a $450,000 investment in equipment that has no salvage"
" "value. The project would provide net income each year as "
" "follows for the life of the project: "
" " "
" "Sales ............................ $500,000 "
" "Less cash variable expenses ...... 200,000 "
" "Contribution margin .............. 300,000 "
" "Less fixed expenses: "
" "Fixed cash expenses ............ $150,000 "
" "Depreciation expenses .......... 45,000 195,000 "
" "Net income ....................... $105,000 "
" " "
" "The company's required rate of return is 12%. What is the "
" "payback period for this project? "
" "a. 3 years "
" "b. 2 years "
" "c. 4.28 years "
" "d. 9 years "
"63. "(Ignore income taxes in this problem.) Buy-Rite Pharmacy has "
"A "purchased a small auto for delivering prescriptions. The auto "
"Medium "was purchased for $9,000 and will have a 6-year useful life "
" "and a $3,000 salvage value. Delivering prescriptions (which "
" "the pharmacy has never done before) should increase gross "
" "revenues by at least $5,000 per year. The cost of these "
" "prescriptions to the pharmacy will be about $2,000 per year. "
" "The pharmacy depreciates all assets using the straight-line "
" "method. The payback period for the auto is: "
" "a. 3.0 years. "
" "b. 1.8 years. "
" "c. 2.0 years. "
" "d. 1.2 years. "
"64. "(Ignore income taxes in this problem.) A company with $800,000"
"C "in operating assets is considering the purchase of a machine "
"Easy "that costs $75,000 and which is expected to reduce operating "
" "costs by $20,000 each year. The payback period for this "
" "machine in years is closest to: "
" "a. 0.27 years. "
" "b. 10.7 years. "
" "c. 3.75 years. "
" "d. 40 years. "

"65. "(Ignore income taxes in this problem.) The Higgins Company has"
"B "just purchased a piece of equipment at a cost of $120,000. "
"Easy "This equipment will reduce operating costs by $40,000 each "
" "year for the next eight years. This equipment replaces old "
" "equipment that was sold for $8,000 cash. The new equipment has"
" "a payback period of: "
" "a. 8.0 years. "
" "b. 2.8 years. "
" "c. 10.0 years. "
" "d. 3.0 years. "
"66. "(Ignore income taxes in this problem.) The Keego Company is "
"D "planning a $200,000 equipment investment that has an estimated"
"Medium "five-year life with no estimated salvage value. The company "
"CMA adapted"has projected the following annual cash flows for the "
" "investment. "
" " "
" "Year Cash Inflows "
" "1 $120,000 "
" "2 60,000 "
" "3 40,000 "
" "4 40,000 "
" "5 40,000 "
" "Total $300,000 "
" " "
" "Assuming that the cash inflows occur evenly over the year, the"
" "payback period for the investment is: "
" "a. 0.75 years. "
" "b. 1.67 years. "
" "c. 4.91 years. "
" "d. 2.50 years. "
"67. "(Ignore income taxes in this problem.) Denny Corporation is "
"A "considering replacing a technologically obsolete machine with "
"Hard "a new state-of-the-art numerically controlled machine. The new"
" "machine would cost $450,000 and would have a ten-year useful "
" "life. Unfortunately, the new machine would have no salvage "
" "value. The new machine would cost $20,000 per year to operate "
" "and maintain, but would save $100,000 per year in labor and "
" "other costs. The old machine can be sold now for scrap for "
" "$50,000. The simple rate of return on the new machine is "
" "closest to: "
" "a. 8.75%. "
" "b. 20.00%. "
" "c. 7.78%. "
" "d. 22.22%. "

"68. "(Ignore income taxes in this problem.) The Jason Company is "
"A "considering the purchase of a machine that will increase "
"Medium "revenues by $32,000 each year. Cash outflows for operating "
" "this machine will be $6,000 each year. The cost of the machine"
" "is $65,000. It is expected to have a useful life of five years"
" "with no salvage value. For this machine, the simple rate of "
" "return is: "
" "a. 20%. "
" "b. 40%. "
" "c. 49.2%. "
" "d. 9.2%. "
"69. "Perkins Company is considering several investment proposals, "
"A "as shown below: "
"Easy "Investment Proposal o "
" "A B C D "
" "Investment required ... $80,000 $100,000 $60,000 $75,000"
" "Present value of future "
" "net cash flows ...... 96,000 150,000 84,000 120,000 "
" " "
" "Rank the proposals in terms of preference using the "
" "profitability index: "
" "a. D, B, C, A. "
" "b. B, D, C, A. "
" "c. B, D, A, C. "
" "d. A, C, B, D. "
"70. "Information on four investment proposals is given below: "
"C " "
"Easy "Proposal Investment Net Present Value "
" "1 $50,000 $30,000 "
" "2 60,000 24,000 "
" "3 30,000 15,000 "
" "4 45,000 9,000 "
" " "
" "Rank the proposals in terms of preference according to the "
" "profitability index: "
" "a. 3, 4, 1, 2. "
" "b. 1, 2, 3, 4. "
" "c. 1, 3, 2, 4. "
" "d. 2, 1, 4, 3. "

Reference: 14-1
(Ignore income taxes in this problem.) Shields Company has gathered the
following data on a proposed investment project:

Investment required in equipment ..... $400,000
Annual cash inflows .................. $80,000
Salvage value ........................ $-0-
Life of the investment ............... 10 years
Discount rate ........................ 10%

"71. "The payback period for the investment is closest to: "
"D "a. 0.2 years. "
"Easy "b. 1.0 years. "
"Refer To: "c. 3.0 years. "
"14-1 "d. 5.0 years. "
"72. "The simple rate of return on the investment is closest to: "
"B "a. 5%. "
"Medium "b. 10%. "
"Refer To: "c. 15%. "
"14-1 "d. 20%. "
"73. "The net present value on this investment is closest to: "
"C "a. $400,000. "
"Medium "b. $80,000. "
"Refer To: "c. $91,600. "
"14-1 "d. $76,750. "
"74. "The internal rate of return on the investment is closest to: "
"C "a. 11%. "
"Medium "b. 13%. "
"Refer To: "c. 15%. "
"14-1 "d. 17%. "

Reference: 14-2
(Ignore income taxes in this problem.) Bugle's Bagel Bakery is
investigating the purchase of a new bagel making machine. This machine
would provide an annual operating cost savings of $3,650 for each of the
next 4 years. In addition, this new machine would allow the production of
one new type of bagel that would result in selling 1,500 dozen more bagels
each year. The company earns a contribution margin of $0.90 on each dozen
bagels sold. The purchase price of this machine is $13,450 and it will have
a 4-year useful life. Bugle's discount rate is 14%.

"75. "The total annual cash inflow from this machine for capital "
"D "budgeting purposes is: "
"Medium "a. $3,650. "
"Refer To: "b. $5,150. "
"14-2 "c. $4,750. "
" "d. $5,000. "
"76. "The internal rate of return for this investment is closest to:"
"C "a. 14%. "
"Medium "b. 16%. "
"Refer To: "c. 18%. "
"14-2 "d. 20%. "

"77. "The net present value of this investment is closest to: "
"A "a. $1,120. "
"Medium "b. $6,550. "
"Refer To: "c. $13,450. "
"14-2 "d. $20,000. "

Reference: 14-3
(Ignore income taxes in this problem.) Treads Corporation is considering
the replacement of an old machine that is currently being used. The old
machine is fully depreciated but can be used by the corporation for five
more years. If Treads decides to replace the old machine, Picco Company has
offered to purchase the old machine for $60,000. The old machine would have
no salvage value in five years.
The new machine would be acquired from Hillcrest Industries for
$1,000,000 in cash. The new machine has an expected useful life of five
years with no salvage value. Due to the increased efficiency of the new
machine, estimated annual cash savings of $300,000 would be generated.
Treads Corporation uses a discount rate of 12%.

"78. "The net present value of the project is closest to: "
"C "a. $171,000. "
"Medium "b. $136,400. "
"Refer To: "c. $141,500. "
"14-3 "d. $560,000. "
"79. "The internal rate of return of the project is closest to: "
"C "a. 14%. "
"Medium "b. 16%. "
"Refer To: "c. 18%. "
"14-3 "d. 20%. "

Reference: 14-4
(Ignore income taxes in this problem.) Oriental Company has gathered the
following data on a proposed investment project:

Investment in depreciable equipment ..... $200,000
Annual net cash flows ................... $ 50,000
Life of the equipment ................... 10 years
Salvage value ........................... -0-
Discount rate ........................... 10%

The company uses straight-line depreciation on all equipment.

"80. "The payback period for the investment would be: "
"D "a. 2.41 years. "
"Medium "b. 0.25 years. "
"Refer To: "c. 10 years. "
"14-4 "d. 4 years. "

"81. "The simple rate of return on the investment would be: "
"C "a. 10%. "
"Medium "b. 35%. "
"Refer To: "c. 15%. "
"14-4 "d. 25%. "
"82. "The net present value of this investment would be: "
"B "a. ($14,350). "
"Medium "b. $107,250. "
"Refer To: "c. $77,200. "
"14-4 "d. $200,000. "

Reference: 14-5
(Ignore income taxes in this problem.) Apex Corp. is planning to buy
production machinery costing $100,000. This machinery's expected useful
life is five years, with no residual value. Apex uses a discount rate of
10% and has calculated the following data pertaining to the purchase and
operation of this machinery:

Estimated
annual net
Year cash inflow
1 $ 60,000
2 30,000
3 20,000
4 20,000
5 20,000

"83. "The payback period is: "
"A "a. 2.50 years. "
"CPA adapted"c. 3.00 years. "
"Refer To: "d. 5.00 years. "
"14-5 " "
"84. "The net present value is closest to: "
"A "a. $20,400. "
"Medium "b. $28,400. "
"CPA adapted"c. $80,000. "
"Refer To: "d. $50,000. "
"14-5 " "

Reference: 14-6
(Ignore income taxes in this problem.) The Finney Company is reviewing the
possibility of remodeling one of its showrooms and buying some new
equipment to improve sales operations. The remodeling would cost $120,000
now and the useful life of the project is 10 years. Additional working
capital needed immediately for this project would be $30,000; the working
capital would be released for use elsewhere at the end of the 10-year
period. The equipment and other materials used in the project would have a
salvage value of $10,000 in 10 years. Finney's discount rate is 16%.

"85. "The immediate cash outflow required for this project would be:"
"B "a. $(120,000). "
"Easy "b. $(150,000). "
"Refer To: "c. $(90,000). "
"14-6 "d. $(130,000). "
"86. "What would the annual net cash inflows from this project have "
"D "to be in order to justify investing in remodeling? "
"Hard "a. $14,495 "
"Refer To: "b. $35,842 "
"14-6 "c. $16,147 "
" "d. $29,158 "

Reference: 14-7
(Ignore income taxes in this problem.) The Sawyer Company has $80,000 to
invest and is considering two different projects, X and Y. The following
data are available on the projects:

Project X Project Y
Cost of equipment needed now ... $80,000 --
Working capital requirement .... -- $80,000
Annual cash operating inflows .. $23,000 $18,000
Salvage value in 5 years ....... $ 6,000 --

Both projects will have a useful life of 5 years; at the end of 5 years,
the working capital will be released for use elsewhere. Sawyer's discount
rate is 12%.

"87. "The net present value of project X is: "
"D "a. $2,915. "
"Medium "b. $(11,708). "
"Refer To: "c. $5,283. "
"14-7 "d. $6,317. "
"88. "The net present value of project Y is closest to: "
"B "a. $15,110. "
"Medium "b. $30,250. "
"Refer To: "c. $11,708. "
"14-7 "d. $(11,708). "

Reference: 14-8
(Ignore income taxes in this problem.) The Becker Company is interested in
buying a piece of equipment that it needs. The following data have been
assembled concerning this equipment:

Cost of required equipment .......... $250,000
Working capital required ............ $100,000
Annual operating cash inflows........ $ 80,000
Cash repair at end of 4 years ....... $ 40,000
Salvage value at end of 6 years ..... $ 90,000

This equipment is expected to have a useful life of 6 years. At the end of
the sixth year the working capital would be released for use elsewhere. The
company's discount rate is 10%.

"89. "The present value of all future operating cash inflows is "
"C "closest to: "
"Easy "a. $480,000. "
"Refer To: "b. $452,300. "
"14-8 "c. $348,400. "
" "d. $278,700. "
"90. "The present value of the net cash flows (all cash inflows less"
"B "all cash outflows) occurring during year 4 is: "
"Easy "a. $40,000. "
"Refer To: "b. $27,320. "
"14-8 "c. $54,640. "
" "d. $42,790. "
"91. "The present value of the net cash flows (all cash inflows less"
"D "all cash outflows) occurring during year 6 is closest to: "
"Medium "a. $270,000. "
"Refer To: "b. $195,900. "
"14-8 "c. $107,200. "
" "d. $152,300. "

Reference: 14-9
(Ignore income taxes in this problem.) UR Company is considering rebuilding
and selling used alternators for automobiles. The company estimates that
the net operating cash flows (sales less cash operating expenses) arising
from the rebuilding and sale of the used alternators would be as follows
(numbers in parentheses indicate an outflow):

Years 1 - 10 ... $ 90,000
Year 11 ........ (20,000)
Year 12 ........ 100,000

In addition to the above net operating cash flows, UR Company would
purchase production equipment costing $200,000 now to use in the rebuilding
of the alternators. The equipment would have a 12-year life and a $15,000
salvage value. The company's discount rate is 10%.

"92. "The present value of the net operating cash flows (sales less "
"C "cash operating expenses) arising from the rebuilding and sale "
"Medium "of the alternators (rounded to the nearest dollar) is: "
"Refer To: "a. $582,735. "
"14-9 "b. $596,735. "
" "c. $577,950. "
" "d. $591,950. "
"93. "The net present value of all cash flows associated with this "
"B "investment (rounded to the nearest dollar) is: "
"Medium "a. $377,950. "
"Refer To: "b. $382,735. "
"14-9 "c. $392,950. "
" "d. $362,950. "

Reference: 14-10
(Ignore income taxes in this problem.) Westland College has a telephone
system that is in poor condition. The system either can be overhauled or
replaced with a new system. The following data have been gathered
concerning these two alternatives:

Present Proposed New
System System
Purchase cost new ....................... $250,000 $300,000
Accumulated depreciation ................ $240,000 -
Overhaul costs needed now ............... $230,000 -
Annual cash operating costs ............. $180,000 $170,000
Salvage value now ....................... $160,000 -
Salvage value at the end of 8 years ..... $152,000 $165,000
Working capital required ................ - $200,000

Westland College uses a 10% discount rate and the total cost approach to
capital budgeting analysis. Both alternatives are expected to have a useful
life of eight years.

"94. "The net present value of the alternative of overhauling the "
"B "present system is: "
"Hard "a. $(1,279,316). "
"Refer To: "b. $(1,119,316). "
"14-10 "c. $801,284. "
" "d. $(1,194,036). "
"95. "The net present value of the alternative of purchasing the new"
"A "system is: "
"Hard "a. $(1,076,495). "
"Refer To: "b. $(1,236,495). "
"14-10 "c. $(1,169,895). "
" "d. $(969,895). "

Reference: 14-11
(Ignore income taxes in this problem.) Lambert Manufacturing has $60,000 to
invest in either Project A or Project B. The following data are available
on these projects:

Project A Project B
Cost of equipment needed now .............. $120,000 $70,000
Working capital investment needed now ..... - $50,000
Annual net operating cash inflows ......... $ 50,000 $45,000
Salvage value of equipment in 6 years ..... $ 15,000 -

Both projects have a useful life of 6 years. At the end of 6 years, the
working capital investment will be released for use elsewhere. Lambert's
discount rate is 14%.

"96. "The net present value of Project A is closest to: "
"D "a. $82,241. "
"Medium "b. $67,610. "
"Refer To: "c. $74,450. "
"14-11 "d. $81,290. "
"97. "The net present value of Project B is closest to: "
"A "a. $77,805. "
"Medium "b. $127,805. "
"Refer To: "c. $55,005. "
"14-11 "d. $105,005. "
"98. "Which of the following statements is (are) correct? "
"C " "
"Medium "I. Project A is acceptable according to the net present value "
"Refer To: "method. "
"14-11 "II. Project A has an internal rate of return greater than 14%."
" " "
" "a. Only I. "
" "b. Only II. "
" "c. Both I and II. "
" "d. Neither I nor II. "

Reference: 14-12
(Ignore income taxes in this problem.) Fast Food, Inc., has purchased a new
donut maker. It cost $16,000 and has an estimated life of 10 years. The
following annual donut sales and expenses are projected:

Sales ..................... $22,000
Expenses:
Flour, etc., required
in making donuts ... $10,000
Salaries ............... 6,000
Depreciation ........... 1,600 17,600
Net income ................ $ 4,400

"99. "The payback period on the new machine is closest to: "
"B "a. 5 years. "
"14-12 "d. 1.4 years. "
"100. "The simple rate of return for the new machine is closest to: "
"C "a. 20%. "
"Easy "b. 37.5%. "
"Refer To: "c. 27.5%. "
"14-12 "d. 80.0%. "

Reference: 14-13
(Ignore income taxes in this problem.) Purvell Company has just acquired a
new machine. Data on the machine follow:

Purchase cost ............ $50,000
Annual cost savings ...... 15,000
Life of the machine ...... 8 years

The company uses straight-line depreciation and a $5,000 salvage value.
(The company considers salvage value in making depreciation deductions.)
Assume cash flows occur uniformly throughout a year.

"101. "The payback period would be closest to: "
"A "a. 3.33 years. "
"14-13 "d. 2.9 years. "
"102. "The simple rate of return would be closest to: "
"C "a. 30.0%. "
"Medium "b. 17.5%. "
"Refer To: "c. 18.75%. "
"14-13 "d. 12.5%. "

Reference: 14-14
(Ignore income taxes in this problem.) Hanley Company purchased a machine
for $125,000 that will be depreciated on the straight-line basis over a
five-year period with no salvage value. The related cash flow from
operations is expected to be $45,000 a year. These cash flows from
operations occur uniformly throughout the year.

"103. "What is the payback period? "
"C "a. 2.1 years. "
"CPA adapted"c. 2.8 years. "
"Refer To: "d. 4.2 years. "
"14-14 " "

"104. "What is the simple rate of return on the initial investment? "
"A "a. 16%. "
"Easy "b. 24%. "
"CPA adapted"c. 28%. "
"Refer To: "d. 36%. "
"14-14 " "

Essay

"105. "(Ignore income taxes in this problem.) Prince Company's "
"Medium "required rate of return is 10%. The company is considering the"
" "purchase of three machines, as indicated below. Consider each "
" "machine independently. "
" " "
" "Required: "
" " "
" "a. Machine A will cost $25,00 and have a life of 15 years. Its"
" "salvage value will be $1,000, and cost savings are projected "
" "at $3,500 per year. Compute the machine's net present value. "
" " "
" "b. How much will Prince Company be willing to pay for Machine "
" "B if the machine promises annual cash inflows of $5,000 per "
" "year for 8 years? "
" " "
" "c. Machine C has a projected life of 10 years. What is the "
" "machine's internal rate of return if it costs $30,000 and "
" "will save $6,000 annually in cash operating costs? "
" "Interpolate to the nearest tenth of a percent. Would you "
" "recommend purchase? Explain. "
" "Answer: "
" "a. 10% Present "
" "Year Amount Factor Value "
" "Investment required now ($25,000) 1.000 ($25,000) "
" "Annual cost savings 1-15 3,500 7.606 26,621 "
" "Salvage value ..... 15 1,000 0.239 239 "
" "Net present value $ 1,860 "
" "b. 10% Present "
" "Year Amount Factor Value "
" "Annual cash inflows 1-8 $ 5,000 5.335 $26,675 "
" " "
" "Since the present value of the cash inflows is $26,675, the "
" "company should be willing to pay up to this amount to acquire "
" "the machine. "

" "c. Investment required ÷ Net annual cash flow = Factor of the "
" "internal rate of return "
" " "
" "$30,000 ÷ %6,000 = 5.000 "
" " "
" "14% factor ............ 5.216 5.216 "
" "True factor ........... 5.000 "
" "16% factor ............ 4.833 "
" "0.216 0.383 "
" " "
" "14% + 2%(0.216 ÷ 0.383) = 15.1% "
" " "
" "The machine should be purchased, since the internal rate of "
" "return is greater than the required rate of return. "
"106. "Ignore income taxes in this problem.) Ursus, Inc., is "
"Medium "considering a project that would have a ten-year life and "
" "would require a $1,000,000 investment in equipment. At the end"
" "of ten years, the project would terminate and the equipment "
" "would have no salvage value. The project would provide net "
" "income each year as follows: "
" " "
" "Sales ................................ $2,000,000 "
" "Less variable expenses ............... 1,400,000 "
" "Contribution margin .................. 600,000 "
" "Less fixed expenses .................. 400,000 "
" "Net income ........................... $ 200,000 "
" " "
" "All of the above items, except for depreciation of $100,000 a "
" "year, represent cash flows. The depreciation is included in "
" "the fixed expenses. The company's required rate of return is "
" "12%. "
" "Required: "
" "a. Compute the project's net present value. "
" "b. Compute the project's internal rate of return, "
" "interpolating to the nearest tenth of a percent. "
" "c. Compute the project's payback period. "
" "d. Compute the project's simple rate of return. "
" "Answer: "
" "a. Since depreciation is the only noncash item on the income "
" "statement, the net annual cash flow can be computed by adding "
" "back depreciation to net income. "
" " "
" "Net income ............. $200,000 "
" "Depreciation ........... 100,000 "
" "Net annual cash flow ... $300,000 "
" " "
" "12% Present "
" "Years Amount Factor Value "
" "Initial investment .. Now $(1,000,000) 1.000 "
" "$(1,000,000) "
" "Net annual cash "
" "flows ............. 1-10 300,000 5.650 1,695,000 "

" "b. The formula for computing the factor of the internal rate "
" "of return (IRR) is: "
" " "
" "Investment required ÷ Net annual cash inflow = Factor of the "
" "IRR "
" "$1,000,000 ÷ $300,000 = 3.333 "
" " "
" "26% factor ........ 3.465 3.465 "
" "True factor ....... 3.333 "
" "28% factor ........ 3.269 "
" "0.132 0.196 "
" " "
" "26% + 2%(0.132 ÷0.196) = 27.3% "
" "c. The formula for the payback period is: "
" "Investment required ÷ Net annual cash inflow = Payback "
" "period "
" "$1,000,000 ÷ $300,000 = 3.33 years "
" " "
" "d. The formula for the simple rate of return is: "
" "Net income ÷ Initial investment = Simple rate of return "
" "$200,000 ÷ $1,000,000 = 20.0% "
"Medium "concern an investment project: "
" " "
" "Investment in equipment ........... $16,000 "
" "Net annual cash inflows ........... $ 3,600 "
" "Working capital required .......... $ 4,500 "
" "Salvage value of the equipment .... $ 2,000 "
" "Life of the project ............... 12 years "
" "Discount rate ..................... 14% "
" " "
" "The working capital will be released for use elsewhere at the "
" "conclusion of the project. "
" "Required: "
" " "
" "Compute the project's net present value. "
" " "
" "Answer: "
" "14% Present "
" "Item Years Amount Factor Value "
" "Investment now ($16,000) 1.000 "
" "($16,000) "
" "Annual cash "
" "inflows ............... 1-12 3,600 5.660 20,376 "
" "Working capital "
" "required .............. now (4,500) 1.000 (4,500) "
" "Working capital "
" "released .............. 12 4,500 0.208 936 "
" "Salvage value "
" "equipment ............. 12 2,000 0.208 416 "
" "Net present value ....... $ 1,228"
" " "

"108. "(Ignore income taxes in this problem.) Bradley Company's "
"Medium "required rate of return is 14%. The company has an opportunity"
" "to be the exclusive distributor of a very popular consumer "
" "item. No new equipment would be needed, but the company would "
" "have to use one-fourth of the space in a warehouse it owns. "
" "The warehouse cost $200,000 new. The warehouse is currently "
" "half-empty and there are no other plans to use the empty "
" "space. In addition, the company would have to invest $100,000 "
" "in working capital to carry inventories and accounts "
" "receivable for the new product line. The company would have "
" "the distributorship for only 5 years. The distributorship "
" "would generate a $17,000 net annual cash inflow. "
" " "
" "Required: "
" " "
" "What is the net present value of the project at a discount "
" "rate of 14%? Should the project be accepted? "
" " "
" "Answer: "
" "14% Present "
" "Years Amount Factor Value "
" "Working capital investment Now $(100,000) 1.000 "
" "$(100,000) "
" "Annual cash inflows ...... 1-5 17,000 3.433 "
" "58,361 "
" "Working capital released 5 100,000 0.519 "
" "51,900 "
" "Net present value ........ $ "
" "10,261 "
" " "
" "Yes, the distributorship should be accepted since the project "
" "has a positive net present value. "
"109. "(Ignore income taxes in this problem.) Monson Company is "
"Medium "considering three investment opportunities with cash flows as "
" "described below: "
" " "
" "Project A: Cash investment now ..................... $15,000 "
" "Cash inflow at the end of 5 years ....... $21,000 "
" "Cash inflow at the end of 8 years ....... $21,000 "
" " "
" "Project B: Cash investment now ..................... $11,000 "
" "Annual cash outflow for 5 years ......... $ 3,000 "
" "Additional cash inflow at the end "
" "of 5 years ............................ $21,000 "
" " "
" "Project C: Cash investment now ..................... $21,000 "
" "Annual cash inflow for 4 years .......... $11,000 "
" "Cash outflow at the end of 3 years ...... $ 5,000 "
" "Additional cash inflow at the end "
" "of 4 years ............................ $15,000 "
" "Required: "
" "Compute the net present value of each project assuming Monson "
" "Company uses a 12% discount rate. "
" " "
" " "
" " "
" " "
" "Answer: "
" "Project A: "
" "12% Present "
" "Amount Factor Value "
" "Cash investment now.............. ($15,000) 1.000 "
" "($15,000) "
" "Cash inflow at the end of 5 years $21,000 0.567 "
" "$11,907 "
" "Cash inflow at the end of 8 years $21,000 0.404 $ "
" "8,484 "
" "Net present value................ $ "
" "5,391 "
" "Project B: "
" "12% Present "
" "($11,000) "
" "Annual cash outflow for 5 years.. ($ 3,000) 3.605 "
" "($10,815) "
" "Additional cash inflow at the "
" "end of 5 years............... $21,000 0.567 $11,907 "
" "Net present value................ ($ "
" "9,908) "
" " "
" "Project C: "
" "12% Present "
" "($21,000) "
" "Annual cash inflow for 4 years... $11,000 3.037 "
" "$33,407 "
" "Cash outflow at the end of "
" "3 years........................ ($ 5,000) 0.712 ($ "
" "3,560) "
" "Additional cash inflow at the "
" "end of 4 years................. $15,000 0.636 $ 9,540"
" "Net present value................ "
" "$18,387 "
"110. "(Ignore income taxes in this problem.) Jim Bingham is "
"Medium "considering starting a small catering business. He would need "
" "to purchase a delivery van and various equipment costing "
" "$125,000 to equip the business and another $60,000 for "
" "inventories and other working capital needs. Rent for the "
" "building used by the business will be $35,000 per year. Jim's "
" "marketing studies indicate that the annual cash inflow from "
" "the business will amount to $120,000. In addition to the "
" "building rent, annual cash outflow for operating costs will "
" "amount to $40,000. Jim wants to operate the catering business "
" "for only six years. He estimates that the equipment could be "
" "sold at that time for 4% of its original cost. Jim uses a 16% "
" "discount rate. "
" " "
" "Required: "
" "Would you advise Jim to make this investment? "

" "Answer: "
" "16% Present "
" "Description Years Amount Factor Value "
" "Van & equipment ..... 0 ($125,000) 1.000 "
" "($125,000) "
" "Working capital ..... 0 ($ 60,000) 1.000 ($ "
" "60,000) "
" "Building rent ....... 1-6 ($ 35,000) 3.685 "
" "($128,975) "
" "inflow ............ 1-6 $ 80,000 3.685 $294,800"
" "Salvage value, "
" "equipment ......... 6 $ 5,000 0.410 $ 2,050"
" "Release of working "
" "capital ........... 6 $ 60,000 0.410 $ 24,600"
"111. "(Ignore income taxes in this problem.) General Manufacturing "
"Medium "Company consists of several divisions, one of which is the "
" "Transportation Division. The company has decided to dispose of"
" "this division since it no longer fits the company's long-term "
" "strategy. An offer of $9,000,000 has been received from a "
" "prospective buyer. If General retained the division, the "
" "company would operate the division for only nine years, after "
" "which the division would no longer be needed and would be sold"
" "for $600,000. If the company retains the division, an "
" "immediate investment of $500,000 would need to be made to "
" "update equipment to current standards. Annual net operating "
" "cash flows would be $1,805,000 if the division is retained. "
" "The company's discount rate is 12%. "
" " "
" "Required: "
" "Using the net present value method, determine whether General "
" "Manufacturing should accept or reject the offer made by the "
" "potential buyer. "
" "Answer: "
" "12% Present "
" "Year Explanation Amount Factor "
" "Valueo "
" "0 Investment to update assets $ (500,000) 1.000 $ "
" "(500,000) "
" "1-9 Annual cash inflows ....... 1,805,000 5.328 "
" "9,617,040 "
" "9 Selling price for "
" "the division ............ 600,000 0.361 216,600 "
" "Net present value ......... $9,333,640 "
" " "
" "The sales price of $9,000,000 is less than the present value "
" "of the cash flows resulting from retaining the division. "
" "General thus should not accept the offer. "

"112. "(Ignore income taxes in this problem.) Mark Stevens is "
"Medium "considering opening a hobby and craft store. He would need "
" "$100,000 to equip the business and another $40,000 for "
" "inventories and other working capital needs. Rent on the "
" "building used by the business will be $24,000 per year. Mark "
" "estimates that the annual cash inflow from the business will "
" "amount to $90,000. In addition to building rent, annual cash "
" "outflow for operating costs will amount to $30,000. Mark plans"
" "to operate the business for only six years. He estimates that "
" "the equipment and furnishings could be sold at that time for "
" "10% of their original cost. Mark uses a discount rate of 16%. "
" " "
" "Required: "
" "Would you advise Mark to make this investment? Use the net "
" "present value method. "
" "Answer: "
" "16% Present "
" "Description Years Amount Factor Value o "
" "Equipment ........... 0 ($100,000) 1.000 ($100,000)"
" "Working capital ..... 0 ($ 40,000) 1.000 ($ 40,000)"
" "Building rent ....... 1-6 ($ 24,000) 3.685 ($ 88,440)"
" "inflow ............ 1-6 $ 60,000 3.685 $221,100 "
" "Salvage value, "
" "equipment ......... 6 $ 10,000 0.410 $ 4,100 "
" "capital ........... 6 $ 40,000 0.410 $ 16,400 "
"113. "(Ignore income taxes in this problem.) Vernon Company has been"
" "offered a 7-year contract to supply a part for the military. "
"Medium "After careful study, the company has developed the following "
" "estimated data relating to the contract: "
" " "
" "Cost of equipment needed ............................. "
" "$300,000 "
" "Working capital needed ............................... $ "
" "50,000 "
" "Annual cash receipts from the delivery of parts, "
" "less cash operating costs .......................... $ 70,000 "
" "Salvage value of equipment at termination of "
" "the contract ....................................... $ 5,000 "
" " "
" "It is not expected that the contract would be extended beyond "
" "the initial contract period. The company's discount rate is "
" "10%. "
" " "
" "Required: "
" "Use the net present value method to determine if the contract "
" "should be accepted. Round all computations to the nearest "
" "dollar. "
" " "
" " "

" "Answer: "
" "10% Present "
" "Description Years Amount Factor Value o "
" "Equipment ........... 0 ($300,000) 1.000 ($300,000)"
" "Working capital ..... 0 ($ 50,000) 1.000 ($ 50,000)"
" "inflow ............ 1-7 $ 70,000 4.868 $340,760 "
" "Salvage value, "
" "equipment ......... 7 $ 5,000 0.513 $ 2,565 "
" "capital ........... 7 $ 50,000 0.513 $ 25,650 "
"114. "(Ignore income taxes in this problem.) AB Company is "
"Hard "considering the purchase of a machine that promises to reduce "
" "operating costs by the same amount for every year of its "
" "6-year useful life. The machine will cost $83,150 and has no "
" "salvage value. The machine has a 20% internal rate of return. "
" " "
" "Required: "
" "What is the annual cost savings promised by the machine? "
" " "
" "Answer: "
" "Investment required ÷ Net annual cash inflow = "
" "Factor of the internal rate of return "
" " "
" "$83,150 ÷ Net annual cash inflow = 3.326 "
" "$83,150 ÷ 3.326 = Net annual cash inflow "
" "= $25,000 "
"115. "(Ignore income taxes in this problem.) Ferris Company has an "
"Easy "old machine that is fully depreciated but has a current "
" "salvage value of $5,000. The company wants to purchase a new "
" "machine that would cost $60,000 and have a 5-year useful life "
" "and zero salvage value. Expected changes in annual revenues "
" "and expenses if the new machine is purchased are: "
" " "
" "Increased revenues ............... $63,000 "
" "Increased expenses: "
" "Salary of additional operator .. $20,000 "
" "Supplies ....................... 9,000 "
" "Depreciation ................... 12,000 "
" "Maintenance .................... 4,000 45,000 "
" "Increased net income .............. $18,000 "
" " "
" "Required: "
" "a. Compute the payback period on the new equipment. "
" "b. Compute the simple rate of return on the new equipment. "
" "Answer: "
" "a. Investment required ÷ Net annual cash inflow = Payback "
" "period "
" "$60,000 - $5,000) ÷ ($18,000 + $12,000) = 1.83 years (rounded)"
" "b. Incremental net income ÷ Investment = Simple rate of return"
" "$18,000 ÷ $55,000 = 32.7% (rounded) "

285679315-Test-Bank-Chapter14-Capital-Budgeting.doc

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