Multiple Choice Questions
1. 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.
Answer:
B LO: 1 Type: RC
2. 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. Whether a pro football team should trade for
and sign a star quarterback to a long-term contract.
Answer:
C LO: 1 Type: N
3. The decision process that has managers select
from among several acceptable investment proposals to make the best use of
limited funds is known as:
A. capital rationing.
B. capital budgeting.
C. acceptance or rejection analysis (ARA).
D. cost analysis.
E. project planning.
Answer:
A LO: 1 Type: RC
4. Capital budgeting tends to focus primarily
on:
A. revenues.
B. costs.
C. cost centers.
D. programs and projects.
E. allocation tools.
Answer:
D LO: 1 Type: RC
5. 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.
Answer:
B LO: 1 Type: RC
6. In a net-present-value analysis, the discount
rate is often called the:
A. payback rate.
B. hurdle rate.
C. minimal value.
D. net unit rate.
E. objective rate of return.
Answer:
B LO: 1 Type: RC
7. The hurdle rate that is used in a
net-present-value analysis is the same as the firm's:
A. discount rate.
B. internal rate of return.
C. minimum desired rate of return.
D. objective rate of return.
E. discount rate and minimum desired
rate of return.
Answer:
E LO: 1 Type: RC
8. Which of the following is taken into account
by the net-present-value method?
|
|
A Project's Immediate Cash Flows
|
|
Cash Flows During a Project's Life
|
|
Time
Value of Money
|
|
A.
|
Yes
|
|
No
|
|
No
|
|
B.
|
Yes
|
|
Yes
|
|
No
|
|
C.
|
Yes
|
|
Yes
|
|
Yes
|
|
D.
|
No
|
|
Yes
|
|
Yes
|
|
E.
|
No
|
|
Yes
|
|
No
|
Answer:
C LO: 1 Type: N
9. Consider the following factors related to an
investment:
I.
The
net income from the investment.
II.
The
cash flows from the investment.
III.
The
timing of the cash flows from the investment.
Which of the preceding factors would be important
considerations in a net-present-value analysis?
A. I only.
B. II only.
C. I and II.
D. II and III.
E. I, II, and III.
Answer:
D LO: 1 Type: N
10. 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.
Answer:
E LO: 1 Type: RC
11. 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:
D LO: 1 Type: RC
12. The internal rate of return:
A. ignores the time value of money.
B. equates a project's cash inflows with its
cash outflows.
C. equates a project's cash outflows with its
expenses.
D. equates the present value of a project's cash
inflows with the present value of the cash outflows.
E. equates the present value of a project's
cash flows with the future value of the project's cash flows.
Answer:
D LO: 1 Type: RC
13. Page Company is contemplating the acquisition
of a machine that costs $50,000 and promises to reduce annual cash operating
costs by $11,000 over each of the next six years. Which of the following is a proper way to
evaluate this investment if the company desires a 12% return on all investments?
A. $50,000 vs. $11,000 x 6.
B. $50,000 vs. $66,000 x 0.507.
C. $50,000 vs. $66,000 x 4.111.
D. $50,000 vs. $11,000 x 4.111.
E. $50,000 x 0.893 vs. $11,000 x 4.111.
Answer:
D LO: 1 Type: A
14. Adams Company can acquire a $750,000 machine
now that will benefit the firm over the next 8 years. Annual savings in cash operating costs are
expected to total $140,000. If the
hurdle rate is 10%, the investment's net present value is:
A. $(226,960).
B. $(3,100).
C. $65,150.
D. $370,000.
E. some other amount.
Answer:
B LO: 1 Type: A
15. Reeder Company, which uses net present value
to analyze investments, requires a 10% minimum rate of return. A staff assistant recently calculated a
$500,000 machine's net present value to be $86,400, excluding the impact of
straight-line depreciation. If Reeder
ignores income taxes and the machine is expected to have a five-year service
life, the correct net present value of the machine would be:
A. $(13,600).
B. $86,400.
C. $186,400.
D. $292,700.
E. $465,500.
Answer:
B LO: 1 Type: A
16. A new asset is expected to provide service
over the next four years. It will cost
$500,000, generates annual cash inflows of $150,000, and requires cash
operating expenses of $30,000 each year.
In addition, a $10,000 overhaul will be needed in year 3. If the company requires a 10% rate of return,
the net present value of this machine would be:
A. $(127,110), and the machine meets the
company's rate-of-return requirement.
B. $(127,110), and the machine does not meet the
company's rate-of-return requirement.
C. $(129,600), and the machine does not meet the
company's rate-of-return requirement.
D. $(151,700), and the machine meets the
company's rate-of-return requirement.
E. some other amount.
Answer:
B LO: 1 Type: A
17. A new machine that costs $172,100 is expected
to save annual cash operating costs of $40,000 over each of the next nine
years. The machine's internal rate of
return is:
A. approximately 14%.
B. approximately 16%.
C. approximately 18%.
D. approximately 20%.
E. some other figure not noted above.
Answer:
C LO: 1 Type: A
18. Paulsen is considering the acquisition of a
$217,750 machine that is expected to produce annual savings in cash operating
costs of $50,000 over the next six years.
If Paulsen uses the internal rate of return (IRR) to evaluate new
investments and the firm has a hurdle rate of 12%, which of the following
statements is correct?
A. The machine's IRR is less than 4%, and the
machine should not be acquired.
B. The machine's IRR is approximately 10%, and
the machine should not be acquired.
C. The machine's IRR is approximately 10%, and
the machine should be acquired.
D. The machine's IRR is approximately 12%, and the
machine should be acquired.
E. All of the preceding statements are false.
Answer:
B LO: 1 Type: A, N
Use the
following to answer questions 19-20:
A machine costs
$25,000; it is expected to generate annual cash revenues of $8,000 and annual cash
expenses of $2,000 for five years. The
required rate of return is 12%.
19. The net present value of the machine is:
A. $(3,840).
B. $(3,370).
C. $0.
D. $21,630.
E. $28,840.
Answer: B LO: 1
Type: A
20. Which of the following statements about the
machine's internal rate of return is true?
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 greater
than 15%.
E. There is insufficient information to make
any judgment about the internal rate of return.
Answer:
C LO: 1 Type: A
Use the
following to answer questions 21-23:
The mayor of
Smalltown is considering the purchase of a new computer system for the city'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:
Year
|
|
Savings
|
|
|
1
|
|
$20,000
|
|
|
2
|
|
25,000
|
|
|
3
|
|
30,000
|
|
|
4
|
|
15,000
|
|
|
5
|
|
12,000
|
|
21. If Smalltown uses a 10% discount rate for
capital-budgeting decisions, the net present value of the computer system would
be:
A. $489.
B. $4,057.
C. $11,658.
D. $63,342.
E. $79,057.
Answer:
B LO: 1 Type: A
22. What can be said about the computer system's
internal rate of return 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. There is insufficient information to make
any judgment about the internal rate of return.
Answer:
A LO: 1 Type: N
23. 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 the city of
$32,000. If the discount rate is 10%,
the net present value of this system would be:
A. $16,440.
B. $23,175.
C. $63,512.
D. $101,440.
E. some other amount.
Answer:
A LO: 1 Type: A
24. A company that is using the internal rate of
return (IRR) to evaluate projects should accept a project if the IRR:
A. is greater than the project's net present value.
B. equates the present value of the project's
cash inflows with the present value of the project's cash outflows.
C. is greater than zero.
D. is greater than the hurdle rate.
E. is less than the firm's cost of investment
capital.
Answer:
D LO: 2 Type: RC
25. Which of the following choices correctly
states the rules for project acceptance under the net-present-value method and
the internal-rate-of-return method?
|
|
Net Present Value
|
|
Internal Rate of Return
|
|
A.
|
Positive
total
|
|
Greater than
hurdle rate
|
|
B.
|
Positive
total
|
|
Less than
hurdle rate
|
|
C.
|
Negative
total
|
|
Greater than
hurdle rate
|
|
D.
|
Negative
total
|
|
Less than
hurdle rate
|
|
E.
|
Greater than
hurdle rate
|
|
Positive
number
|
Answer:
A LO: 2 Type: RC
26. 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.
Answer:
A LO: 2 Type: RC
27. 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 (REG).
Answer:
B LO: 2 Type: RC
28. Which of the following choices correctly
states how funds are assumed to be reinvested under the net-present-value
method and the internal-rate-of-return method?
|
|
Net Present Value
|
|
Internal Rate of Return
|
|
A.
|
At the hurdle
rate
|
|
At the hurdle
rate
|
|
B.
|
At the hurdle
rate
|
|
At the return
earned on the project
|
|
C.
|
At the cost
of debt capital
|
|
At the cost
of debt capital
|
|
D.
|
At the cost
of debt capital
|
|
At the cost
of equity capital
|
|
E.
|
At the cost
of equity capital
|
|
At the cost
of equity capital
|
Answer:
B LO: 2 Type: RC
29. 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. items "A" and "D" above.
Answer:
E LO: 2 Type: RC
30. 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?
|
|
Net
Present Value
|
|
Internal
Rate of Return
|
|
|
A.
|
Considered
|
|
Considered
|
|
|
B.
|
Considered
|
|
Ignored
|
|
|
C.
|
Ignored
|
|
Considered
|
|
|
D.
|
Ignored
|
|
Ignored
|
|
|
E.
|
The correct
answer depends on the depreciation method (straight line or accelerated) that
is used.
|
|||
Answer:
D LO: 2 Type: RC
31. Consider the following statements about the
total-cost and the incremental-cost approaches of investment evaluation:
I.
Both
approaches will yield the same conclusions.
II.
Choosing
between these approaches is a matter of personal preference.
III.
The
incremental approach focuses on cost differences between alternatives.
Which of the above statements is (are) true?
A. I only.
B. II only.
C. III only.
D. II and III.
E. I, II, and III.
Answer: E LO: 3
Type: RC
32. 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 postaudit.
C. control of capital expenditures (CCE).
D. overall cost performance.
E. the cost evaluation phase.
Answer:
B LO: 3 Type: RC
33. Consider the following statements about
capital budgeting postaudits:
I.
Postaudits
can be used to detect desirable projects that were rejected.
II.
Postaudits
can be used to detect undesirable projects that were accepted.
III.
Postaudits
may reveal shortcomings in cash-flow projections, providing insights that allow
a firm to improve future predictions.
Which of the above statements is (are) correct?
A. I only.
B. II only.
C. III only.
D. II and III.
E. I, II, and III.
Answer:
D LO: 3 Type: RC
34. Generally speaking, which of the following
would not directly affect a company's income tax payments?
A. Advertising expense.
B. Gain on sale of machinery.
C. Sales revenue.
D. Land owned by the firm.
E. Loss on sale of building.
Answer:
D LO: 4 Type: RC
35. A company's cash flows from income taxes are
normally affected by:
A. revenues.
B. operating expenses.
C. gains on the sale of assets.
D. losses on the sale of assets.
E. all of the above.
Answer:
E LO: 4 Type: RC
36. Consider the following statements about taxes
and after-tax cash flows:
I.
Capital
budgeting analyses should incorporate after-tax cash flows rather than
before-tax cash flows.
II.
Added
company revenues will result in lower taxes for a firm.
III.
Operating
expenses may actually provide a tax benefit for an organization.
Which
of the above statements is (are) correct?
A. I only.
B. II only.
C. III only.
D. I and II.
E. I and III.
Answer:
E LO: 4 Type: RC, N
37. 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)].
Answer:
D LO: 4 Type: N
38. 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.
Answer:
C LO: 4 Type: N
39. Assume that a capital project is being
analyzed by a discounted-cash-flow approach, and an employee first assumes no
income taxes and then later assumes a 30% income tax rate. How would depreciation expense be
incorporated in the analysis?
|
|
No Income Taxes
|
|
30% Income
Tax Rate
|
|
|
A.
|
Considered
|
|
Considered
|
|
|
B.
|
Considered
|
|
Ignored
|
|
|
C.
|
Ignored
|
|
Considered
|
|
|
D.
|
Ignored
|
|
Ignored
|
|
|
E.
|
The correct
answer depends on the depreciation method that is used.
|
|||
Answer:
C LO: 4 Type: N
40. 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.
Answer:
B LO: 4 Type: RC
41. When income taxes are considered in capital
budgeting, the cash flows related to a company's depreciation expense would be
correctly figured by taking the cash paid for depreciation and:
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 none of the above because there is no
cash paid for depreciation.
Answer:
E LO: 4 Type: N
42. Jester plans to generate $650,000 of sales
revenue if a capital project is implemented.
Assuming a 30% tax rate, the sales revenue should be reflected in the
analysis by a:
A. $195,000 inflow.
B. $195,000 outflow.
C. $455,000 inflow.
D. $455,000 outflow.
E. $650,000 inflow.
Answer:
C LO: 4 Type: A
43. Highlander Company plans to incur $350,000 of
salaries expense if a capital project is implemented. Assuming a 30% tax rate, the salaries should
be reflected in the analysis by a:
A. $105,000 inflow.
B. $105,000 outflow.
C. $245,000 inflow.
D. $245,000 outflow.
E. $350,000 outflow.
Answer:
D LO: 4 Type: A
44. Penn Company plans to incur $180,000 of
salaries expense and produce $300,000 of additional sales revenue if a capital
project is implemented. Assuming a 30%
tax rate, these two items collectively should appear in a capital budgeting
analysis as:
A. a $36,000 inflow.
B. a $36,000 outflow.
C. an $84,000 inflow.
D. an $84,000 outflow.
E. some other amount.
Answer:
C LO: 4
Type: A
45. Brookside Company has $70,000 of depreciation
expense and is subject to a 30% income tax rate. On an after-tax basis, depreciation results
in a:
A. $21,000 inflow.
B. $21,000 outflow.
C. $49,000 inflow.
D. $49,000 outflow.
E. neither an inflow nor an outflow because
depreciation is a noncash expense.
Answer:
A LO: 4 Type: A
46. Crossland Company is studying a capital
project that will produce $600,000 of added sales revenue, $400,000 of
additional cash operating expenses, and $50,000 of depreciation. Assuming a 30% income tax rate, the company's
after-tax cash inflow (outflow) is:
A. $105,000.
B. $125,000.
C. $155,000.
D. $175,000.
E. some other amount.
Answer: C LO: 4
Type: A
47. Which of the following is the proper
calculation of a company's depreciation tax shield?
A. Depreciation ÷ tax rate.
B. Depreciation ÷ (1 - tax rate).
C. Depreciation x tax rate.
D. Depreciation x (1 - tax rate).
E. Depreciation deduction + income taxes.
Answer:
C LO: 4 Type: RC
48. A depreciation tax shield is a(n):
A. after-tax cash outflow.
B. increase in income tax.
C. noncash factor.
D. reduction in income tax.
E. sporadic fluctuation in income tax.
Answer:
D LO: 4 Type: RC
49. Consider the following statements about
depreciation tax shields:
I.
A
depreciation tax shield provides distinct benefits to a business.
II.
A
depreciation tax shield should be ignored when doing a net-present-value
analysis.
III.
A
depreciation tax shield can occur in more than one year.
Which
of the above statements is (are) correct?
A. I only.
B. II only.
C. III only.
D. I and II.
E. I and III.
Answer:
E LO: 4 Type: RC
50. A company that uses accelerated depreciation:
A. would write off a larger portion of an
asset's cost sooner than under the straight-line method.
B. would find that depreciation speeds up, with
a small portion taken in early years and larger amounts taken in later years.
C. would find that more tax benefits occur
earlier than under the straight-line method.
D. would find itself out of compliance with
generally accepted accounting principles (GAAP).
E. would find that choices "A" and
"C" are true.
Answer:
E LO: 4 Type: RC
51. David Company 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?
|
|
When Majority
of Depreciation
is Taken
|
|
When Majority
of Tax Savings
Occur
|
|
Depreciation
Method
With Higher
Present
Value
|
|
A.
|
Early in
life
|
|
Early in
life
|
|
Accelerated
|
|
B.
|
Early in
life
|
|
Early in
life
|
|
Straight-line
|
|
C.
|
Early in
life
|
|
Late in
life
|
|
Straight-line
|
|
D.
|
Late in
life
|
|
Late in
life
|
|
Straight-line
|
|
E.
|
Late in
life
|
|
Early in
life
|
|
Accelerated
|
Answer:
A LO: 4 Type: RC, N
52. Julie Company purchased a $200,000 machine
that has a four-year life and no salvage value.
The company uses straight-line depreciation on all asset acquisitions
and is subject to a 30% tax rate. The
proper cash flow to show in a discounted-cash-flow analysis as occurring at
time 0 would be:
A. $(200,000).
B. $(140,000).
C. $(35,000).
D. $15,000.
E. $50,000.
Answer: A LO: 4
Type: A
53. If a company desires to be in compliance with
current income tax law and write off the cost of its assets rapidly, the firm
would use:
A. straight-line depreciation.
B. sum-of-the-years'-digits depreciation.
C. accelerated depreciation.
D. the Modified Accelerated Cost Recovery System
(MACRS).
E. annuity depreciation.
Answer:
D LO: 5 Type: RC
54. The Modified Accelerated Cost Recovery System
(MACRS) assumes that, on average, assets will be placed in service:
A. at the beginning of the tax year.
B. three months into the tax year.
C. halfway through the tax year.
D. at the end of the tax year.
E. in the next tax year.
Answer:
C LO: 5 Type: RC
55. A company used the net-present-value method
to analyze an investment and found the investment to be very attractive. If the firm used straight-line depreciation
and changes to the Modified Accelerated Cost Recovery System (MACRS), the
investment's net present value will:
A. increase.
B. remain the same.
C. decrease.
D. change, but the direction cannot be
determined based on the data presented.
E. fluctuate in an erratic manner.
Answer:
A LO: 5 Type: N
56. 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.
Answer: D LO: 6
Type: A
57. Ralston Company received $7,000 cash from the
sale of a machine that had an $11,000 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. $2,100.
B. $4,900.
C. $5,800.
D. $7,000.
E. $8,200.
Answer:
E LO: 6 Type: A
58. A machine was sold in December 20x3 for $9,000. It was purchased in January 20x1 for $15,000,
and depreciation of $12,000 was recorded from the date of purchase through 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.
Answer:
B LO: 6 Type: A
59. Rogers Company purchased equipment for
$30,000 in December 20x1. The equipment
is expected to generate $10,000 per year of additional revenue and incur $2,000
per year of additional cash expenses, beginning in 20x2. Under MACRS, depreciation in 20x2 will be
$3,000. If the firm's income tax rate is
40%, the after-tax cash flow in 20x2 would be:
A. $3,200.
B. $3,600.
C. $4,800.
D. $6,000.
E. some other amount.
Answer:
D LO: 6 Type: A
Use the
following to answer questions 60-61:
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.
60. The loss on disposal would be:
A. $350.
B. $500.
C. $650.
D. $2,500.
E. none, because the transaction produced a
gain.
Answer:
B LO: 6 Type: A
61. The net after-tax cash flow of the disposal is:
A. $2,100.
B. $2,350.
C. $2,500.
D. $2,650.
E. some other amount.
Answer:
D LO: 6 Type: A
62. Wright Company is considering a five-year
project that requires a typical investment in working capital, in this case,
$100,000. Consider the following
statements about this situation:
I.
Wright
should include a $100,000 outflow that occurs at time 0 in a
discounted-cash-flow analysis.
II.
Wright
should include separate $100,000 outflows in each year of the project's
five-year life.
III.
Wright
should include a $100,000 recovery of its working-capital investment in year 5
of a discounted-cash-flow analysis.
Which
of the above statements is (are) correct?
A. I only.
B. II only.
C. III only.
D. I and II.
E. I and III.
Answer:
E LO: 6 Type: RC
63. A machine is expected to produce annual
savings in cash operating costs of $400,000 for the next six years. If the firm 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. $1,742,000.
E. some other amount.
Answer:
C LO: 6 Type: A
64. A machine is expected to produce increases in
cash operating costs of $200,000 for the next six years. If the firm has a 14% after-tax hurdle rate
and is subject to a 30% income tax rate, the correct discounted net cash flow
would be:
A. $(233,340).
B. $(544,460).
C. $(777,800).
D. $(1,011,140).
E. some other amount.
Answer:
B LO: 6 Type: A
65. A new machine is expected to produce a MACRS
deduction in three years of $50,000. If
the firm has a 12% after-tax hurdle rate and is subject to a 30% income tax
rate, the correct discounted net cash flow to include in an acquisition
analysis would be:
A. $0.
B. $10,680.
C. $24,920.
D. $46,280.
E. some other amount.
Answer:
B LO: 6 Type: A
66. In 10 years, Hopkins Company plans to receive
$9,000 cash from the sale of a machine that has a $5,000 book value. If the company is subject to a 30% income tax
rate and has an 8% after-tax hurdle rate, the correct discounted net cash flow
would be:
A. $2,916.90.
B. $3,611.40.
C. $4,167.00.
D. $4,722.60.
E. some other amount.
Answer:
B LO: 6 Type: A
67. In eight years, Larson Company plans to
receive $11,000 cash from the sale of a machine that has a $16,000 book
value. If the company is subject to a
30% income tax rate and has a 12% after-tax hurdle rate, the correct discounted
net cash flow would be:
A. $606.
B. $1,414.
C. $3,838.
D. $5,050.
E. some other amount.
Answer:
D LO: 6 Type: A
68. Which of the following tools is sometimes
used to rank investment proposals?
A. Profitability index.
B. Annuity index.
C. Project assessment guide (PAG).
D. Investment opportunity index.
E. Capital ranking index.
Answer:
A LO: 7 Type: RC
69. 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. none of the above, because the net present
value cannot be gauged by the profitability index.
E. the proposal should be rejected.
Answer:
B LO: 7 Type: N
70. St. Andrews ranks investments by using the
profitability index (PI). The following
data relate to Project X and Project Y:
|
|
Project X
|
|
Project Y
|
||
|
Initial investment
|
$400,000
|
$1,300,000
|
|||
|
Present value of inflows
|
600,000
|
1,800,000
|
|||
Which
project would be more attractive as judged by its ranking, and why?
A. Project X because the PI is 1.50.
B. Project Y because the PI is 1.38.
C. Project X because the PI is 0.67.
D. Project Y because the PI is 0.72.
E. Both projects would be equally attractive in
terms of ranking, as indicated by a positive PI.
Answer:
A LO: 7 Type: A
71. Wakefield evaluates future projects by using
the profitability index. The company is
currently reviewing five similar projects and must choose one of the following:
|
Project
|
|
Initial
Investment
|
|
Present Value
of Cash
Inflows
|
||
|
1
|
|
$100,000
|
|
$ 97,000
|
||
|
2
|
|
50,000
|
|
80,000
|
||
|
3
|
|
75,000
|
|
110,000
|
||
|
4
|
|
60,000
|
|
100,000
|
||
|
5
|
|
150,000
|
|
200,000
|
||
Which
project should Wakefield select if the decision is based entirely on the
profitability index?
A. Project 1.
B. Project 2.
C. Project 3.
D. Project 4.
E. Project 5.
Answer:
D LO: 7 Type: A
72. 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.
Answer:
A LO: 8 Type: RC
73. Consider the following statements about the
payback period:
I.
As
shown in your text, the payback period considers the time value of money.
II.
The
payback period can only be used if net cash inflows are uniform throughout a
project's life.
III.
The
payback period ignores cash inflows that occur after the payback period is
reached.
Which
of the above statements is (are) correct?
A. I only.
B. II only.
C. III only.
D. I and II.
E. I, II, and III.
Answer:
C LO: 8 Type: RC
74. A piece of equipment costs $30,000, and is
expected to generate $8,500 of annual cash revenues and $1,500 of annual cash
expenses. The disposal value at the end
of the estimated 10-year life is $3,000.
Ignoring income taxes, the payback period is:
A. 3.53 years.
B. 3.86 years.
C. 4.29 years.
D. 6.98 years.
E. some other period of time not noted above.
Answer:
C LO: 8 Type: A
75.
Portland is
considering the acquisition of new machinery that will produce uniform benefits
over the next eight years. The following
information is available:
Annual savings in cash operating costs: $350,000
Annual depreciation expense: $250,000
If the company is subject to a 30% tax rate, what
denominator should be used to compute the machinery's payback period?
A.
$70,000.
B.
$170,000.
C.
$245,000.
D.
$320,000.
E.
Some other amount.
Answer: D LO:
8 Type: A, N
76. Pinecrest is considering a $600,000
investment in new equipment that is anticipated to produce the following net
cash inflows:
|
Year
|
|
Net Cash Inflows
|
|
|
1
|
|
$120,000
|
|
|
2
|
|
250,000
|
|
|
3
|
|
110,000
|
|
|
4
|
|
80,000
|
|
|
5
|
|
160,000
|
|
If
cash flows occur evenly throughout a year, the equipment's payback period is:
A. 4 years, 2 months.
B. 4 years, 3 months.
C. 4 years, 4 months.
D. 5 years.
E. some other period of time not noted above.
Answer:
B LO: 8 Type: A, N
77. Which of the following project evaluation
methods focuses on accounting income rather than cash flows?
A. Net present value.
B. Accounting rate of return.
C. Internal rate of return.
D. Payback period.
E. None of the above.
Answer:
B LO: 8
Type: RC
78. The accounting rate of return focuses on the:
A. total accounting income over a project's
life.
B. average 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.
Answer:
B LO: 8 Type: RC
79.
Which of the
following choices correctly depicts whether discounted cash flows are used by
the method noted when evaluating long-term investments?
|
|
Net
Present Value
|
|
Internal Rate
of Return
|
|
Accounting
Rate of Return
|
|
A.
|
No
|
|
No
|
|
Yes
|
|
B.
|
Yes
|
|
No
|
|
Yes
|
|
C.
|
Yes
|
|
No
|
|
No
|
|
D.
|
Yes
|
|
Yes
|
|
No
|
|
E.
|
Yes
|
|
Yes
|
|
Yes
|
Answer: D LO:
8 Type: RC
80. Consider the following statements about the
accounting rate of return:
I.
The
accounting rate of return focuses on a project's income rather than its cash
flows.
II.
Companies
can figure the accounting rate of return on either the initial investment
figure or an average investment figure.
III.
The
accounting rate of return considers the time value of money.
Which
of the above statements is (are) correct?
A. I only.
B. II only.
C. III only.
D. I and II.
E. II and III.
Answer:
D LO: 8 Type: RC
81. Mulligan Corporation, which is subject to a
30% income tax rate, is considering a $150,000 asset that will result in the
following over its seven-year life:
Total
revenue: $1,190,000
Total
operating expenses (excluding depreciation): $770,000
Total
depreciation: $150,000
The
accounting rate of return on the initial investment is:
A. 16%.
B. 18%.
C. 26%.
D. 28%.
E. some other figure.
Answer:
B LO: 8 Type: A
82. San Remo has a $4,000,000 asset investment
and is subject to a 30% income tax rate.
Cash inflows are expected to average $600,000 before tax over the next
few years; in contrast, average income before tax is anticipated to be
$500,000. The company's accounting rate
of return is:
A. 8.75%.
B. 10.50%.
C. 12.50%.
D. 15.00%
E. some other figure.
Answer:
A LO: 8 Type: A
83. When making investment decisions that involve
advanced manufacturing systems, the use of net present value:
A. presents no special problems for the analyst.
B. often gives rise to net-present-value figures
that are negative despite a manager's belief that the investment is beneficial
for the firm.
C. is not recommended.
D. often omits a number of factors that are
difficult to quantify (e.g., greater manufacturing flexibility, improved
product quality, and so forth).
E. is characterized by choices "B"
and "D" above.
Answer:
E LO: 9 Type: RC
84. 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.
Answer:
A LO: 9 Type: RC, N
85. A cash flow measured in nominal dollars is:
A. the actual cash flow that we experience.
B. the adjustment for a change in the dollar's
purchasing power.
C. the discounted cash flow.
D. the realistic cash flow after taxes.
E. none of the above.
Answer:
A LO: 10 Type: RC
86. A cash flow measured in real dollars:
A. is the actual cash flow that we experience.
B. is the actual cash flow adjusted for a change
in the dollar's purchasing power.
C. is discounted to reflect the time value of
money.
D. equals the cash flow measured in nominal
dollars.
E. coincides with the amount of contemplated
new investment.
Answer:
B LO: 10 Type: RC
87. Consider the following statements about the
accounting for inflation in a capital budgeting analysis:
I.
An
analyst can use nominal dollars in conjunction with a nominal interest rate.
II.
An
analyst can use real dollars in conjunction with a real interest rate.
III.
An
analyst can use nominal dollars in conjunction with a real interest rate.
Which
of the above statements is (are) correct?
A. I only.
B. II only.
C. III only.
D. I and II.
E. II and III.
Answer:
D LO: 10 Type: RC
exercises
Net Present Value
88. Green is considering the replacement of some
machinery that has zero book value and a current market value of $2,800. One possible alternative is to invest in new
machinery that costs $30,000. The new
equipment has a four-year service life and an estimated salvage value of $3,500,
will produce annual cash operating savings of $9,400, and will require a $2,200
overhaul in year 3. The company uses
straight-line depreciation.
Required:
Prepare
a net-present-value analysis of Green's replacement decision, assuming an 8%
hurdle rate and no income taxes. Should
the machinery be acquired? Note: Round
calculations to the nearest dollar.
LO: 1 Type: A
Answer:
|
Purchase of
new machine
|
$(30,000) x
1.0
|
$(30,000)
|
|
Sale of old
machine
|
$2,800 x 1.0
|
2,800
|
|
Cash
operating savings
|
$9,400 x 3.312
|
31,133
|
|
Overhaul
|
$(2,200) x
0.794
|
(1,747)
|
|
Salvage value
|
$3,500 x 0.735
|
2,573
|
|
Total
|
|
$ 4,759
|
The machinery should be acquired
because the investment has a positive net present value.
Determination of Cash Flows; Net Present
Value
89. On January 2, 20x1, Rebecca Brown purchased
800 shares of Bazooka Telecommunications 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, 20x2.
Rebecca sold her entire investment on December 30, 20x2, generating a
$5,000 gain on the sale of stock.
Required:
A. Prepare a dated listing of the cash
inflows and outflows related to Rebecca's stock investment. Ignore income taxes.
B. Assume that Rebecca has a 10% hurdle rate
for all investments. Rounding to the
nearest dollar, compute the net present value of her investment in Bazooka and
determine whether she achieved her 10% goal.
LO: 1 Type: A, N
Answer:
|
A.
|
January 2, 20x1
|
Purchase (800 shares x
$35)
|
$(28,000)
|
||||
|
|
December 28, 20x1
|
Dividend (800 shares x
$1.50)
|
1,200
|
||||
|
|
December 28, 20x2
|
Dividend (800 shares x
$2.00)
|
1,600
|
||||
|
|
December 30, 20x2
|
Sale ($28,000 + $5,000)
|
33,000
|
||||
|
B.
|
Rebecca achieved her
goal, as indicated by the positive net present value.
|
||||||
|
|
Purchase
of shares
|
$(28,000)
x 1.0
|
$(28,000)
|
||||
|
|
Dividend,
20x1
|
$1,200
x 0.909
|
1,091
|
||||
|
|
Dividend,
20x2
|
$1,600
x 0.826
|
1,322
|
||||
|
|
Sale
of shares
|
$33,000
x 0.826
|
27,258
|
||||
|
|
Total
|
|
$ 1,671
|
||||
Net Present Value, Outsourcing
90. Mark Industries is currently purchasing part
no. 76 from an outside supplier for $80 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 six years is expected to total 300,000 units at variable manufacturing
costs of $75 per unit.
Mark must acquire $80,000 of new
equipment if it reopens the plant. The
equipment has a six-year service life and a $14,000 salvage value, and will be
depreciated by the straight-line method.
Repairs and maintenance are expected to average $5,200 per year in years
4-6, 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% hurdle rate to
determine whether Mark should make or buy part no. 76. Ignore income taxes.
LO: 1,
3 Type: A
Answer:
|
Mark is
better off to make part no. 76.
|
|
Buy:
|
|
|
|
Purchase (300,000 units x $80)
|
$(24,000,000) x 4.111
|
$(98,664,000)
|
|
|
|
|
|
Make:
|
|
|
|
Variable manufacturing costs
(300,000 units x $75)
|
$(22,500,000) x 4.111
|
$(92,497,500)
|
|
New equipment
|
$(80,000) x 1.0
|
(80,000)
|
|
Repairs and maintenance
|
$(5,200) x (4.111 - 2.402)
|
(8,887)
|
|
Equipment sale
|
$14,000 x 0.507
|
7,098
|
|
Total
|
|
$(92,579,289)
|
Evaluation of an Investment Analysis
91. The Airways Company 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, an accountant prepared the following analysis:
|
Annual net
cash inflow
|
|
|
$ 75,000
|
|
Annual
depreciation
|
$45,000
|
|
|
|
Annual
average cost of overhaul
|
8,333
|
|
(53,333)
|
|
Average annual
income
|
|
$ 21,667
|
|
|
Return on
investment = $21,667 ÷ $280,000 = 7.74%
|
|||
The accountant 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.
LO: 1 Type: A, N
Answer:
|
A.
|
The
accountant is focusing on income rather than cash flows. The cash flows should be discounted to
reflect the time value of money, and depreciation should be omitted because
of the absence of taxes.
|
||||
|
B.
|
Purchase
price
|
$(280,000) x
1.0
|
$(280,000)
|
||
|
|
Annual net
cash inflows
|
$75,000 x
4.111
|
308,325
|
||
|
|
Overhaul
|
$(50,000) x
0.636
|
(31,800)
|
||
|
|
Salvage value
|
$10,000 x
0.507
|
5,070
|
||
|
|
Total
|
|
$ 1,595
|
||
|
|
The project
should be accepted because the net present value is positive.
|
||||
|
C.
|
The net
present value is positive using a discount rate of 12%. Thus, the internal rate of return is greater
than 12%.
|
||||
Net Present Value, Internal Rate of
Return
92. Harrison Township is studying a 700-acre site
for a new landfill. The new site will
save $70,000 in annual operating costs for 10 years, as Harrison currently uses
the landfill of a neighboring municipality.
Other data are:
Purchase
price per acre: $550
Site
preparation costs: $110,000
Hurdle
rate: 6%
Ignore
income taxes.
Required:
A. Use the net-present-value method and
determine whether the landfill should be acquired.
B. Determine the landfill's approximate
internal rate of return.
LO: 1 Type: A
Answer:
|
A.
|
Purchase
price (700 x $550)
|
$(385,000) x
1.0
|
$(385,000)
|
|
|
|
Site
preparation
|
$(110,000) x
1.0
|
(110,000)
|
|
|
|
Savings in
operating costs
|
$70,000 x
7.360
|
515,200
|
|
|
|
Total
|
|
$ 20,200
|
|
|
|
Yes, the
landfill should be acquired because it has a positive net present value.
|
|||
|
B.
|
Let X =
present value factor
$70,000X =
($385,000 + $110,000)
X = 7.071
A review of
annuity factors for 10 years finds an internal rate of return that falls
between 6% (7.360) and 8% (6.710).
|
|||
Overview
of the Internal Rate of Return
93. 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.
LO: 1 Type: A, N
Answer:
A.
The
internal rate of return is the true economic yield on a project, taking the
time value of money into consideration.
B.
At
the internal rate of return, the present value of the cash inflows equals the
present value of the cash outflows.
Thus, the net present value is zero.
C.
$149,040
÷ $45,000 = 3.312, which corresponds with the factor of an 8% return on a
four-year project.
Cash-Flow Determination; Tax-Free and Tax Environments
94.
Simon Company is
considering a $5.4 million asset investment that has a four-year service life
and a $400,000 salvage value. The
investment is expected to produce annual savings in cash operating costs of
$860,000 and will require a $250,000
overhaul in year 3, which is fully-deductible for tax purposes.
Simon uses the net-present-value method to analyze
investments. Asset investments are
depreciated by the straight-line method, ignoring salvage values in related
computations.
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 3, and (5) disposal of the asset in year 4. Note cash outflows in parentheses.
B.
Repeat
requirement "A," assuming the company is subject to a 30% income tax
rate.
LO: 2, 4, 6
Type: A
Answer:
A.
Asset
acquisition: $(5,400,000)
Annual savings in cash operating costs: $860,000
Annual straight-line depreciation: $0
Year 3 overhaul: $(250,000)
Year 4 asset disposal: $400,000
B.
Asset
acquisition: $(5,400,000)
Annual savings in cash operating costs: $860,000 x 0.7
= $602,000
Annual straight-line depreciation: $5,400,000 ÷ 4
years = $1,350,000; $1,350,000 x 0.3 = $405,000
Year 3 overhaul: $(250,000) x 0.7 = $(175,000)
Year 4 asset disposal: $5,400,000 - $5,400,000
accumulated depreciation = $0 book value; $0 book value - $400,000 salvage
value = $400,000 gain; $400,000 gain x 0.3 = $(120,000) added tax; $400,000
salvage value - $(120,000) added tax = $280,000
Depreciation as a Tax
Shield, MACRS, Discounted Cash Flow
95. Smith Corporation recently purchased a
$1,200,000 asset that has a three-year service life and no salvage value. The company is subject to a 30% income tax
rate and employs a 12% after-tax hurdle rate in capital investment decisions.
Management
is studying whether to depreciate the asset by using the straight-line method
or the Modified Accelerated Cost Recovery System (MACRS). Assume that the following MACRS factors are
in effect: year 1, 33%; year 2, 45%; year 3, 15%; and year 4, 7%
Required:
A.
Calculate
the total depreciation expense that will be taken by each of the methods under
consideration.
B.
Calculate
the total tax savings that will occur with each method.
C.
On
the basis of your calculations in part "B," which of the two methods
will management likely prefer? Explain
your answer.
D.
Calculate
the present value of the tax savings under each method. Round to the nearest dollar.
LO: 4, 5,
6 Type: A, N
Answer:
|
A.
|
Both
methods will result in the total asset cost of $1,200,000 being written off
as depreciation expense.
|
|||
|
B.
|
Straight-line:
$1,200,000 ÷ 3 years = $400,000 per
year; $400,000 x 0.30 = $120,000 annual tax
savings, or $360,000 over the asset's
entire life.
|
|||
|
|
MACRS:
|
|||
|
|
Year 1: $1,200,000 x 0.33 x 0.30
|
$118,800
|
||
|
|
Year 2: $1,200,000 x 0.45 x 0.30
|
162,000
|
||
|
|
Year 3: $1,200,000 x 0.15 x 0.30
|
54,000
|
||
|
|
Year 4: $1,200,000 x 0.07 x 0.30
|
25,200
|
||
|
|
|
$360,000
|
||
|
C.
|
Although
the total dollar amounts are the same, the timing differs, with MACRS
producing greater savings in the earlier part of the asset's life. These dollar savings can be reinvested by
the business to generate additional returns, as verified by the present value
calculations in requirement "D."
|
|||
|
D.
|
Straight-line:
|
|
||
|
|
$120,000 x 2.402
|
$288,240
|
||
|
|
|
|
||
|
|
MACRS:
|
|
||
|
|
Year 1:
$118,800 x 0.893
|
$106,088
|
||
|
|
Year 2: $162,000 x 0.797
|
129,114
|
||
|
|
Year 3: $54,000 x 0.712
|
38,448
|
||
|
|
Year 4: $25,200 x 0.636
|
16,027
|
||
|
|
|
$289,677
|
||
Cash Flows Related to Asset Ownership, Discounted Cash Flow, Taxes
96. Morgan Corporation plans to purchase $1.5
million of equipment in the not-too-distant future. The equipment will have a $300,000 salvage
value and will be depreciated over a six-year service life by the straight-line
method. Morgan is subject to a 40%
income tax rate.
The
company's accountant is about to perform a net-present-value analysis, assuming
a 12% 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 Morgan sells the equipment for only $250,000 because of a recent
change in market conditions.
LO: 4,
6 Type: A
Answer:
|
A.
|
Year 0:
$(1,500,000) x 1.0 = $(1,500,000)
Year 1:
($1,500,000 - $300,000) ÷ 6 years = $200,000; $200,000 x 0.40 x 0.893 =
$71,440
|
||
|
B.
|
Cost
|
$1,500,000
|
|
|
|
Less:
Accumulated depreciation
|
1,200,000
|
|
|
|
Book value
|
$ 300,000
|
|
|
|
Selling price
|
250,000
|
|
|
|
Loss on sale
|
$ 50,000
|
|
|
|
|
|
|
|
|
Proceeds from
sale
|
$ 250,000
|
|
|
|
Tax savings
on loss: $50,000 x 0.40
|
20,000
|
|
|
|
Total cash
flow
|
$ 270,000
|
|
|
|
|
|
|
|
|
Discounted
cash flow: $270,000 x 0.507
|
$ 136,890
|
|
Determination of Cash Flows; Discounting; Taxes
97. 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.
LO: 4,
6 Type: A
Answer:
1. $(600,000) x 1.0 =
$(600,000)
2. $20,000 x 0.30 = $6,000;
$6,000 x 0.826 = $4,956
3. $50,000 x 0.70 =
$35,000; $35,000 x 5.335 = $186,725
4. $35,000
- $25,000 = $10,000 gain; $10,000 x 0.30 = $3,000 tax; $35,000 - $3,000 = $32,000;
$32,000 x 0.564 = $18,048
5. $(6,000) x 0.70 =
$(4,200); $(4,200) x 0.621 = $2,608
Net Present Value, Taxes
98. The Warren Machine Tool Company is
considering the addition of a computerized lathe to its equipment
inventory. The initial cost of the
equipment is $600,000, and the lathe is expected to have a useful life of five
years and no salvage value. The cost
savings and increased capacity attributable to the machine are estimated to
generate increases in the firm's annual cash inflows (before considering
depreciation) of $180,000. The machine
will be depreciated as follows for tax purposes: $200,000 in year 1, $266,700
in year 2, $88,860 in year 3, and $44,440 in year 4.
Warren
is currently in the 40% income tax bracket.
A 10% after-tax rate of return is desired.
Required:
A.
What
is the net present value of the investment?
Round to the nearest dollar.
B.
Should
the machine be acquired by the firm?
C.
Assume
that the equipment will be sold at the end of its useful life for
$100,000. If the depreciation amounts
are not revised, calculate the dollar impact of this change on the total net
present value.
LO: 4, 5,
6 Type: A, N
Answer:
|
A.
|
Purchase
price
|
$(600,000) x
1.0
|
$(600,000)
|
||||
|
|
Increases in
cost savings
and
capacity
|
$180,000 x
0.60 x 3.791
|
409,428
|
||||
|
|
MACRS:
|
|
|
||||
|
|
Year 1
|
$200,000 x
0.40 x 0.909
|
72,720
|
||||
|
|
Year 2
|
$266,700 x
0.40 x 0.826
|
88,118
|
||||
|
|
Year 3
|
$88,860 x
0.40 x 0.751
|
26,694
|
||||
|
|
Year 4
|
$44,440 x
0.40 x 0.683
|
12,141
|
||||
|
|
Total
|
|
$ 9,101
|
||||
|
B.
|
Yes, the
machine should be acquired because it has a positive net present value.
|
||||||
|
C.
|
Cost
|
$600,000
|
|||||
|
|
Less:
Accumulated depreciation
|
600,000
|
|||||
|
|
Book value
|
$ --
|
|||||
|
|
Selling price
|
100,000
|
|||||
|
|
Gain on sale
|
$100,000
|
|||||
|
|
|
|
|||||
|
|
Proceeds from
sale
|
$100,000
|
|||||
|
|
Less: Tax on
gain ($100,000 x 0.40)
|
40,000
|
|||||
|
|
Total cash
flow
|
$ 60,000
|
|||||
|
|
|
|
|||||
|
|
Discounted
cash flow: $60,000 x 0.621
|
$ 37,260
|
|||||
|
|
|
|
|||||
|
|
The net
present value will increase by $37,260.
|
||||||
Net
Present Value, Taxes
99. 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.
LO: 3, 4,
6 Type: A
Answer:
|
Worrell is better off to make
part no. 456.
|
|||||
|
Buy:
|
|
|
|
|
|
|
Purchase (400,000 units x $90 x 0.70)
|
|
$(25,200,000) x 3.605
|
|
$(90,846,000)
|
|
|
Make:
|
|
|
|
|
|
|
Variable manufacturing costs (400,000 units x $88 x 0.70)
|
|
$(24,640,000) x 3.605
|
|
$(88,827,200)
|
|
|
New equipment
|
|
$(200,000) x 1.0
|
|
(200,000)
|
|
|
Depreciation ($200,000 ÷ 5 years = $40,000; $40,000 x
0.30)
|
|
$12,000 x 3.605
|
|
43,260
|
|
|
Maintenance ($12,000 x 0.70)
|
|
$8,400 x 0.636
|
|
(5,342)
|
|
|
Equipment sale ($20,000 - $0 book value = $20,000 gain;
$20,000 x 0.30 = $6,000 tax; $20,000 - $6,000)
|
|
$14,000 x 0.567
|
|
7,938
|
|
|
Total
|
|
|
|
$(88,981,344)
|
|
Net
Present Value, Internal Rate of Return, Payback, Taxes
100.
Wexler
Corporation is considering the acquisition of a new machine that costs
$350,000. The machine is expected to
have a four-year service life and will produce annual savings in cash operating
costs of $100,000. Wexler uses
straight-line depreciation, is subject to a 30% income tax rate, has an
after-tax hurdle rate of 12%, 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" totaled $110,410, 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.
LO: 2, 3, 4, 8
Type: RC, A
Answer:
|
A.
|
Cash operating costs: $100,000 x
0.7 = $70,000
Depreciation tax savings: $350,000 ÷ 4 years =
$87,500; $87,500 x 0.3 = $26,250
|
||||
|
B.
|
1.
|
Initial
investment
Annual cash inflows
Net present value
|
$(350,000) x 1.0
$110,410 x 3.037
|
$(350,000)
335,315
$ (14,685)
|
|
|
|
2.
3.
|
The machine is not
considered an attractive investment because it has a negative net present
value.
$350,000
÷ $110,410 = 3.170, which corresponds with the factor of a 10% return on a
four-year project. Given the hurdle
rate of 12%, the machine is not considered an attractive investment.
$350,000 ÷ $110,410 = 3.17 years
|
|||
Payback, Accounting Rate of Return, Net Present Value
101. 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.
|
Year
|
|
Initial Cost and
Book Value
|
|
Yearly After-Tax Net
Cash Inflows
|
|
Yearly Net Income
|
|
1
|
|
$35,000
|
|
$20,000
|
|
$ 2,500
|
|
2
|
|
21,000
|
|
17,500
|
|
3,500
|
|
3
|
|
10,500
|
|
15,000
|
|
4,500
|
|
4
|
|
3,500
|
|
12,500
|
|
5,500
|
|
5
|
|
----
|
|
10,000
|
|
6,500
|
|
|
|
|
|
$75,000
|
|
$22,500
|
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.
LO: 6,
8 Type: A
Answer:
|
A.
|
The
project's payback is 3 years. By the
conclusion of this time period, Ivory will have recovered the investment's
cost of $52,500 ($20,000 + $17,500 + $15,000 = $52,500).
|
||
|
B.
|
The
accounting rate of return is 8.6%:
Average income ($22,500 ÷ 5 years = $4,500) ÷ initial
investment ($52,500)
|
||
|
C.
|
Year 0:
$(52,500) x 1.0
|
$(52,500)
|
|
|
|
Year 1:
$20,000 x 0.877
|
17,540
|
|
|
|
Year 2:
$17,500 x 0.769
|
13,458
|
|
|
|
Year 3:
$15,000 x 0.675
|
10,125
|
|
|
|
Year 4:
$12,500 x 0.592
|
7,400
|
|
|
|
Year 5:
$10,000 x 0.519
|
5,190
|
|
|
|
|
$ 1,213
|
|
Payback, Accounting Rate of Return, Net Present Value, Cash-Flow
Determination
102. 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.
LO: 4, 6,
8 Type: A
Answer:
|
A.
|
Depreciation: $100,000 ÷ 5 years = $20,000
Annual after-tax cash flows: ($30,000 x 0.70) + ($20,000 x 0.30) = $27,000
Payback: $100,000 ÷ $27,000 = 3.7 years
|
|||
|
B.
|
Average income: ($30,000 - $20,000) x 0.70 = $7,000
Accounting rate of return: $7,000 ÷ $100,000 = 7%
|
|||
|
C.
|
Initial investment
|
$(100,000) x 1.0
|
$(100,000)
|
|
|
|
Savings in operating costs
|
$21,000 x 3.993
|
83,853
|
|
|
|
Depreciation tax savings
|
$6,000 x 3.993
|
23,958
|
|
|
|
Net present value
|
|
$ 7,811
|
|
Payback, Accounting Rate of Return
103. Custard Treats, which sells frozen custard
and sandwiches, is considering a new site that will require a $1 million
investment for land acquisition and construction costs. The following operating results are expected:
|
Sales revenue
|
|
$620,000
|
|
Less operating expenses:
|
|
|
|
Food & supplies
|
$210,000
|
|
|
Wages & salaries
|
180,000
|
|
|
Insurance & taxes
|
20,000
|
|
|
Utilities
|
10,000
|
|
|
Depreciation
|
50,000
|
470,000
|
|
Operating income
|
|
$150,000
|
Disregard
income taxes.
Required:
A.
If
management requires a payback period of four 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?
LO: 8 Type: A, N
Answer:
A.
Annual
net cash inflows: $620,000 - ($470,000 - $50,000) = $200,000
Payback: $1,000,000 ÷ $200,000 = 5 years
No,
because the payback fails to meet management's guideline.
B.
$150,000
÷ $1,000,000 = 15%
C.
Payback
and the accounting rate of return ignore the time value of money, which is the
foundation of the net-present-value method.
DISCUSSION QUESTIONS
Comparisons Between Net
Present Value and the Internal Rate of Return
104. 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.
LO: 2 Type: RC
Answer:
A.
In
the NPV method, cash flows are assumed to be reinvested at the hurdle rate.
With the IRR, cash flows are assumed to be reinvested at the same rate as the
project's return.
B. In the NPV method, a higher hurdle rate
can be used, either for the entire analysis or for the estimated cash inflows
(savings) that occur late in the project's life.
Postaudits
105. Postaudits are an important part of capital
budgeting.
Required:
A. What is a postaudit of a capital
investment project?
B. What are the benefits of a postaudit?
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 postaudit process will show that this project should have been
funded." Comment on the manager's
understanding of the postaudit process.
LO: 3 Type: RC
Answer:
A.
A
postaudit is a review of the actual cash flows generated by a project and a
comparison of the actual net present value with the original, anticipated net
present value (or IRR).
B. The postaudit provides an opportunity to
identify problems in the implementation of a project, changes in the project's
environment, errors in the estimation of cash flows, or weaknesses in the
process by which the project was developed.
Hopefully, an organization will learn from the postaudit and, if
appropriate, change its ways so that past errors are not repeated.
C. The manager's understanding of the
postaudit process is incorrect. The
postaudit is applied to projects that are funded/implemented. It is not a mechanism to show what might have
happened if a rejected project had been accepted.
Depreciation as a Tax Shield
106. Depreciation is often described as a
"tax shield."
Required:
A.
Explain
how depreciation provides such a shield.
B.
MACRS
is an accelerated depreciation system.
Explain how an accelerated system can provide a more beneficial tax
shield than, say, a straight-line depreciation system.
LO: 4,
5 Type: RC
Answer:
A.
Depreciation
does not require a cash outlay. (The cash
outlay occurred when the asset was acquired.)
However, depreciation reduces taxable income and consequently, reduces
the cash outflow for income taxes. Thus,
depreciation provides a reduction in cash outflows for income taxes, or in
other words, shields some of a firm's income.
B. Under an accelerated depreciation system,
the asset's cost is written off more rapidly than under the straight-line
system. This leaves funds for
re-investment sooner, thus allowing a firm to generate greater returns because the
money is invested for a longer period of time.
Profitability
Index
107. 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?
LO: 7 Type: RC
Answer:
A.
The
profitability index equals the present value of a project's cash inflows
divided by the initial investment.
B. Both projects provide a return greater
than the hurdle rate and both are acceptable.
It is not possible to say which one is better. The profitability index provides a ratio that
is not influenced by the size of the project—a limitation of net-present-value
(NPV) analysis. Thus, a project that has
a greater NPV and a greater profitability index generally will be more
attractive than another project.
The
Payback Method
108. 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?
LO: 8 Type: RC
Answer:
A.
The
payback period is the time required to recover the initial investment. Projects with the shortest payback are generally
viewed as being the most attractive.
B. Yes, the payback period is based on net
cash inflows to the firm (i.e., those after taxes).
C. There are two major deficiencies. The payback method completely ignores cash
flows that occur after the payback point has been reached. This method also ignores the time value of
money.
Justification
of Investments in Advanced Manufacturing Systems
109. 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 reasons behind
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.
LO: 9 Type: RC, N
Answer:
A.
Negative
net present values may arise from several factors: the investments are very
costly; the hurdle rate may be very high to compensate for project risk; the
time horizon may be too short; and a number of benefits associated with the
project may have been excluded from the analysis because of related
quantification problems.
B. Greater flexibility in the manufacturing
process and improvements in product quality are very difficult to
quantify. As a result, these items may
be excluded from a discounted-cash-flow analysis, decreasing an investment's
attractiveness.
C.
No comments:
Post a Comment