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Exam 25: Capital Budgeting and Managerial Decisions

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Question 61

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Porter Co. is analyzing two projects for the future. Assume that only one project can be selected. $\begin{array} { l r r } & \text { Project X } & \text { Project } Y \\\text { Cost of machine } & \$ 68,000 & \$ 60,000 \\\text { Net cash flow: } & & \\\text { Year 1 } & 24,000 & 4,000 \\\text { Year 2 } & 24,000 & 26,000 \\\text { Year 3 } & 24,000 & 26,000 \\\text { Year 4 } & 0 & 20,000\end{array}$ - The payback period in years for Project X is:

A) 2.00.
B) 2.83.
C) 3.50.
D) 3.83.
E) 4.00.

F) None of the above
G) A) and E)

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Question 62

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A machine costs $180,000 and will have an eight-year life, a $20,000 salvage value, and straight-line depreciation is used. Management estimates the machine will yield an after-tax net income of $12,500 each year. Compute the accounting rate of return for the investment.

A) 10.8%.
B) 12.5%.
C) 26.8%.
D) 22.5%.
E) 11.8%.

F) None of the above
G) B) and E)

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Question 63

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

When computing payback period, the year in which a capital investment is made is year 1.

Chang Industries has 2,000 defective units of product that have already cost $14 each to produce. A salvage company will purchase the defective units as they are for $5 each. Chang's production manager reports that the defects can be corrected for $6 per unit, enabling them to be sold at their regular market price of $21. - The incremental income or loss on reworking the units is:

Two investments with exactly the same payback periods are not equally valuable to an investor because the timing of net cash flows may be different.

A company puts four products through a common production process. This process costs $100,000 each year. The four products can be sold when they emerge from this process at the "split-off point", or processed further and then sold. Data about the four products for the coming period are: $\begin{array} { l | l | l | l | l } & & \text { Unit Sales } & \text { Unit Sales } & \\\hline & & \text { Price per } & \text { Price per } & \\\hline & & \text { urnit at } & \text { unit after } & \text { Additional } \\\hline & & \text { Split-Off } & \text { Further } & \text { Processing } \\\hline \text { Product } & \text { Volume } & \text { Point } & \text { Processing } & \text { Costs } \\\hline \text { Stroller } & 20,000 \mathrm { lb } . & \$ 28.00 & \$ 42.00 & \$ 400,000 \\\hline \text { Walker } & 10,000 \mathrm { lb } . & 7.00 & 28.00 & 144.000 \\\hline \text { Jogger } & 5,000 \mathrm { lb } & 36.00 & 58.00 & 120.000 \\\hline \text { Runner } & 5,000 \mathrm { lb } & 18.00 & 22.00 & 40.000\end{array}$ Determine which products should be sold at the split-off point and which should be processed further.

Which of the following cash flows is not considered when using the net present value method?

Capital budgeting is the process of analyzing:

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

Alfarsi Industries uses the net present value method to make investment decisions and requires a 15% annual return on all investments. The company is considering two different investments. Each require an initial investment of $15,000 and will produce cash flows as follows: $\begin{array}{c}\text {End of}&&\text {Investment}\\\text {Year}\\&\text {A}&\text {B}\\1 & \$ 8,000 & \$ 0 \\2 & 8,000 & 0 \\3 & 8,000 & 24,000\end{array}$ The present value factors of $\$ 1$ each year at $15 \%$ are: $\begin{array} { l l } 1 & 0.8696 \\ 2 & 0.7561 \\ 3 & 0.6575 \end{array}$ - The present value of an annuity of $1 for 3 years at 15% is 2.2832 The net present value of Investment B is:

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

The minimum acceptable rate of return on an investment, often the company's cost of capital, is called the ________.

Bluebird Mfg. has received a special one-time order for 15,000 bird feeders at $3 per unit. Bluebird currently produces and sells 75,000 units at $7.00 each. This level represents 80% of its capacity. These bird feeders would be marketed under the wholesaler's name and would not affect Bluebird's sales through its normal channels. Production costs for these units are $3.50 per unit, which includes $2.25 variable cost and $1.25 fixed cost. - If Bluebird accepts this additional business, the incremental revenue will be:

A disadvantage of using the payback period to compare investment alternatives is that:

The payback period method of evaluating an investment fails to consider cash inflows after the point where an investment's costs are fully recovered.

The payback period method, unlike the net present value method, does not ignore cash flows after the point of cost recovery.

The accounting rate of return is based on cash flows rather than net income in its calculation.

Net cash flow is cash inflows minus cash outflows.

Granfield Company has a piece of manufacturing equipment with a book value of $40,000 and a remaining useful life of four years. At the end of the four years the equipment will have a zero salvage value. The market value of the equipment is currently $22,000. Granfield can purchase a new machine for $120,000 and receive $22,000 in return for trading in its old machine. The new machine will reduce variable manufacturing costs by $19,000 per year over the four-year life of the new machine. The total increase or decrease in net income by replacing the current machine with the new machine (ignoring the time value of money) is: