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Exam 24: Capital Budgeting and Investment Analysis

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Question 41

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The accounting rate of return is calculated as:

A) The after-tax income divided by the total investment.
B) The after-tax income divided by the average investment.
C) The cash flows divided by the average investment.
D) The cash flows divided by the total investment.
E) The average investment divided by the after-tax income.

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

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Question 42

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A disadvantage of an investment with a short payback period is that it will produce revenue for only a short period of time.

A) True
B) False

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Question 43

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Capital budgeting decisions are not affected by return on investment considerations.

A company produces two boat models,Montauk and Orient.Both products are being considered for major investment projects next year.Relevant data follow: $\begin{array}{lrr}&\underline{\text{Montauk }}&\underline{\text{Orient }}\\\text{New investment}&\$ 424,000&\$ 380,000\\\text{Expected 3-year net cash flows:}\\\text{Year 1}&150,000&130,000\\\text{Year 2}&160,000&130,000\\\text{Year 3}&170,000&130,000\end{array}$ Required: Use the payback period to evaluate these two investment projects.

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

There is only one method of evaluating capital budgeting decisions.

A capital budgeting method that considers how quickly a project recovers costs is known as ______________________.An enhancement to this method that considers the time value of money is called _________________.

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

A company is considering purchasing a machine for $21,000.The machine will generate an after-tax net income of $2,000 per year.Annual depreciation expense would be $1,500.What is the payback period for the new machine?

A given project requires a $28,500 investment and is expected to generate end-of-period annual cash inflows of $12,000 for each of three years.Assuming a discount rate of 10%,what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below: $\begin{array} { c c c } i = 10 \% & i = 10 \% / 4 & i = 10 \% / 1 \\n = 1 & n = 2 & n = 3 \\\hline .9091 & .8264 & .7513\end{array}$

A company is considering the purchase of a new machine for $48,000.Management predicts that the machine can produce sales of $16,000 each year for the next 10 years.Expenses are expected to include direct materials,direct labor,and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year.The company's tax rate is 40%.What is the payback period for the new machine?

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

Bower Co.is reviewing a capital investment of $50,000.This project's projected cash flows over a five-year period are estimated at $20,000 each year. Required: a.Calculate the payback period. b.Calculate the break-even time.Assume a 12% hurdle rate and use the table below: $\begin{array} { lc } &\text{Present}\\&\text{Value}\\\underline{\text{Periods }}&\underline{\text{of 1 at 12 \%}} \\1&0.8929 \\2&0.7972 \\3&0.7118 \\4&0.6355 \\5&0.5674\end{array}$ c.Using the results in (a)and (b)make a recommendation for the project.

A company wishes to buy new equipment for $85,000.The equipment is expected to generate an additional $35,000 in cash inflows for four years.All cash flows occur at year-end.A bank will make an $85,000 loan to the company at a 10% interest rate so that the company can purchase the equipment.Use the table below to determine the present value of the future cash flows and the net present value of the investment. $\begin{array}{cc}&\text { Present Value }\\\text { Year } & \text { of 1 at } 10 \% \\0 & 1.0000 \\1 & 0.9091 \\2 & 0.8264 \\3 & 0.7513 \\4 & 0.6830\end{array}$

A company has a decision to make between two investment alternatives.The company requires a 10% return on investment.Predicted data is provided below: $\begin{array} { l rr } &\underline{\text { Investment Y}} & \underline{\text { Investment Z}} \\\text {Projected after-tax net income}&\$ 40,000&\$ 42,000\\\text {Investment costs}&\$ 600,000&\$ 675,000\\\text {Estimated life}&6 \text { years }&6 \text { years }\end{array}$ The present value of an annuity for six years at 10% is 4.3553.This company uses straight-line depreciation. Required: a.Calculate the net present value for each investment. b.Which investment should this company select? Explain.

Scott Corporation is considering the purchase of new equipment costing $30,000.The projected annual after-tax net income from the equipment is $1,200,after deducting $10,000 for depreciation.The revenue is to be received at the end of each year.The machine has a useful life of three years and a $4,000 salvage value.Scott requires a 12% return on its investments.The factors for the present value of $1 for different periods follow: $\begin{array} { l r } \underline{\text { Periods }} & \underline{12 \text { Percent }} \\1 & 0.8929 \\2 & 0.7972 \\3 & 0.7118 \\4 & 0.6355\end{array}$ What is the net present value of the machine and what is the maximum Scott would have been willing to pay for it?

Three widely used methods of comparing investment alternatives are payback period,net present value,and rate of return on average investment.

A company is considering two alternative investment opportunities,each of which requires an initial cash outlay of $110,000.The expected net cash flows from the two projects follow: $\begin{array}{lrr}&\underline{\text{Project A}}&\underline{\text{Project Z}}\\\text{Year 1}&\$30,000&\$44,000\\\text{Year 2}&44,000&70,000\\\text{Year 3}&\underline{70,000}&\underline{30,000}\\\text{Totalst}&\underline{\underline{\$ 144,000}}&\underline{\underline{\$ 144,000}}\end{array}$ Required: a,Based on a comparison of their net present values,and assuming the same discount rate (greater than zero)is required for both projects,which project is the better investment? (Check one answer.) ________________ Project A ________________ Project Z ________________ The projects are equally desirable b.Use the table values below to find the net present value of the cash flows associated with Project A,discounted at 12%: $\begin{array} { l c } \underline{\text { Period}} & \underline{\text { Present Value of } 1 \text { at } 12 \%} \\1 & 0.8929 \\2 & 0.7972 \\3 & 0.7118\end{array}$

Which of the following is an objective of capital budgeting?

In business decision-making,managers typically examine the two fundamental factors of: