CHAPTER 13 QUESTIONS

Clairmont Corporation is considering the purchase of a machine that would cost $150,000 and would last for 5 years. At the end of 5 years, the machine would have a salvage value of $18,000. By reducing labor and other operating costs, the machine would provide annual cost savings of $37,000. The company requires a minimum pretax return of 12% on all investment projects. The present value of the annual cost savings of $37,000 is closest to: A) $133,385 B) $235,070 C) $185,000 D) $20,979

A) $133,385

The following data on a proposed investment project have been provided: Cost of equipment: $50,000 Working capital is required: $30,000 Salvage value of equipment: $0 Annual cash inflows from the project: $20,000 Required rate of return: 20% Life of the project: 8 years The net present value of the project would be: A) $3,730 B) $0 C) $32,450 D) $88,370

A) $3,730

Lajeunesse Corporation uses a discount rate of 19% in its capital budgeting. Partial analysis of an investment in automated equipment with a useful life of 8 years has thus far yielded a net present value of -$127,991. This analysis did not include any estimates of the intangible benefits of automating this process nor did it include any estimate of the salvage value of the equipment. Ignoring any salvage value, to the nearest whole dollar how large would the additional cash flow per year from the intangible benefits have to be to make the investment in the automated equipment financially attractive? A) $32,370 B) $15,999 C) $127,991 D) $24,318

A) $32,370

The management of Kobler Corporation is investigating an investment in equipment that would have a useful life of 5 years. The company uses a discount rate of 10% in its capital budgeting. Good estimates are available for the initial investment and the annual cash operating outflows, but not for the annual cash inflows and the salvage value of the equipment. The net present value of the initial investment and the annual cash outflows is -$235,421. Ignoring any salvage value, to the nearest whole dollar how large would the annual cash inflow have to be to make the investment in the equipment financially attractive? A) $62,100 B) $23,542 C) $235,421 D) $47,084

A) $62,100

Clairmont Corporation is considering the purchase of a machine that would cost $150,000 and would last for 5 years. At the end of 5 years, the machine would have a salvage value of $18,000. By reducing labor and other operating costs, the machine would provide annual cost savings of $37,000. The company requires a minimum pretax return of 12% on all investment projects. The net present value of the proposed project is closest to: A) -$6,409 B) -$11,295 C) $1,385 D) -$16,615

A) -$6,409

Dube Corporation is considering the following three investment projects: D // E // F Investment required: $(11,000) // $(41,000) // $(86,000) PV of cash inflows: $11,330 // $46,330 // $95,460 The profitability index of investment project E is closest to: A) 0.13 B) 1.13 C) 0.87 D) 0.12

A) 0.13

The management of Stanforth Corporation is investigating automating a process. Old equipment, with a current salvage value of $24,000, would be replaced by a new machine. The new machine would be purchased for $516,000 and would have a 6 year useful life and no salvage value. By automating the process, the company would save $173,000 per year in cash operating costs. The simple rate of return on the investment is closest to: A) 17.7% B) 16.9% C) 33.5% D) 16.7%

A) 17.7%

Wombles Corporation is contemplating purchasing equipment that would increase sales revenues by $478,000 per year and cash operating expenses by $249,000 per year. The equipment would cost $738,000 and have a 9 year life with no salvage value. The annual depreciation would be $82,000. The simple rate of return on the investment is closest to: A) 19.9% B) 30.8% C) 31.0% D) 11.1%

A) 19.9%

A company with $600,000 in operating assets is considering the purchase of a machine that costs $72,000 and which is expected to reduce operating costs by $18,000 each year. These reductions in cost occur evenly throughout the year. The payback period for this machine in years is closest to: A) 4 years B) 8.3 years C) 0.25 years D) 33.3 years

A) 4 years

Kautzer Corporation is considering a project that would require an investment of $418,000 and would last for 9 years. The incremental annual revenues and expenses generated by the project during those 9 years would be as follows: Sales: $111,000 Less: variable expenses: 11,000 Contribution margin: 100,000 LESS: fixed expenses Salaries: 12,000 Rents: 19,000 Depreciation: 45,000 Total fixed expenses: 76,000 Net operating income: $24,000 The scrap value of the project's assets at the end of the project would be $13,000. The payback period of the project is closest to: A) 5.9 years B) 6.1 years C) 17.4 years D) 16.9 years

A) 5.9 years

Bowen Company is considering several investment proposals, as shown below: A / B / C / D Investment required: $95,000 / $120,000 / $90,000 / $150,000 PV of future net cash flows: $107,000 / $130,000 / $105,000 / $180,000 If the project profitability index is used, the ranking of the projects would be: A) D C A B B) D B A C C) B A C D D) D A B C

A) D C A B

In capital budgeting computations, discounted cash flow methods: A) automatically provide for recovery of initial investment. B) can't be used unless cash flows are uniform from year to year. C) assume that all cash flows occur at the beginning of a period. D) responses a, b, and c are all correct.

A) automatically provide for recovery of initial investment.

The investment required for the project profitability index should: A) be reduced by the amount of any salvage recovered from the sale of old equipment. B) be reduced by the amount of any salvage recovered from the sale of the new equipment at the end of its useful life. C) be reduced by the amount of any salvage recovered from the sale of both the old and new equipment. D) none of the above is correct.

A) be reduced by the amount of any salvage recovered from the sale of old equipment.

Stratford Company purchased a machine with an estimated useful life of seven years. The machine will generate cash inflows of $9,000 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 $17,000? A) $43,812 B) $26,812 C) $17,000 D) $22,195

B) $26,812

Fossa Road Paving Company is considering an investment in a curb-forming machine. The machine will cost $240,000, will last 10 years, and will have a $40,000 salvage value at the end of 10 years. The machine is expected to generate net cash inflows of $60,000 per year in each of the 10 years. Fossa's discount rate is 18%. What is the net present value of this machine? A) $5,840 B) $37,280 C) $(48,780) D) $69,640

B) $37,280

The management of Cackowski Corporation has been concerned for some time with the financial performance of its product I11S and has considered discontinuing it on several occasions. Data from the company's accounting system appear below: Sales: $760,000 Variable Expenses: $350,000 Fixed Manufacturing Expenses:$212,000 Fixed Selling and Administrative Expenses: $152,000 In the company's accounting system all fixed expenses of the company are fully allocated to products. Further investigation has revealed that $212,000 of the fixed manufacturing expenses and $152,000 of the fixed selling and administrative expenses are avoidable if product I11S is discontinued. According to the company's accounting system, what is the net operating income earned by product I11S? Include all costs in this calculation—whether relevant or not. A) $410,000 B) $46,000 C) $(46,000) D) $(410,000)

B) $46,000

Anthony operates a part time auto repair service. He estimates that a new diagnostic computer system will result in increased cash inflows of $1,500 in Year 1, $2,100 in Year 2, and $3,200 in Year 3. If Anthony's required rate of return is 10%, then the most he would be willing to pay for the new computer system would be: A) $4,599 B) $5,501 C) $5,638 D) $5,107

B) $5,501

Lambert Manufacturing has $100,000 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: $100,000 // $60,000 Working capital investment needed now: -- // $40,00 Annual cash operating inflows: $40,000 // $35,000 Salvage value of equipment 6 years: $10,000 // -- Both projects will 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 required rate of return is 14%. The company uses the total cost approach to evaluating alternatives. The net present value of project A is: A) $51,000 B) $69,120 C) $55,560 D) $94,450

B) $69,120

Villena Corporation is considering a project that would require an investment of $48,000. No other cash outflows would be involved. The present value of the cash inflows would be $52,800. The profitability index of the project is closest to: A) 0.90 B) 0.10 C) 1.10 D) 0.09

B) 0.10

Messersmith Corporation is investigating automating a process by purchasing a machine for $688,000 that would have an 8 year useful life and no salvage value. By automating the process, the company would save $160,000 per year in cash operating costs. The new machine would replace some old equipment that would be sold for scrap now, yielding $19,000. The annual depreciation on the new machine would be $86,000. The simple rate of return on the investment is closest to: A) 23.3% B) 11.1% C) 10.8% D) 12.5%

B) 11.1%

Overland Company has gathered the following data on a proposed investment project: Investment in depreciable equipment: $150,000 Annual cash flows: $40,000 Salvage value of equipment: $0 Life of the equipment: 10 years Required rate of return: 10% The company uses straight-line depreciation on all equipment. The simple rate of return on the investment is: A) 26.67% B) 16.67% C) 36.67% D) 10.00%

B) 16.67%

Major Corporation is considering the purchase of a new machine for $5,000. The machine has an estimated useful life of 5 years and no salvage value. The machine will increase Major's cash flows by $2,000 annually for 5 years. Major uses straight-line depreciation. The company's required rate of return is 10%. What is the payback period for the machine? A) 5.00 years B) 2.50 years C) 7.58 years D) 8.34 years

B) 2.50 years

Overland Company has gathered the following data on a proposed investment project: Investment in depreciable equipment: $150,000 Annual cash flows: $40,000 Salvage value of equipment: $0 Life of the equipment: 10 years Required rate of return: 10% The company uses straight-line depreciation on all equipment. The payback period for the investment is: A) 0.27 years B) 3.75 years C) 10.00 years D) 2.13 years

B) 3.75 years

An expansion at Fidell, Inc., would increase sales revenues by $75,000 per year and cash operating expenses by $38,000 per year. The initial investment would be for equipment that would cost $135,000 and have a 5 year life with no salvage value. The annual depreciation on the equipment would be $27,000. The simple rate of return on the investment is closest to: A) 20.0% B) 7.4% C) 27.4% D) 13.3%

B) 7.4%

Crowley Corporation is considering three investment projects-F, G, and H. Project F would require an investment of $21,000, Project G of $49,000, and Project H of $82,000. No other cash outflows would be involved. The present value of the cash inflows would be $21,210 for Project F, $57,820 for Project G, and $95,120 for Project H. Rank the projects according to the profitability index, from most profitable to least profitable. A) F,H,G B) G,H,F C) H,F,G D) H,G,F

B) G,H,F

If taxes are ignored, all of the following items are included in a discounted cash flow analysis except: A) future operating cash savings. B) depreciation expense. C) future salvage value. D) investment in working capital.

B) depreciation expense.

The net present value (NPV) method of investment project analysis assumes that the project's cash flows are reinvested at the: A) internal rate of return. B) discount rate used in the NPV calculation. C) firm's simple rate of return. D) firm's average ROI.

B) discount rate used in the NPV calculation.

The management of Mashiah Corporation is considering the purchase of a machine that would cost $290,000, would last for 6 years, and would have no salvage value. The machine would reduce labor and other costs by $102,000 per year. The company requires a minimum pretax return of 13% on all investment projects. The net present value of the proposed project is closest to: A) $154,663 B) $322,000 C) $117,796 D) $245,246

C) $117,796

A project requires an initial investment of $70,000 and has a project profitability index of 0.932. The present value of the future cash inflows from this investment is: A) $70,000 B) $36,231 C) $135,240 D) Cannot be determined from the data provided.

C) $135,240

A company wants to have $40,000 at the end of a five-year period through investment of a single sum now. How much needs to be invested in order to have the desired sum in five years, if the money can be invested at 10%: A) $10,551 B) $8,000 C) $24,840 D) $12,882

C) $24,840

The management of Cantell Corporation is considering a project that would require an initial investment of $47,000. No other cash outflows would be required. The present value of the cash inflows would be $55,930. The profitability index of the project is closest to: A) 1.19 B) 0.81 C) 0.19 D) 0.16

C) 0.19

The management of Helberg Corporation is considering a project that would require an investment of $203,000 and would last for 6 years. The annual net operating income from the project would be $103,000, which includes depreciation of $30,000. The scrap value of the project's assets at the end of the project would be $23,000. The payback period of the project is closest to: A) 1.5 years B) 2.0 years C) 1.4 years D) 1.7 years

C) 1.4 years

Information on four investment proposals is given below: 1 / 2 / 3 / 4 Investment required: $20,000 / $15,000 / $12,000 / $18,000 Net present value: $10,000 / $6,000 / $9,600 / $10,800 Rank the proposals in terms of preference according to the project profitability index: A) 1, 4, 3, 2 B) 4, 1, 3, 2 C) 3, 4, 1, 2 D) 2, 1, 4, 3

C) 3, 4, 1, 2

The management of Edelmann Corporation is considering the following three investment projects: Project R / Project S / Project T Investment required: $(13,000) / $(59,000) / $(79,000) Rank the projects according to the profitability index, from most profitable to least profitable. A) T, S, R B) R, T, S C) S, T, R D) T, R, S

C) S, T, R

Some investment projects require that a company increase its working capital. Under the net present value method, the investment and eventual recovery of working capital should be treated as: A) an initial cash outflow. B) a future cash inflow. C) both an initial cash outflow and a future cash inflow. D) irrelevant to the net present value analysis.

C) both an initial cash outflow and a future cash inflow.

Tam Company is negotiating for the purchase of equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in cash operating costs. The equipment's estimated useful life is 10 years, with no salvage value, and would be depreciated by the straight-line method. Tam's required rate of return is 12%. The net present value of this investment is: A) $5,760 B) $6,440 C) $12,200 D) $13,000

D) $13,000

Lambert Manufacturing has $100,000 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: $100,000 // $60,000 Working capital investment needed now: -- // $40,00 Annual cash operating inflows: $40,000 // $35,000 Salvage value of equipment 6 years: $10,000 // -- Both projects will 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 required rate of return is 14%. The company uses the total cost approach to evaluating alternatives. The net present value of Project B is: A) $90,355 B) $76,115 C) $36,115 D) $54,355

D) $54,355

Overland Company has gathered the following data on a proposed investment project: Investment in depreciable equipment: $150,000 Annual cash flows: $40,000 Salvage value of equipment: $0 Life of the equipment: 10 years Required rate of return: 10% The company uses straight-line depreciation on all equipment. A) $40,000 B) $3,625 C) $57,831 D) $95,800

D) $95,800

Tam Company is negotiating for the purchase of equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in cash operating costs. The equipment's estimated useful life is 10 years, with no salvage value, and would be depreciated by the straight-line method. Tam's required rate of return is 12%. The simple rate of return of this investment is: A) 8% B) 20% C) 12% D) 10%

D) 10%

The management of Duker Corporation is investigating purchasing equipment that would increase sales revenues by $130,000 per year and cash operating expenses by $39,000 per year. The equipment would cost $328,000 and have an 8 year life with no salvage value. The simple rate of return on the investment is closest to: A) 12.5% B) 27.7% C) 38.5% D) 15.2%

D) 15.2%

Tam Company is negotiating for the purchase of equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in cash operating costs. The equipment's estimated useful life is 10 years, with no salvage value, and would be depreciated by the straight-line method. Tam's required rate of return is 12%. The payback period of this investment is: A) 4 years B) 1 year C) 10 years D) 5 years

D) 5 years

Dube Corporation is considering the following three investment projects: D // E // F Investment required: $(11,000) // $(41,000) // $(86,000) PV of cash inflows: $11,330 // $46,330 // $95,460 Rank the projects according to the profitability index, from most profitable to least. A) F E D B) D F E C) F D E D) E F D

D) E F D

The simple rate of return method is desirable because of its simplicity and the fact that it takes the time value of money into account. T/F

FALSE

When considering a number of investment projects, the project that has the best payback period will also always have the highest net present value. T/F

FALSE

Although the payback method focuses on cash flows, it does not recognize the time value of money. T/F

TRUE

Both the net present value method and the internal rate of return method can be used as a screening tool in capital budgeting decisions. T/F

TRUE

Discounted cash flow techniques automatically provide for recovery of initial investment. T/F

TRUE

If investment funds are limited, the net present value of one project should not be compared directly to the net present value of another project unless the initial investments in these projects are equal. T/F

TRUE

In calculating payback where new equipment is replacing old equipment, any salvage value to be received on disposal of the old equipment should be deducted from the cost of the new equipment. T/F

TRUE

In the payback method, depreciation is added back to net operating income when computing the net annual cash flow. T/F

TRUE

The internal rate of return is the rate of return of an investment project over its useful life. T/F

TRUE

The present value of a cash flow will never be greater than the future dollar amount of the cash flow. T/F

TRUE

When computing the project profitability index of an investment project, the investment required will include any investment made in working capital at the beginning of the project. T/F

TRUE

When discounted cash flow methods of capital budgeting are used, the working capital required for a project is ordinarily counted as a cash outflow at the beginning of the project and as a cash inflow at the end of the project. T/F

TRUE

When using internal rate of return to evaluate investment projects, if the internal rate of return is greater than the required rate of return, the project should be accepted. T/F

TRUE