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Exam 11: Capital Budgeting and Investment Analysis

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Question 81

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A company wishes to buy new equipment for $9,000. The equipment is expected to generate an additional $2,800 in cash inflows for six years. All cash flows occur at year-end. A bank will make a $9,000 loan to the company at a 10% interest rate so that the company can purchase the equipment. Use the table below to determine break-even time for this equipment: Present Value Year of 1 at 10% 0 1.0000 1 0.9091 2 0.8265 3 0.7513 4 0.6830 5 0.6209 6 0.5645

A) Break-even time is between two and three years.
B) Break-even time is between three and four years.
C) Break-even time is between four and five years.
D) Break-even time is between five and six years.
E) This project will never break-even.

F) C) and E)
G) B) and C)

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Question 82

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If a manager were concerned with the time value of money, from which two capital budgeting methods should the manager choose?

A) IRR or Payback.
B) BET or IRR.
C) BET or Payback.
D) NPV or ARR.
E) NPV or Payback.

F) C) and D)
G) A) and E)

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Question 83

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The net present value capital budgeting method considers all estimated cash flows for the project's expected life.

The following present value factors are provided for use in this problem. $\begin{array} { c c c } \text { Periods } & \text { Presert Value } & \text { Presert Value of an } \\ & \text { of } \$ 1 \text { at } 8 \% & \text { Annuity of } \$ 1 \text { at } 8 \% \\1 & 0.9259 & 0.9259 \\2 & 0.8573 & 1.7833 \\3&0.7938&2.5771\\4 & 0.7938 & 2.5771\end{array}$ Cliff Co. wants to purchase a machine for $40,000, but needs to earn an 8% return. The expected year-end net cash flows are $12,000 in each of the first three years, and $16,000 in the fourth year. What is the machine's net present value?

After-tax net income divided by the average amount invested in a project, is the:

The net cash flow of a particular investment project:

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

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: End of Investment Year A B $\begin{array} { | r | r | r | } \hline 1 & \$ 8,000 & \$ 0 \\\hline 2 & 8,000 & 0 \\\hline 3 & 8,000 & 24,000 \\\hline\end{array}$ The present value factors of $1 each year at 15% are: $\begin{array}{llcc} \text {1 } &0.8696\\ \text { 2} &0.7561\\ \text { 3 } &0.6575\\\end{array}$ The present value of an annuity of $1 for 3 years at 15% is 2.2832 The net present value of Investment A is:

The time value of money concept works on the principle that a dollar today is worth more than a dollar tomorrow.

The calculation of annual net cash flow from a particular investment project should include all of the following except:

A company is trying to decide which of two new product lines to introduce in the coming year. The company requires a 12% return on investment. The predicted revenue and cost data for each product line follows: $\begin{array} { | l | r | r | } \hline & \text { Product A } &{ \text { Product B } } \\\hline \text { Unit sales } & 25,000 & 20,000 \\\hline \text { Unit sales price } & \$ 30 & \$ 30 \\\hline \text { Direct materials } & \$ 15,000 & \$ 8,000 \\\hline \text { Direct labor } & \$ 120,000 & \$ 80,000 \\\hline \text { Other cash operating expenses } & \$ 30,000 & \$ 25,000 \\\hline \text { New equipment costs } & \$ 2,500,000 & \$ 1,500,000 \\\hline \text { Estimated useful life (no salvage) } & 5 \text { years } & 5 \text { years } \\\hline\end{array}$ The company has a 30% tax rate and it uses the straight-line depreciation method. The present value of an annuity of 1 for 5 years at 12% is 3.6048. Compute the net present value for each piece of equipment under each of the two product lines. Which, if either of these two investments is acceptable?

When making capital budgeting decisions, companies usually prefer shorter payback periods. Explain why shorter payback periods are desirable.

Turk Manufacturing is considering purchasing two machines. Each machine costs $9,000 and will produce cash flows as follows: End of Machine Year A B $\begin{array} { | r | r | r | } \hline 1 & \$ 5,000 & \$ 1,000 \\\hline 2 & 4,000 & 2,000 \\\hline 3 & 2,000 & 11,000 \\\hline\end{array}$ Turk Manufacturing uses the net present value method to make the decision, and it requires a 15% annual return on its investments. The present value factors of 1 at 15% are: 1 year, 0.8696; 2 years, 0.7561; 3 years, 0.6575. Which machine should Turk purchase?

Net cash flow can be calculated by adjusting the projected net income from a project for any non-cash revenues and expenses.

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

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

The following data concerns a proposed equipment purchase: Cost $144,000 Salvage value $ 4,000 Estimated useful life 4 years Annual net cash flows $ 46,100 Depreciation method Straight-line The annual average investment amount used to calculate the accounting rate of return is:

A company is considering the purchase of new equipment for $42,000. The projected annual cash inflow is $18,000. The machine has a useful life of 3 years and no salvage value. Management of the company requires a 12% return on investment. The present value of an annuity of $1 for various periods follows: Period Present value of an annuity of 1 at 12% 1 0.8929 2 1.6901 3 `2.4018 What is the net present value of this machine assuming all cash flows occur at year-end?

If a manager was not concerned with the time value of money, from which two capital budgeting methods should the manager choose?