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Exam 24: Capital Budgeting and Investment Analysis

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Question 41

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

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Payback period = 2 years + ($...

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Question 42

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A company purchases a machine for $1,000,000. The machine has an expected life of 9 years and no salvage value. The company anticipates a yearly net income of $60,000 after taxes of 30% to be received uniformly throughout each year. What is the accounting rate of return?

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Accounting rate of r...

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Question 43

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

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 _________________.

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

Accounting rate of return is the simplest capital budgeting method. It gives managers an estimate of how soon they will recover their initial investment.

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

What is discounting?

If two projects have the same risks, the same payback periods, and the same initial investments, they are equally attractive.

The following data concerns a proposed equipment purchase. $\begin{array} { l r } \text { Cost } & \$ 58,000 \\\text { Salvage value } & \$ 3,000 \\\text { Estimated useful life } & 5 \text { years } \\\text { Annual net cash flows } & \$ 18,000 \\\text { Depreciation method } & \text { Straight-line }\end{array}$ Assuming that net cash flows are received evenly throughout the year, the accounting rate of return is:

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

Neither the net present value nor the internal rate of return methods of evaluating investments consider the time value of money.

In using the internal rate of return method, management must consider a hurdle rate in making its decisions. What is a hurdle rate? What factors does management have to consider in selecting a hurdle rate?

The payback method of evaluating an investment fails to consider how long the investment will generate cash inflows beyond the payback period.

Daniels 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 3 years and no salvage value. Daniels requires a 12% return on its investments. The factors for the present value of $1 for different periods follow: $\begin{array} { l r } \text { Periods } & \text { 12 Percent } \\1 & 0.8929 \\2 & 0.7972 \\3 & 0.7118 \\4 & 0.6355\end{array}$ What is the net present value of the machine?

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. $\begin{array} { c c } \text { Year } & \begin{array} { c } \text { Present Value } \\\text { of } 1 \text { at } 10 \%\end{array} \\0 & 1.0000 \\1 & 0.9091 \\2 & 0.8264 \\3 & 0.7513 \\4 & 0.6830 \\5 & 0.6209 \\6 & 0.5645\end{array}$

A company is considering purchasing a machine for $123,000. The machine is expected to generate a net after-tax income of $8,200 per year. Depreciation expense would be $12,300. What is the payback period for this machine?

A hurdle rate is the minimum acceptable rate of return for an investment.

A company buys a machine for $60,000 that has an expected life of 9 years and no salvage value. The company anticipates a yearly net income of $2,850 after taxes of 30%, with the cash flows to be received evenly throughout of each year. What is the accounting rate of return?

Neither the payback period nor the accounting rate of return methods of evaluating investments considers the time value of money.