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Exam 7: Capital Budgeting Decisions

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Question 71

True/False

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In calculating the "investment required" for the project profitability index, the amount invested should not be reduced by any salvage recovered from the sale of old equipment.

A) True
B) False

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Question 72

Multiple Choice

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The management of Elamin Corporation is considering the purchase of a machine that would cost $365,695 and would have a useful life of 9 years. The machine would have no salvage value. The machine would reduce labor and other operating costs by $61,000 per year. The internal rate of return on the investment in the new machine is closest to (Ignore income taxes.) : Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided.

A) 9%
B) 11%
C) 12%
D) 10%

E) C) and D)
F) B) and D)

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Question 73

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The cost of capital is the average rate of return that the company earns on its investments.

Lambert Manufacturing has $100,000 to invest in either Project A or Project B. The following data are available on these projects (Ignore income taxes.) : Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided. Both projects will have a useful life of 6 years and the total cost approach to net present value analysis. 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 net present value of Project A is:

Laws Corporation is considering the purchase of a machine costing $16,000. Estimated cash savings from using the new machine are $4,120 per year. The machine will have no salvage value at the end of its useful life of six years and the required rate of return for Laws Corporation is 12%. The machine's internal rate of return is closest to (Ignore income taxes.) : Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided.

The management of Hibert Corporation is considering three investment projects-W, X, and Y. Project W would require an investment of $21,000, Project X of $66,000, and Project Y of $95,000. The present value of the cash inflows would be $22,470 for Project W, $73,920 for Project X, and $98,800 for Project Y. (Ignore income taxes.) Rank the projects according to the profitability index, from most profitable to least profitable.

In an effort to reduce costs, Pontic Manufacturing Corporation is considering an investment in equipment that will reduce defects. This equipment will cost $420,000, will have an estimated useful life of 10 years, and will have an estimated salvage value of $50,000 at the end of 10 years. The company's discount rate is 22%. What amount of cost savings will this equipment have to generate per year in each of the 10 years in order for it to be an acceptable project? (Ignore income taxes.) . Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided. (Round your intermediate calculations to 3 decimal places.)

In preference decisions, the profitability index and internal rate of return methods will rank projects in the same order of preference.

Joetz Corporation has gathered the following data on a proposed investment project (Ignore income taxes.) : The company uses straight-line depreciation on all equipment. Assume cash flows occur uniformly throughout a year except for the initial investment. Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided. The internal rate of return of the investment is closest to:

Jojola Corporation is investigating buying a small used aircraft for the use of its executives. The aircraft would have a useful life of 5 years. The company uses a discount rate of 13% in its capital budgeting. The net present value of the initial investment and the annual operating cash cost is -$439,238. Management is having difficulty estimating the annual benefit of having the aircraft and estimating the salvage value of the aircraft. (Ignore income taxes.) Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided. Ignoring the annual benefit, to the nearest whole dollar how large would the salvage value of the aircraft have to be to make the investment in the aircraft financially attractive?

Buy-Rite Pharmacy has purchased a small auto for delivering prescriptions. The auto was purchased for $24,000 and will have a 6-year useful life and a $6,000 salvage value. Delivering prescriptions (which the pharmacy has never done before) should increase gross revenues by at least $28,000 per year. The cost of these prescriptions to the pharmacy will be about $22,000 per year. The pharmacy depreciates all assets using the straight-line method. The payback period for the auto is closest to (Ignore income taxes.) :

(Ignore income taxes in this problem.) The management of an amusement park is considering purchasing a new ride for $80,000 that would have a useful life of 10 years and a salvage value of $10,000. The ride would require annual operating costs of $32,000 throughout its useful life. The company's discount rate is 9%. Management is unsure about how much additional ticket revenue the new ride would generate-particularly since customers pay a flat fee when they enter the park that entitles them to unlimited rides. Hopefully, the presence of the ride would attract new customers. Required: How much additional revenue would the ride have to generate per year to make it an attractive investment?

Croce, Inc., is investigating an investment in equipment that would have a useful life of 7 years. The company uses a discount rate of 8% in its capital budgeting. The net present value of the investment, excluding the salvage value, is −$515,967. To the nearest whole dollar how large would the salvage value of the equipment have to be to make the investment in the equipment financially attractive? (Ignore income taxes.) Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided.

Denny Corporation is considering replacing a technologically obsolete machine with a new state-of-the-art numerically controlled machine. The new machine would cost $450,000 and would have a ten-year useful life. Unfortunately, the new machine would have no salvage value. The new machine would cost $20,000 per year to operate and maintain, but would save $100,000 per year in labor and other costs. The old machine can be sold now for scrap for $50,000. The simple rate of return on the new machine is closest to (Ignore income taxes.) :

Bau Long-Haul, Inc., is considering the purchase of a tractor-trailer that would cost $281,656, would have a useful life of 7 years, and would have no salvage value. The tractor-trailer would be used in the company's hauling business, resulting in additional net cash inflows of $76,000 per year. The internal rate of return on the investment in the tractor-trailer is closest to (Ignore income taxes.) : Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided.

The management of Hansley Corporation is investigating an investment in equipment that would have a useful life of 5 years. The company uses a discount rate of 18% 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 -$273,300. (Ignore income taxes.) Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided. 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?

Almendarez Corporation is considering the purchase of a machine that would cost $320,000 and would last for 7 years. At the end of 7 years, the machine would have a salvage value of $51,000. By reducing labor and other operating costs, the machine would provide annual cost savings of $72,000. The company requires a minimum pretax return of 18% on all investment projects. (Ignore income taxes.) Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided. The present value of the annual cost savings of $72,000 is closest to:

The management of Leitheiser Corporation is considering a project that would require an initial investment of $51,000. No other cash outflows would be required. The present value of the cash inflows would be $57,630. The profitability index of the project is closest to (Ignore income taxes.) :

If the net present value of a project is zero based on a discount rate of 16%, then the internal rate of return is:

(Ignore income taxes in this problem.) The management of Schenk Corporation is investigating automating a process by replacing old equipment by a new machine. The old equipment would be sold for scrap now for $13,000. The new machine would cost $648,000, would have a 9 year useful life, and would have no salvage value. By automating the process, the company would save $186,000 per year in cash operating costs. Required: Determine the simple rate of return on the investment to the nearest tenth of a percent. Show your work!