Capital Budgeting Decisions - youcancallmefrance
True/False Questions
1. When cash flows are uneven and vary from year to year, the internal rate of return method is easier to use than the net present value method.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2 Level: Hard
2. For capital budgeting decisions, the net present value method is superior to the simple rate of return method.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,6 Level: Easy
3. Depreciation is included as a cash flow in capital budgeting decisions to ensure that the original cost of the asset is fully recovered.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium
4. Even when done properly, the total-cost and incremental-cost approaches to choosing between alternatives will sometimes yield different answers.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium
5. An increase in the expected salvage value at the end of a capital budgeting project will have no effect on the internal rate of return for that project.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium
6. The intangible benefits of automation cannot be estimated with any accuracy and therefore should be ignored in capital budgeting decisions.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Medium
7. When making preference decisions about competing investment proposals, the project profitability index is superior to the internal rate of return.
Ans: True AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium
8. The project profitability index is computed by dividing the net present value of the project by the investment required by the project.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy
9. In calculating the “investment required” for the project profitability index, the amount invested should be reduced by any salvage recovered from the sale of old equipment.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium
10. The payback method is most appropriate for projects whose cash flows extend far into the future.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Medium
11. When using the payback method, any cash flows for a project that occur after the payback period are not considered in computing the payback period for that project.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Medium
12. The present value of a given future cash flow will increase as the discount rate decreases.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 7 Level: Medium
13. If a company is operating at a profit, the cash inflow resulting from the depreciation tax shield is computed by multiplying the depreciation deduction by one minus the tax rate.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
14. All cash inflows are taxable.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy
15. The after-tax benefit, or net cash inflow, realized from a particular taxable cash receipt can be obtained by multiplying the cash receipt by one minus the tax rate.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy
Multiple Choice Questions
16. Suture Corporation's discount rate is 12%. If Suture has a 5-year investment project that has a project profitability index of zero, this means that:
A) the net present value of the project is equal to zero.
B) the internal rate of return of the project is equal to the discount rate.
C) the payback period of the project is equal to the project's useful life.
D) both A and B above are true.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2,4,5 Level: Hard
17. Amster Corporation has not yet decided on the required rate of return to use in its capital budgeting. This lack of information will prevent Amster from calculating a project's:
| |Payback |Net Present Value |Internal Rate of Return |
|A) |No |No |No |
|B) |Yes |Yes |Yes |
|C) |No |Yes |Yes |
|D) |No |Yes |No |
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2,5 Level: Medium Source: CMA, adapted
18. If income taxes are ignored, how is depreciation used in the following capital budgeting techniques?
| |Internal Rate of Return |Net Present Value |
|A) |Excluded |Excluded |
|B) |Excluded |Included |
|C) |Included |Excluded |
|D) |Included |Included |
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2 Level: Medium Source: CPA, adapted
19. If the net present value of a project is zero based on a discount rate of 16%, then the internal rate of return is:
A) equal to 16%.
B) less than 16%.
C) greater than 16%.
D) cannot be determined from this data.
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2 Level: Medium
20. Three potential investment projects (A, B, and C) at Nit Corporation all require the same initial investment, have the same useful life (3 years), and have no expected salvage value. Expected net cash inflows from these three projects each year is as follows:
| | |A |B |C |
| |Year 1 |$1,000 |$2,000 |$3,000 |
| |Year 2 |$2,000 |$2,000 |$2,000 |
| |Year 3 |$3,000 |$2,000 |$1,000 |
What can be determined from the information provided above?
A) the net present value of project C will be the highest.
B) the internal rate of return of projects A and C cannot be computed.
C) the net present value and the internal rate of return will be the same for all three projects.
D) both A and B above.
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard
21. A project's net present value, ignoring income taxes, is affected by:
A) the net book value of an asset that is replaced.
B) the depreciation on an asset that is replaced.
C) the depreciation to be taken on assets used directly on the project.
D) proceeds from the sale of an asset that is replaced.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy Source: CPA, adapted
22. A company has unlimited funds to invest at its discount rate. The company should invest in all projects having:
A) an internal rate of return greater than zero.
B) a net present value greater than zero.
C) a simple rate of return greater than the discount rate.
D) a payback period less than the project's estimated life.
Ans: B AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy Source: CMA, adapted
23. When the cash flows are the same every period after the initial investment in a project, the payback period is equal to:
A) the net present value.
B) the simple rate of return.
C) the factor of the internal rate of return.
D) the payback rate of return.
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2,5 Level: Hard Source: CMA, adapted
24. The internal rate of return method assumes that a project's cash flows are reinvested at the:
A) internal rate of return.
B) simple rate of return.
C) required rate of return.
D) payback rate of return.
Ans: A AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium Source: CMA, adapted
25. (Ignore income taxes in this problem.) Which of the following would be used in the calculation of the internal rate of return of an investment in new machinery to replace old machinery?
A) The annual depreciation expense on the new machinery.
B) The cost of an overhaul that would be needed on the old machinery in three years.
C) The salvage value of the old machinery in ten years.
D) both B and C above.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium
26. The project profitability index and the internal rate of return:
A) will always result in the same preference ranking for investment projects.
B) will sometimes result in different preference rankings for investment projects.
C) are less dependable than the payback method in ranking investment projects.
D) are less dependable than net present value in ranking investment projects.
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4,5 Level: Medium
27. Zonifugal Corporation needs to purchase a new conveyor system for its factory. Four different conveyor systems have been proposed. Which calculation would be the best one for Zonifugal to use to determine which system to purchase?
A) payback period
B) simple rate of return
C) net present value
D) project profitability index
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium
28. A preference decision:
A) is concerned with whether a project clears the minimum required rate of return hurdle.
B) comes before the screening decision.
C) is concerned with determining which of several acceptable alternatives is best.
D) responses A, B, and C are all correct.
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy
29. In an equipment investment decision, which of the following amounts would be unaffected by a change in the tax rate?
A) the present value of the initial investment in the equipment.
B) the present value of the increase in working capital needed.
C) the present value of the salvage value of the equipment.
D) both A and B above.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
30. When evaluating a project, the portion of the fixed corporate headquarters expense that would be allocated to the project should be:
A) included as a cash outflow on an after-tax basis by multiplying the expense by one minus the tax rate.
B) included as a cash outflow on an after-tax basis by multiplying the expense by the tax rate.
C) included as a cash outflow on a before-tax basis.
D) ignored.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Hard
31. (Ignore income taxes in this problem.) Given the following data:
| |Cost of equipment |$55,750 |
| |Annual cash inflows |$10,000 |
| |Internal rate of return |16% |
The life of the equipment must be:
A) it is impossible to determine from the data given
B) 15 years
C) 12.5 years
D) 5.75 years
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Hard
Solution:
The internal rate of return factor is 5.575, or $55,750 ÷ $10,000. In the table for the Present Value of an Annuity of $1 in Arrears, the factor of 5.575 can be found in the 16% column in the 15th row; 15 then represents the life of the equipment.
32. (Ignore income taxes in this problem.) Heap Company is considering an investment in a project that will have a two year life. The project will provide a 10% internal rate of return, and is expected to have a $40,000 cash inflow the first year and a $50,000 cash inflow in the second year. What investment is required in the project?
A) $74,340
B) $77,660
C) $81,810
D) $90,000
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2 Level: Hard Source: CMA, adapted
Solution:
| |Year(s) |Amount |10% Factor |PV |
|Cash inflow−1st year |1 |40,000 |0.909 |$36,360 |
|Cash inflow−2nd year |2 |50,000 |0.826 | 41,300 |
|Net present value | | | |$77,660 |
For the net present value of this project to be zero, the initial investment should be equal to the present value of the cash inflows, or $77,660.
33. (Ignore income taxes in this problem.) Congener Beverage Corporation is considering an investment in a capital budgeting project that has an internal rate of return of 20%. The only cash outflow for this project is the initial investment. The project is estimated to have an 8 year life and no salvage value. Cash inflows from this project are expected to be $100,000 per year in each of the 8 years. Congener's discount rate is 16%. What is the net present value of this project?
A) $5,215
B) $15,464
C) $50,700
D) $55,831
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2 Level: Hard
Solution:
Internal rate of return factor = Initial investment ÷ Annual inflows
Look up the factor in the table Present Value of an Annuity of $1 in Arrears for 8 periods, 20% column; the factor is 3.837. Substituting into the above equation, 3.837 = Initial investment ÷ $100,000
Initial investment = $383,700.
| |Year(s) |Amount |16% Factor |PV |
|Initial investment |Now |($383,700) |1.000 |($383,700) |
|Annual net cash receipts |1-8 |$100,000 |4.344 | 434,400 |
|Net present value | | | |$ 50,700 |
34. (Ignore income taxes in this problem.) The Able Company is considering buying a new donut maker. This machine will replace an old donut maker that still has a useful life of 2 years. The new machine will cost $2,500 a year to operate, as opposed to the old machine, which costs $2,700 per year to operate. Also, because of increased capacity, an additional 10,000 donuts a year can be produced. The company makes a contribution margin of $0.02 per donut. The old machine can be sold for $5,000 and the new machine costs $25,000. The incremental annual net cash inflows provided by the new machine would be:
A) $200
B) $400
C) $5,200
D) $5,400
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard
Solution:
|Operating cost savings per year ($2,700 − $2,500) |$200 |
|Additional contribution margin provided by the new donut maker ($0.02 × 10,000) | 200 |
|Incremental annual net cash inflows provided by new machine |$400 |
35. (Ignore income taxes in this problem.) Given the following data:
| |Initial investment |$80,000 |
| |Annual cash inflow |? |
| |Salvage value |$0 |
| |Net present value |$13,600 |
| |Life of the project |6 years |
| |Discount rate |16% |
Based on the data given above, the annual cash inflow from the project after the initial investment is closest to:
A) $50,116
B) $21,710
C) $25,400
D) $38,376
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard
Solution:
First, set up table:
| |Year(s) |Amount |16% Factor |PV |
|Initial investment |Now |$80,000 |1.000 |($80,000) |
|Annual cash inflows |1-6 |? |3.685 | ? |
|Net present value | | | |$13,600 |
Second, solve for the present value of the annual cash inflow:
PV of annual cash inflow = $13,600 − (-$80,000) = $93,600
Finally, solve for the annual cash inflow:
Annual cash inflow × 3.685 = $93,600
Annual cash inflow = $25,400
36. (Ignore income taxes in this problem.) Virginia Company invested in a four-year project. Virginia's discount rate is 10%. The cash inflows from this project are:
| |Year |Cash Inflow |
| |1 |$4,000 |
| |2 |$4,400 |
| |3 |$4,800 |
| |4 |$5,200 |
Assuming a positive net present value of $1,000, the amount of the original investment was closest to:
A) $2,552
B) $4,552
C) $13,427
D) $17,400
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard Source: CPA, adapted
Solution:
Net present value of cash inflows − Original investment = Net present value of project
Original investment = NPV of cash inflows − NPV of project
= $14,427 − $1,000 = $13,427
| |Year(s) |Amount |10% Factor |PV |
|Year 1 inflow |1 |$4,000 |0.909 |$ 3,636 |
|Year 2 inflow |2 |$4,400 |0.826 |3,634 |
|Year 3 inflow |3 |$4,800 |0.751 |3,605 |
|Year 4 inflow |4 |$5,200 |0.683 | 3,552 |
|Net present value of cash inflows | | | |$14,427 |
37. (Ignore income taxes in this problem.) Para Corporation is reviewing the following data relating to an energy saving investment proposal:
| |Initial investment |$50,000 |
| |Life of the project |5 years |
| |Salvage value |$10,000 |
| |Annual cash savings |? |
What annual cash savings would be needed in order to satisfy the company's 12% required rate of return (rounded to the nearest one hundred dollars)?
A) $10,600
B) $11,100
C) $12,300
D) $13,900
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard Source: CPA, adapted
Solution:
| |Years |Amount |12% Factor |Present Value |
|Total investment |Now |($50,000) |1.000 |($50,000) |
|Annual cash savings |1-5 |? |3.605 |? |
|Salvage value |5 |$10,000 |0.567 | 5,670 |
|Net present value | | | |$ 0 |
To solve for the present value of the annual cash savings:
-$50,000 + PV of annual cash savings + $5,670 = $0
PV of annual cash savings = $44,330
To solve for the amount of the annual cash savings:
Amount of annual cash savings × 3.605 = $44,330
Amount of annual cash savings = $12,297, which rounds to $12,300
38. (Ignore income taxes in this problem.) Nevus Tattoo Parlor is considering a capital budgeting project. This project will initially require a $25,000 investment in equipment and a $3,000 working capital investment. The useful life of this project is 5 years with an expected salvage value of zero on the equipment. The working capital will be released at the end of the 5 years. The new system is expected to generate net cash inflows of $9,000 per year in each of the 5 years. Nevus' discount rate is 14%. The net present value of this project is closest to:
A) $(3,088)
B) $3,383
C) $4,454
D) $5,897
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium
Solution:
| |Year(s) |Amount |14% Factor |PV |
|Initial investment |Now |($25,000) |1.000 |($25,000) |
|Working capital needed |Now |($3,000) |1.000 |( 3,000) |
|Annual cost savings |1-5 |$9,000 |3.433 |30,897 |
|Working capital released |5 |$3,000 |0.519 | 1,557 |
|Net present value | | | |$ 4,454 |
39. (Ignore income taxes in this problem.) The Malaise Prevention Agency is a non-profit organization that does all of its own informational printing. The printing press that Malaise currently is using needs a $20,000 overhaul. This will extend the useful life of the press by 8 years. As an alternative, Malaise could buy a brand new modern press for $45,000. The new press would also last 8 years. The annual operating expenses of the old press are $12,000. The annual operating expenses of the new press will only be $7,000. The old press is not expected to have a salvage value in 8 years. The new press is expected to have a $6,000 salvage value in 8 years. Malaise's discount rate is 14%. The net present value of the decision to buy the new press instead of overhauling the old press is closest to:
A) $301
B) $(301)
C) $4,195
D) $(46,089)
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard
Solution:
| |Year(s) |Amount |14% Factor |PV |
|Initial investment |Now |($45,000) |1.000 |($45,000) |
|Annual cost savings ($12,000 − $7,000) |1-8 |$5,000 |4.639 |23,195 |
|Salvage value |8 |$6,000 |0.351 | 2,106 |
|Net present value of new press | | | |($19,699) |
|Cost to overhaul old press |$20,000 |
|NPV of new press | 19,699 |
|NPV of new press vs. old press |$ 301 |
40. (Ignore income taxes in this problem.) Nevland Corporation is considering the purchase of a machine that would cost $130,000 and would last for 6 years. At the end of 6 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 $44,000. The company requires a minimum pretax return of 19% on all investment projects. The net present value of the proposed project is closest to:
A) $38,040
B) $26,376
C) $74,902
D) $20,040
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |19% Factor |PV |
|Initial investment |Now |($130,000) |1.000 |($130,000) |
|Annual cost savings |1-6 |$44,000 |3.410 |150,040 |
|Salvage value |6 |$18,000 |0.352 | 6,336 |
|Net present value | | | |$ 26,376 |
41. (Ignore income taxes in this problem) The management of Penfold Corporation is considering the purchase of a machine that would cost $440,000, would last for 7 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 16% on all investment projects. The net present value of the proposed project is closest to:
A) -$28,022
B) $96,949
C) -$79,196
D) $274,000
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |16% Factor |PV |
|Initial investment |Now |($440,000) |1.000 |($440,000) |
|Annual cost savings |1-7 |$102,000 |4.039 | 411,978 |
|Net present value | | | |($ 28,022) |
42. (Ignore income taxes in this problem.) Dowlen, Inc., is considering the purchase of a machine that would cost $150,000 and would last for 6 years. At the end of 6 years, the machine would have a salvage value of $23,000. The machine would reduce labor and other costs by $36,000 per year. Additional working capital of $6,000 would be needed immediately. All of this working capital would be recovered at the end of the life of the machine. 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) $9,657
B) -$2,004
C) $6,699
D) $13,223
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |12% Factor |PV |
|Initial investment |Now |($150,000) |1.000 |($150,000) |
|Working capital needed |Now |($6,000) |1.000 |(6,000) |
|Annual cost savings |1-6 |$36,000 |4.111 |147,996 |
|Working capital released |6 |$6,000 |0.507 |3,042 |
|Salvage value |6 |$23,000 |0.507 | 11,661 |
|Net present value | | | |$ 6,699 |
43. (Ignore income taxes in this problem.) The Poteran Company is considering a machine that will save $3,000 a year in cash operating costs each year for the next six years. At the end of six years it would have no salvage value. If this machine costs $9,060 now, the machine's internal rate of return is closest to:
A) 18%
B) 20%
C) 22%
D) 24%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $9,060 ÷ $3,000 = 3.020
The factor of 3.020 for 6 years represents an internal rate of return of 24%.
44. (Ignore income taxes in this problem) 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:
A) 9%
B) 11%
C) 12%
D) 10%
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Easy
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $365,695 ÷ $61,000 = 5.995
The factor of 5.995 for 9 years represents an internal rate of return of 9%.
45. (Ignore income taxes in this problem.) 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:
A) 19%
B) 18%
C) 21%
D) 16%
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Easy
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $281,656 ÷ $76,000 = 3.706
The factor of 3.706 for 7 years represents an internal rate of return of 19%.
46. (Ignore income taxes in this problem.) Golab Roofing is considering the purchase of a crane that would cost $69,846, would have a useful life of 6 years, and would have no salvage value. The use of the crane would result in labor savings of $21,000 per year. The internal rate of return on the investment in the crane is closest to:
A) 18%
B) 20%
C) 19%
D) 17%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Easy
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $69,846 ÷ $21,000 = 3.326
The factor of 3.326 for 6 years represents an internal rate of return of 20%.
47. (Ignore income taxes in this problem) Boe Corporation is investigating buying a small used aircraft for the use of its executives. The aircraft would have a useful life of 9 years. The company uses a discount rate of 10% in its capital budgeting. The net present value of the investment, excluding the salvage value of the aircraft, is -$439,527. Management is having difficulty estimating the salvage value of the aircraft. 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?
A) $439,527
B) $43,953
C) $4,395,270
D) $1,036,620
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $439,527 ÷ 0.424 = $1,036,613 (answer is slightly off due to rounding)
48. (Ignore income taxes in this problem) The management of Byrge Corporation is investigating buying a small used aircraft to use in making airborne inspections of its above-ground pipelines. The aircraft would have a useful life of 8 years. The company uses a discount rate of 10% in its capital budgeting. The net present value of the investment, excluding the intangible benefits, is -$448,460. To the nearest whole dollar how large would the annual intangible benefit have to be to make the investment in the aircraft financially attractive?
A) $44,846
B) $56,058
C) $84,060
D) $448,460
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $448,460 ÷ 5.335 = $84,060
49. (Ignore income taxes in this problem) The management of Osborn Corporation is investigating an investment in equipment that would have a useful life of 8 years. The company uses a discount rate of 12% in its capital budgeting. The net present value of the investment, excluding the annual cash inflow, is -$401,414. 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) $48,170
B) $50,177
C) $80,800
D) $401,414
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum annual cash flows
= Negative net present value to be offset ÷ Present value factor
= $401,414 ÷ 4.968 = $80,800
50. (Ignore income taxes in this problem.) 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?
A) $41,277
B) $885,021
C) $515,967
D) $6,449,588
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $515,967 ÷ 0.583 = $885,021
51. A project has an initial investment of $100,000 and a project profitability index of 0.15. The discount rate is 12%. The net present value of the project is closest to:
A) $15,000
B) $115,000
C) $112,000
D) $12,000
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium Source: CMA, adapted
Solution:
Project profitability index = Net present value ÷ Investment required
0.15 = Net present value ÷ $100,000
Net present value = $15,000
52. A company is pondering an investment project that has an internal rate of return which is equal to the company's discount rate. The project profitability index of this investment project is:
A) 0.0
B) 0.5
C) 1.0
D) 1.5
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium
53. (Ignore income taxes in this problem.) The management of Solar Corporation is considering the following three investment projects:
| | |Project L |Project M |Project N |
| |Investment required |$37,000 |$55,000 |$82,000 |
| |Present value of cash inflows |$38,480 |$62,150 |$90,200 |
Rank the projects according to the profitability index, from most profitable to least profitable.
A) M,N,L
B) L,N,M
C) N,L,M
D) N,M,L
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy
Solution:
| |Project L |Project M |Project N |
|Investment required (a) |($37,000) |($55,000) |($82,000) |
|Present value of cash inflows | 38,480 | 62,150 | 90,200 |
|Net present value (b) |$ 1,480 |$ 7,150 |$ 8,200 |
|Project profitability index (b) ÷ (a) |0.04 |0.13 |0.10 |
|Ranked by project profitability index |3 |1 |2 |
54. (Ignore income taxes in this problem.) Trovato 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 $51,840. The profitability index of the project is closest to:
A) 0.07
B) 0.08
C) 0.92
D) 1.08
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy
Solution:
| |Project Q |
|Investment required (a) |($48,000) |
|Present value of cash inflows | 51,840 |
|Net present value (b) |$ 3,840 |
|Project profitability index (b) ÷ (a) |0.08 |
55. (Ignore income taxes in this problem.) Ryner Corporation is considering three investment projects-S, T, and U. Project S would require an investment of $20,000, Project T of $69,000, and Project U of $83,000. No other cash outflows would be involved. The present value of the cash inflows would be $23,200 for Project S, $77,970 for Project T, and $94,620 for Project U. Rank the projects according to the profitability index, from most profitable to least profitable.
A) U,T,S
B) T,S,U
C) U,S,T
D) S,U,T
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy
Solution:
| |Project S |Project T |Project U |
|Investment required (a) |($20,000) |($69,000) |($83,000) |
|Present value of cash inflows | 23,200 | 77,970 | 94,620 |
|Net present value (b) |$ 3,200 |$ 8,970 |$11,620 |
|Project profitability index (b) ÷ (a) |0.16 |0.13 |0.14 |
|Ranked by project profitability index |1 |3 |2 |
56. (Ignore income taxes in this problem.) 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:
A) 1.13
B) 0.87
C) 0.13
D) 0.12
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy
Solution:
| |Project Q |
|Investment required (a) |($51,000) |
|Present value of cash inflows | 57,630 |
|Net present value (b) |$ 6,630 |
|Project profitability index (b) ÷ (a) |0.13 |
57. (Ignore income taxes in this problem.) Olinick Corporation is considering a project that would require an investment of $343,000 and would last for 8 years. The incremental annual revenues and expenses generated by the project during those 8 years would be as follows:
| |Sales |$227,000 |
| |Variable expenses | 52,000 |
| |Contribution margin | 175,000 |
| |Fixed expenses: | |
| |Salaries |27,000 |
| |Rents |41,000 |
| |Depreciation | 40,000 |
| |Total fixed expenses | 108,000 |
| |Net operating income |$ 67,000 |
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) 3.0 years
B) 5.1 years
C) 3.2 years
D) 4.8 years
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Easy
Solution:
Net annual cash flow = Net operating income + Depreciation
= $67,000 + $40,000 = $107,000
Payback period = Investment required ÷ Net annual cash flow
= $343,000 ÷ $107,000 = 3.2 years
In this case the salvage value plays no part in the payback period since all of the investment is recovered before the end of the project.
58. (Ignore income taxes in this problem.) The management of Lanzilotta Corporation is considering a project that would require an investment of $263,000 and would last for 8 years. The annual net operating income from the project would be $66,000, which includes depreciation of $31,000. The scrap value of the project's assets at the end of the project would be $15,000. The payback period of the project is closest to:
A) 3.8 years
B) 2.6 years
C) 2.7 years
D) 4.0 years
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Easy
Solution:
Net annual cash flow = Net operating income + Depreciation
= $66,000 + $31,000 = $97,000
Payback period = Investment required ÷ Net annual cash flow
= $263,000 ÷ $97,000 = 2.7 years
In this case the salvage value plays no part in the payback period since all of the investment is recovered before the end of the project.
59. (Ignore income taxes in this problem.) Slomkowski Corporation is contemplating purchasing equipment that would increase sales revenues by $298,000 per year and cash operating expenses by $143,000 per year. The equipment would cost $712,000 and have a 8 year life with no salvage value. The annual depreciation would be $89,000. The simple rate of return on the investment is closest to:
A) 9.3%
B) 21.8%
C) 22.1%
D) 12.5%
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 6 Level: Easy
Solution:
The simple rate of return is computed as follows:
| |Cost of machine, net of salvage value (a) |$712,000 |
| |Useful life (b) |8 years |
| |Annual depreciation (a) ÷ (b) |$89,000 |
| | | |
| |Annual incremental revenue ($298,000 − $143,000) |$155,000 |
| |Less annual depreciation | 89,000 |
| |Annual incremental net operating income |$ 66,000 |
Simple rate of return = Annual incremental net operating income ÷ Initial investment = $66,000 ÷ $712,000 = 9.3%
60. (Ignore income taxes in this problem.) The management of Plotnik Corporation is investigating purchasing equipment that would increase sales revenues by $269,000 per year and cash operating expenses by $156,000 per year. The equipment would cost $294,000 and have a 6 year life with no salvage value. The simple rate of return on the investment is closest to:
A) 16.7%
B) 38.4%
C) 23.8%
D) 21.8%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 6 Level: Easy
Solution:
The simple rate of return is computed as follows:
| |Cost of machine, net of salvage value (a) |$294,000 |
| |Useful life (b) |6 years |
| |Annual depreciation (a) ÷ (b) |$49,000 |
| | | |
| |Annual incremental revenue ($269,000 − $156,000) |$113,000 |
| |Less annual depreciation | 49,000 |
| |Annual incremental net operating income |$ 64,000 |
Simple rate of return = Annual incremental net operating income ÷ Initial investment = $64,000 ÷ $294,000 = 21.8%
61. (Ignore income taxes in this problem.) An expansion at Fey, Inc., would increase sales revenues by $150,000 per year and cash operating expenses by $47,000 per year. The initial investment would be for equipment that would cost $328,000 and have a 8 year life with no salvage value. The annual depreciation on the equipment would be $41,000. The simple rate of return on the investment is closest to:
A) 41.3%
B) 18.9%
C) 12.5%
D) 31.4%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 6 Level: Easy
Solution:
The simple rate of return is computed as follows:
| |Annual incremental revenue ($150,000 − $47,000) |$103,000 |
| |Less annual depreciation | 41,000 |
| |Annual incremental net operating income |$ 62,000 |
Simple rate of return = Annual incremental net operating income ÷ Initial investment = $62,000 ÷ $328,000 = 18.9%
62. (Ignore income taxes in this problem.) Crowl Corporation is investigating automating a process by purchasing a machine for $792,000 that would have a 9 year useful life and no salvage value. By automating the process, the company would save $132,000 per year in cash operating costs. The new machine would replace some old equipment that would be sold for scrap now, yielding $21,000. The annual depreciation on the new machine would be $88,000. The simple rate of return on the investment is closest to:
A) 11.1%
B) 16.7%
C) 5.7%
D) 5.6%
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 6 Level: Easy
Solution:
The simple rate of return is computed as follows:
| |Cost of machine, net of scrap (a) ($792,000 − $21,000) |$771,000 |
| | | |
| |Annual cost savings |$132,000 |
| |Less annual depreciation | 88,000 |
| |Annual incremental net operating income |$ 44,000 |
Simple rate of return = Annual incremental net operating income ÷ Initial investment = $44,000 ÷ $771,000 = 5.7%
63. (Ignore income taxes in this problem.) The management of Ro Corporation is investigating automating a process. Old equipment, with a current salvage value of $11,000, would be replaced by a new machine. The new machine would be purchased for $243,000 and would have a 9 year useful life and no salvage value. By automating the process, the company would save $69,000 per year in cash operating costs. The simple rate of return on the investment is closest to:
A) 18.1%
B) 11.1%
C) 28.4%
D) 17.3%
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 6 Level: Easy
Solution:
The simple rate of return is computed as follows:
| |Cost of machine, net of salvage value (a) |$243,000 |
| |Useful life (b) |9 years |
| |Annual depreciation (a) ÷ (b) |$27,000 |
| | | |
| |Annual cost savings |$69,000 |
| |Less annual depreciation | 27,000 |
| |Annual incremental net operating income |$42,000 |
Simple rate of return = Annual incremental net operating income ÷ Initial investment, less salvage value = $42,000 ÷ ($243,000 − $11,000) = 18.1%
64. (Ignore income taxes in this problem.) A company wants to have $20,000 at the end of a ten-year period by investing a single sum now. How much needs to be invested in order to have the desired sum in ten years, if the money can be invested at 12%?
A) $3,254.68
B) $3,539.82
C) $6,440.00
D) $7,720.00
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 7 Level: Easy
Solution:
Factor from Present Value of $1 table, 12%, 10 years: 0.322
$20,000 × 0.322 = $6,440.00
65. (Ignore income taxes in this problem.) At an interest rate of 14%, approximately how much would you need to invest today if you wanted to have $2,000,000 in 10 years?
A) $383,436
B) $540,000
C) $740,741
D) $1,043,200
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 7 Level: Easy
Solution:
Factor from Present Value of $1 table, 14%, 10 years: 0.270
$2,000,000 × 0.270 = $540,000
66. (Ignore income taxes in this problem.) How much would you have to invest today in the bank at an interest rate of 8% to have an annuity of $4,800 per year for 7 years, with nothing left in the bank at the end of the 7 years? Select the amount below that is closest to your answer.
A) $33,600
B) $2,798
C) $24,989
D) $31,111
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 7 Level: Easy
Solution:
Factor from Present Value of an Annuity of $1 in Arrears Table, 8%, 7 years: 5.206
$4,800 × 5.206 = $24,989
67. (Ignore income taxes in this problem.) You have deposited $24,764 in a special account that has a guaranteed interest rate. If you withdraw $4,300 at the end of each year for 9 years, you will completely exhaust the balance in the account. The guaranteed interest rate is closest to:
A) 6%
B) 10%
C) 17%
D) 56%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 7 Level: Hard
Solution:
$4,300 × Factor from PV of Annuity table = $24,764
Factor from PV of Annuity table = 5.759
Looking in Present Value of an Annuity of $1 in Arrears in the 9th row, 5.759 is found in the 10% column which is the guaranteed interest rate.
68. (Ignore income taxes in this problem.) You have deposited $7,620 in a special account that has a guaranteed interest rate of 19% per year. If you are willing to completely exhaust the account, what is the maximum amount that you could withdraw at the end of each of the next 7 years? Select the amount below that is closest to your answer.
A) $1,295
B) $2,056
C) $2,219
D) $1,089
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 7 Level: Medium
Solution:
Factor from Present Value of an Annuity of $1 in Arrears table, 19%, 7 years: 3.706
$7,620 ÷ 3.706 = $2,056
69. (Ignore income taxes in this problem.) Suddeth Corporation has entered into a 6 year lease for a building it will use as a warehouse. The annual payment under the lease will be $2,468. The first payment will be at the end of the current year and all subsequent payments will be made at year-ends. What is the present value of the lease payments if the discount rate is 5%?
A) $12,528
B) $14,103
C) $14,808
D) $11,050
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 7 Level: Easy
Solution:
Factor from Present Value of an Annuity of $1 in Arrears table, 5%, 6 years: 5.076
$2,468 × 5.076 = $12,528
70. (Ignore income taxes in this problem.) Domebo Corporation has entered into a 7 year lease for a piece of equipment. The annual payment under the lease will be $3,400, with payments being made at the beginning of each year. If the discount rate is 14%, the present value of the lease payments is closest to:
A) $9,511
B) $16,623
C) $20,877
D) $23,800
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 7 Level: Hard
Solution:
Annual payments made at the beginning of the year mean that the first lease payment would be paid immediately; the present value of the first lease payment is therefore $3,400. The next six lease payments for years 2-7 made at the beginning of each year is equivalent to six payments at the end of each year for years 1 through 6. The table for the Present Value of an Annuity of $1 in Arrears can be used to calculate the years 1-6.
Factor from Present Value of an Annuity of $1 in Arrears table, 14%, 6 years: 3.889
($3,400 × 3.889) + $3,400 = $16,623
71. Wedge Corporation uses a discount rate of 14% and has a tax rate of 30%. The following cash flows occur in the last year of a 10-year equipment selection investment project:
| |Cost savings for the year |$180,000 |
| |Working capital released |$120,000 |
| |Salvage value from sale of equipment |$25,000 |
At the end of the ten years when the equipment is sold, its net book value for tax purposes is zero. The total after-tax present value of the cash flows above is closest to:
A) $45,765
B) $48,465
C) $61,425
D) $71,145
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Solution:
| |Years |Amount |Tax Effect |
|Net cash inflow |10 |$180,000 |0.70 |
|Salvage value |10 |$25,000 |0.70 |
|Working capital released |10 |$120,000 | |
|Net present value | | | |
| |After-Tax Cash |14% Factor |Present Value |
| |Flows | | |
|Net annual cash inflow |$126,000 |0.270 |$34,020 |
|Salvage value |$17,500 |0.270 |4,725 |
|Working capital released |$120,000 |0.270 | 32,400 |
|Net present value | | |$71,145 |
72. A company anticipates a taxable cash receipt of $80,000 in year 3 of a project. The company's tax rate is 30% and its discount rate is 10%. The present value of this future cash flow is closest to:
A) $42,056
B) $56,000
C) $24,000
D) $18,032
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Solution:
After-tax cash flow = Before-tax cash flow × (1 − Tax rate)
= $80,000 × (1 − 0.30) = $56,000
Present value factor from Present Value of $1: 0.751
Present value = $56,000 × 0.751 = $42,056
73. A company anticipates a taxable cash expense of $30,000 in year 4 of a project. The company's tax rate is 30% and its discount rate is 14%. The present value of this future cash flow is closest to:
A) $(21,000)
B) $(5,329)
C) $(9,000)
D) $(12,432)
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Solution:
After-tax cash flow = Before-tax cash flow × (1 − Tax rate)
= $30,000 × (1 − 0.30) = $21,000
Present value factor from Present Value of $1: 0.592
Present value = $21,000 × 0.592 = $12,432
74. A company anticipates a depreciation deduction of $70,000 in year 4 of a project. The company's tax rate is 30% and its discount rate is 12%. The present value of the depreciation tax shield resulting from this deduction is closest to:
A) $31,140
B) $49,000
C) $21,000
D) $13,356
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Solution:
Depreciation tax shield = $70,000 × 30% = $21,000
Present value of depreciation shield = $21,000 × 0.636* = $13,356
*Factor from Present Value of $1 table, 12%, 4 years
75. A company needs an increase in working capital of $50,000 in a project that will last 4 years. The company's tax rate is 30% and its discount rate is 14%. The present value of the release of the working capital at the end of the project is closest to:
A) $15,000
B) $20,723
C) $29,600
D) $35,000
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Solution:
Present value of working capital release = $50,000 × 0.592* = $29,600
*Factor from Present Value of $1 table
76. Dunn Construction, Inc., has a large crane that cost $35,000 when purchased ten years ago. Depreciation taken to date totals $25,000. The crane can be sold now for $6,000. Assuming a tax rate of 40%, if the crane is sold the total after-tax cash inflow for capital budgeting purposes will be:
A) $8,400
B) $12,000
C) $7,600
D) $10,000
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Hard
Solution:
| |Sale proceeds |$ 6,000 |
| |Less book value of crane ($35,000 − $25,000) | 10,000 |
| |Loss on sale of crane |($ 4,000) |
| |Cash proceeds from sale |$6,000 |
| |Add tax benefit of loss ($4,000 × 0.40) | 1,600 |
| |Total after-tax cash inflow from sale |$7,600 |
77. If an investment of $90,000 made now has annual cash operating inflows of $5,000, and if the tax rate is 40%, then the after-tax cash operating inflow each year would be:
A) $2,000
B) $36,000
C) $3,000
D) $54,000
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy
Solution:
After-tax cash operating inflow = $5,000 × (1 – 0.40) = $3,000
78. If a company's income tax rate is 30% and its annual depreciation deduction is $80,000, then the annual tax savings from the depreciation tax shield is:
A) $56,000
B) $24,000
C) $80,000
D) $32,000
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy
Solution:
Annual tax savings from depreciation tax shield = $80,000 × 0.30 = $24,000
79. Garfield, Inc., is considering a ten-year investment project with forecasted cash revenues of $40,000 per year and forecasted cash expenses of $29,000 per year. The initial cost of the equipment for the project is $23,000. The salvage value of the equipment is $9,000 at the end of the ten years of the project. The net book value of the equipment for tax purposes will be zero at the end of the ten years. The project requires a working capital investment of $7,000 at its inception and another working capital infusion of $5,000 at the end of year five. All of this working capital would be released for use elsewhere at the end of the project. The company's tax rate is 40%. What is the after-tax net cash flow in the tenth year of the project?
A) $32,000
B) $24,000
C) $20,000
D) $11,000
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium Source: CMA, adapted
Solution:
| |Salvage sale proceeds |$9,000 |
| |Less book value | 0 |
| |Gain on sale |$9,000 |
Net after-tax cash flow in year 10:
| |Gain on sale [$9,000 × (1 − 0.40)] |$ 5,400 |
| |Initial working capital |7,000 |
| |5th year working capital |5,000 |
| |Net revenue per year [($40,000 − $29,000) × (1 − 0.40)] | 6,600 |
| |Net after-tax cash flow |$24,000 |
Use the following to answer questions 80-81:
The Golden Company is analyzing projects A, B, and C as possible investment opportunities. Each of these projects has a useful life of eight years. The following information has been obtained:
| | |Project A |Project B |Project C |
| |Initial investment |$250,000 |$475,000 |$380,000 |
| |Present value of future net cash inflows |$290,000 |$503,000 |$422,000 |
| |Internal rate of return |16% |20% |18% |
80. Consider the following statements:
I. Project A is preferred to Project B according to a net present value ranking.
II. Project A is preferred to Project B according to an internal rate of return ranking.
III. Project A is preferred to Project B according to a project profitability index ranking.
Which is true?
A) Only I
B) Only II
C) Only I and II
D) Only I and III
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
ACIPA FN: Decision Making AICPA FN: Reporting LO: 1,2,4 Level: Easy
Solution:
| | |Project A |Project B |Project C |
| |Initial investment (a) |$250,000 |$475,000 |$380,000 |
| |Present value of future net cash inflows |$290,000 |$503,000 |$422,000 |
| |Net present value (b) |$40,000 |$28,000 |$42,000 |
| |Project profitability index (b) ÷ (a) |0.16 |0.06 |0.11 |
| |Internal rate of return |16% |20% |18% |
81. Consider the following statements:
I. Project A has the highest ranking according to the project profitability index criterion.
II. Project B has the highest ranking according to the internal rate of return criterion.
III. Project C has the highest ranking according to the net present value criterion.
Which is true?
A) Only II
B) Only I and III
C) Only II and III
D) I, II and III
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1,2,4 Level: Easy
Solution:
| | |Project A |Project B |Project C |
| |Initial investment (a) |$250,000 |$475,000 |$380,000 |
| |Present value of future net cash inflows |$290,000 |$503,000 |$422,000 |
| |Net present value (b) |$40,000 |$28,000 |$42,000 |
| |Project profitability index (b) ÷ (a) |0.16 |0.06 |0.11 |
| |Internal rate of return |16% |20% |18% |
Use the following to answer questions 82-85:
(Ignore income taxes in this problem.) Chee Company has gathered the following data on a proposed investment project:
| |Investment required in equipment |$240,000 |
| |Annual cash inflows |$50,000 |
| |Salvage value |$0 |
| |Life of the investment |8 years |
| |Required rate of return |10% |
82. The payback period for the investment is closest to:
A) 0.2 years
B) 2.5 years
C) 4.8 years
D) 5.0 years
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Easy
Solution:
Payback period = Investment required ÷ Annual cash inflows
= $240,000 ÷ $50,000
= 4.8 years
83. The simple rate of return on the investment is closest to:
A) 12.5%
B) 10.0%
C) 20.8%
D) 8.3%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 6 Level: Medium
Solution:
The simple rate of return is computed as follows:
| |Cost of machine, net of salvage value (a) |$240,000 |
| |Useful life (b) |8 years |
| |Annual depreciation (a) ÷ (b) |$30,000 |
| |Annual cash inflows |$50,000 |
| |Less annual depreciation | 30,000 |
| |Annual incremental net operating income |$20,000 |
Simple rate of return = Annual incremental net operating income ÷ Initial investment = $20,000 ÷ $240,000 = 8.3%
84. The net present value on this investment is closest to:
A) $160,000
B) $240,024
C) $58,800
D) $26,750
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium
Solution:
| |Year(s) |Amount |10% Factor |PV |
|Annual cash inflows |1-8 |$50,000 |5.335 |$266,750 |
|Initial investment |Now |($240,000) |1.000 |( 240,000) |
|Net present value | | | |$ 26,750 |
85. The internal rate of return on the investment is closest to:
A) 11%
B) 13%
C) 15%
D) 17%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $240,000 ÷ $50,000 = 4.800
The factor of 4.800 for 8 years represents an internal rate of return of close to 13%.
Use the following to answer questions 86-87:
(Ignore income taxes in this problem.) The Rapp Company is considering buying a new machine which will require an initial outlay of $15,000. The company estimates that over the next four years this machine would save $6,000 per year in cash operating expenses. At the end of four years, the machine would have no salvage value. The company's required rate of return is 14%.
86. The net present value of this investment is closest to:
A) $(12,632)
B) $17,484
C) $2,484
D) $3,612
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium
Solution:
| |Year(s) |Amount |14% Factor |PV |
|Annual cost savings |1-4 |$6,000 |2.914 |$17,484 |
|Initial investment |Now |($15,000) |1.000 |( 15,000) |
|Net present value | | | |$ 2,484 |
87. The machine's internal rate of return is closest to:
A) 16%
B) 18%
C) 20%
D) 22%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium
Solution:
Factor of the internal rate of return = Investment required ÷ Net annual cash inflow = $15,000 ÷ $6,000 = 2.500
The factor of 2.500 for 4 years represents an internal rate of return of almost 22%.
Use the following to answer questions 88-89:
(Ignore income taxes in this problem.) Allo Foundation, a tax-exempt organization, invested $200,000 in cost-saving equipment. The equipment has a five-year useful life with no salvage value. Allo estimates that the annual cash savings from this project will amount to $65,000. On investments of this type, Allo's required rate of return is 12%.
88. The net present value of the project is closest to:
A) $34,300
B) $36,400
C) $90,000
D) $125,000
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium Source: CPA, adapted
Solution:
| |Year(s) |Amount |12% Factor |PV |
|Annual cost savings |1-5 |$65,000 |3.605 |$234,325 |
|Initial investment |Now |($200,000) |1.000 |( 200,000) |
|Net present value | | | |$ 34,325 |
89. Allo's internal rate of return on this project is closest to:
A) 13%
B) 15%
C) 17%
D) 19%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium Source: CPA, adapted
Solution:
Factor of the internal rate of return = Investment required ÷ Net annual cash inflow = $200,000 ÷ $65,000 = 3.077
The factor of 3.077 for 5 years represents an internal rate of return of almost 19%.
Use the following to answer questions 90-91:
(Ignore income taxes in this problem.) Dumora Corporation is considering an investment project that will require an initial investment of $9,400 and will generate the following net cash inflows in each of the five years of its useful life:
| | |Year 1 |Year 2 |Year 3 |Year 4 |Year 5 |
| |Net cash inflows |$1,000 |$2,000 |$4,000 |$6,000 |$5,000 |
Dumora’s discount rate is 16%.
90. Dumora's payback period for this investment project is closest to:
A) 1.91 years
B) 2.61 years
C) 2.89 years
D) 3.40 years
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Medium
Solution:
| |Amount |Remaining Balance |
|Initial investment | |$9,400 |
|Year 1 cash inflow |$1,000 |$8,400 |
|Year 2 cash inflow |$2,000 |$6,400 |
|Year 3 cash inflow |$4,000 |$2,400 |
Year 4: $2,400 ÷ $6,000 = 0.4
Therefore, the payback period for this investment is 3.4 years.
91. Dumora's net present value for this investment project is closest to:
A) $(832)
B) $1,204
C) $1,376
D) $2,386
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium
Solution:
| |Year(s) |Amount |16% Factor |PV |
|Cost savings−Year 1 |1 |$1,000 |0.862 |$ 862 |
|Cost savings−Year 2 |2 |$2,000 |0.743 |1,486 |
|Cost savings−Year 3 |3 |$4,000 |0.641 |2,564 |
|Cost savings−Year 4 |4 |$6,000 |0.552 |3,312 |
|Cost savings−Year 5 |5 |$5,000 |0.476 |2,380 |
|Initial investment |Now |($9,400) |1.000 |( 9,400) |
|Net present value | | | |$1,204 |
Use the following to answer questions 92-93:
(Ignore income taxes in this problem.) Vandezande Inc. is considering the acquisition of a new machine that costs $370,000 and has a useful life of 5 years with no salvage value. The incremental net operating income and incremental net cash flows that would be produced by the machine are:
| | |Incremental net operating income |Incremental net cash flows |
| |Year 1 |$54,000 |$128,000 |
| |Year 2 |$31,000 |$105,000 |
| |Year 3 |$52,000 |$126,000 |
| |Year 4 |$49,000 |$123,000 |
| |Year 5 |$48,000 |$122,000 |
92. If the discount rate is 10%, the net present value of the investment is closest to:
A) $370,000
B) $457,479
C) $234,000
D) $87,479
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium Source: CMA, adapted
Solution:
| |Year(s) |Amount |10% Factor |PV |
|Initial investment |Now |($370,000) |1.000 |($370,000) |
|Year 1 incremental net cash inflow |1 |$128,000 |0.909 |116,352 |
|Year 2 incremental net cash inflow |2 |$105,000 |0.826 |86,730 |
|Year 3 incremental net cash inflow |3 |$126,000 |0.751 |94,626 |
|Year 4 incremental net cash inflow |4 |$123,000 |0.683 |84,009 |
|Year 5 incremental net cash inflow |5 |$122,000 |0.621 | 75,762 |
|Net present value | | | |$ 87,479 |
93. The payback period of this investment, rounded off to the nearest tenth of a year, is closest to:
A) 2.9 years
B) 4.9 years
C) 3.1 years
D) 5.0 years
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Medium Source: CMA, adapted
Solution:
| |Amount |Remaining |
| | |Balance |
|Initial investment | |$370,000 |
|Year 1 cash inflow |$128,000 |$242,000 |
|Year 2 cash inflow |$105,000 |$137,000 |
|Year 3 cash inflow |$126,000 |$11,000 |
Year 4: $11,000 ÷ $123,000 = 0.1 (rounded to nearest tenth)
Therefore, the payback period for this investment is 3.1 years.
Use the following to answer questions 94-95:
(Ignore income taxes in this problem.) Oriol Inc. is considering the acquisition of equipment that costs $360,000 and has a useful life of 6 years with no salvage value. The incremental net cash flows that would be generated by the equipment are:
| | |Incremental net cash flows |
| |Year 1 |$115,000 |
| |Year 2 |$138,000 |
| |Year 3 |$95,000 |
| |Year 4 |$91,000 |
| |Year 5 |$133,000 |
| |Year 6 |$134,000 |
94. If the discount rate is 19%, the net present value of the investment is closest to:
A) $346,000
B) $398,667
C) $38,667
D) $121,841
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy Source: CMA, adapted
Solution:
| |Year(s) |Amount |19% Factor |PV |
|Initial investment |Now |($360,000) |1.000 |($360,000) |
|Year 1 incremental net cash inflow |1 |$115,000 |0.840 |96,600 |
|Year 2 incremental net cash inflow |2 |$138,000 |0.706 |97,428 |
|Year 3 incremental net cash inflow |3 |$95,000 |0.593 |56,335 |
|Year 4 incremental net cash inflow |4 |$91,000 |0.499 |45,409 |
|Year 5 incremental net cash inflow |5 |$133,000 |0.419 |55,727 |
|Year 6 incremental net cash inflow |6 |$134,000 |0.352 | 47,168 |
|Net present value | | | |$38,667 |
95. The payback period of this investment is closest to:
A) 4.1 years
B) 2.9 years
C) 5.0 years
D) 3.1 years
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Easy Source: CMA, adapted
Solution:
| |Amount |Remaining |
| | |Balance |
|Initial investment | |$360,000 |
|Year 1 cash inflow |$115,000 |245,000 |
|Year 2 cash inflow |138,000 |107,000 |
|Year 3 cash inflow |95,000 |12,000 |
Year 4: $12,000 ÷ $91,000 = 0.1 (rounded to nearest tenth)
Therefore, the payback period for this investment is 3.1 years.
Use the following to answer questions 96-98:
(Ignore income taxes in this problem.) Morrel University has a small shuttle bus that is in poor mechanical condition. The bus can be either overhauled now or replaced with a new shuttle bus. The following data have been gathered concerning these two alternatives:
| | |Present Bus |New Bus |
| |Purchase cost new |$32,000 |$40,000 |
| |Remaining net book value |$21,000 |— |
| |Major repair needed now |$9,000 |— |
| |Annual cash operating costs |$12,000 |$8,000 |
| |Salvage value now |$10,000 |— |
| |Trade-in value in seven years |$2,000 |$5,000 |
The University could continue to use the present bus for the next seven years. Whether the present bus is used or a new bus is purchased, the bus would be traded in for another bus at the end of seven years. The University uses a discount rate of 12% and the total cost approach to net present value analysis in evaluating its investment decisions.
96. If the new bus is purchased, the present value of the annual cash operating costs associated with this alternative is (rounded off to the nearest hundred dollars):
A) $(54,800)
B) $(36,500)
C) $(16,200)
D) $(42,800)
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |12% Factor |PV |
|Annual cash operating costs |1-7 |($8,000) |4.564 |($36,512) |
97. If the present bus is repaired, the present value of the annual cash operating costs associated with this alternative is (rounded off to the nearest hundred dollars):
A) $(36,500)
B) $(16,200)
C) $(47,200)
D) $(54,800)
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |12% Factor |PV |
|Annual cash operating costs |1-7 |($12,000) |4.564 |($54,768) |
98. If the present bus is repaired, the present value of the salvage received on sale of the bus seven years from now is:
A) $(2,260)
B) $2,260
C) $904
D) $(904)
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |12% Factor |PV |
|Salvage value |7 |$2,000 |0.452 |$904 |
Use the following to answer questions 99-100:
(Ignore income taxes in this problem.) Becker Billing Systems, Inc., has an antiquated high-capacity printer that needs to be upgraded. The system either can be overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives:
| | |Overhaul Present System |Purchase New System |
| |Purchase cost when new |$300,000 |$400,000 |
| |Accumulated depreciation |$220,000 |— |
| |Overhaul costs needed now |$250,000 |— |
| |Annual cash operating costs |$120,000 |$90,000 |
| |Salvage value now |$90,000 |— |
| |Salvage value in ten years |$30,000 |$80,000 |
| |Working capital required |— |$50,000 |
The company uses a 10% discount rate and the total-cost approach to capital budgeting analysis. The working capital required under the new system would be released for use elsewhere at the conclusion of the project. Both alternatives are expected to have a useful life of ten years.
99. The net present value of the overhaul alternative (rounded to the nearest hundred dollars) is:
A) $(750,300)
B) $(725,800)
C) $(975,800)
D) $(987,400)
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard
Solution:
| |Year(s) |Amount |10% Factor |PV |
|Annual operating costs |1-10 |($120,000) |6.145 |($737,400) |
|Overhaul costs |Now |($250,000) |1.000 |(250,000) |
|Salvage value |10 |$30,000 |0.386 | 11,580 |
|Net present value | | | |($975,820) |
100. The net present value of the new system alternative (rounded to the nearest hundred dollars) is:
A) $(862,900)
B) $(552,900)
C) $(758,400)
D) $(987,400)
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard
Solution:
| |Year(s) |Amount |10% Factor |PV |
|Initial investment |Now |($400,000) |1.000 |($400,000) |
|Annual operating costs |1-10 |($90,000) |6.145 |(553,050) |
|Salvage value−old equip. |Now |$90,000 |1.000 |90,000 |
|Salvage value |10 |$80,000 |0.386 |30,880 |
|Working capital required |Now |($50,000) |1.000 |(50,000) |
|Working capital released |10 |$50,000 |0.386 | 19,300 |
|Net present value | | | |($862,870) |
Use the following to answer questions 101-102:
(Ignore income taxes in this problem.) 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.
101. The present value of the annual cost savings of $72,000 is closest to:
A) $22,608
B) $874,298
C) $504,000
D) $274,464
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |18% Factor |PV |
|Annual cost savings |1-7 |$72,000 |3.812 |$274,464 |
102. The net present value of the proposed project is closest to:
A) -$29,522
B) -$45,536
C) $5,464
D) -$94,042
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |18% Factor |PV |
|Initial investment |Now |($320,000) |1.000 |($320,000) |
|Annual cost savings |1-7 |$72,000 |3.812 |274,464 |
|Salvage value |7 |$51,000 |0.314 | 16,014 |
|Net present value | | | |($ 29,522) |
Use the following to answer questions 103-104:
(Ignore income taxes in this problem.) The management of Opray Corporation is considering the purchase of a machine that would cost $360,000, would last for 7 years, and would have no salvage value. The machine would reduce labor and other costs by $78,000 per year. The company requires a minimum pretax return of 11% on all investment projects.
103. The present value of the annual cost savings of $78,000 is closest to:
A) $763,064
B) $177,027
C) $546,000
D) $367,536
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |11% Factor |PV |
|Annual labor savings |1-7 |$78,000 |4.712 |$367,536 |
104. The net present value of the proposed project is closest to:
A) $15,646
B) $89,588
C) $7,536
D) $186,000
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |11% Factor |PV |
|Initial investment |Now |($360,000) |1.000 |($360,000) |
|Annual net cash receipts |1-7 |$78,000 |4.712 | 367,536 |
|Net present value | | | |$ 7,536 |
Use the following to answer questions 105-106:
(Ignore income taxes in this problem.) Paragas, Inc., is considering the purchase of a machine that would cost $370,000 and would last for 8 years. At the end of 8 years, the machine would have a salvage value of $52,000. The machine would reduce labor and other costs by $96,000 per year. Additional working capital of $4,000 would be needed immediately. All of this working capital would be recovered at the end of the life of the machine. The company requires a minimum pretax return of 19% on all investment projects.
105. The combined present value of the working capital needed at the beginning of the project and the working capital released at the end of the project is closest to:
A) -$3,004
B) $0
C) -$12,080
D) $11,816
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |19% Factor |PV |
|Working capital required |Now |($4,000) |1.000 |($4,000) |
|Working capital released |8 |$4,000 |0.249 | 996 |
|Net present value | | | |($3,004) |
106. The net present value of the proposed project is closest to:
A) $9,584
B) $78,530
C) $22,532
D) $19,528
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
Solution:
| |Year(s) |Amount |19% Factor |PV |
|Initial investment |Now |($370,000) |1.000 |($370,000) |
|Annual labor savings |1-8 |$96,000 |3.954 |379,584 |
|Working capital required |Now |($4,000) |1.000 |(4,000) |
|Working capital released |8 |$4,000 |0.249 |996 |
|Salvage value |8 |$52,000 |0.249 | 12,950 |
|Net present value | | | |$ 19,530 |
Use the following to answer questions 107-108:
(Ignore income taxes in this problem.) Undersymington Company has an opportunity to invest in a machine that would cost $28,000, and that would produce cost savings of $8,000 each year for the next five years.
107. If the machine has zero salvage value, then the internal rate of return is closest to:
A) 10.4%
B) 10.9%
C) 12.8%
D) 13.2%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $28,000 ÷ $8,000 = 3.500.
The factor of 3.500 for 5 years represents an internal rate of return of somewhat more than 13%, or 13.2%.
108. If the machine's salvage value at the end of the project is $4,000, then the internal rate of return is:
A) less than 11%
B) less than 12%, but greater than 11%
C) less than 13%, but greater than 12%
D) greater than 13%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Hard
Solution:
Factor of the internal rate of return without considering salvage value
= Investment required ÷ Net annual cash inflow = $28,000 ÷ $8,000 = 3.500.
The factor of 3.500 for 5 years represents an internal rate of return of somewhat more than 13%, or 13.2%.
Since the IRR is more than 13% without considering the salvage value, adding in the present value of the salvage value will further increase the IRR.
Use the following to answer questions 109-110:
(Ignore income taxes in this problem.) Cabe Corporation uses a discount rate of 18% in its capital budgeting. Partial analysis of an investment in automated equipment with a useful life of 7 years has thus far yielded a net present value of -$155,606. 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.
109. 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) $40,820
B) $22,229
C) $28,009
D) $155,606
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $155,606 ÷ 3.812 = $40,820
110. Ignoring any cash flows from intangible benefits, to the nearest whole dollar how large would the salvage value of the automated equipment have to be to make the investment in the automated equipment financially attractive?
A) $495,561
B) $28,009
C) $155,606
D) $864,478
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $155,606 ÷ 0.314 = $495,561
Use the following to answer questions 111-112:
(Ignore income taxes in this problem.) 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.
111. 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) $54,660
B) $49,194
C) $87,400
D) $273,300
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $273,300 ÷ 3.127 = $87,400
112. Ignoring the cash inflows, 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?
A) $625,400
B) $1,518,333
C) $273,300
D) $49,194
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $273,300 ÷ 0.437 = $625,400
Use the following to answer questions 113-114:
(Ignore income taxes in this problem.) Lem Corporation is investigating buying a small used aircraft for the use of its executives. The aircraft would have a useful life of 7 years. The company uses a discount rate of 11% in its capital budgeting. The net present value of the initial investment and the annual operating cash cost is -$317,966. Management is having difficulty estimating the annual benefit of having the aircraft and estimating the salvage value of the aircraft.
113. 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?
A) $2,890,600
B) $317,966
C) $34,976
D) $659,680
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $317,966 ÷ 0.482 = $659,680
114. Ignoring any salvage value, to the nearest whole dollar how large would the annual benefit have to be to make the investment in the aircraft financially attractive?
A) $67,480
B) $317,966
C) $34,976
D) $45,424
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $317,966 ÷ 4.712 = $67,480
Use the following to answer questions 115-116:
(Ignore income taxes in this problem.) Eddie Corporation is considering the following three investment projects:
| | |Project C |Project D |Project E |
| |Investment required |$36,000 |$41,000 |$85,000 |
| |Present value of cash inflows |$39,960 |$47,560 |$92,650 |
115. The profitability index of investment project D is closest to:
A) 0.16
B) 0.84
C) 0.14
D) 1.16
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy
Solution:
| |Project D |
|Investment required (a) |($41,000) |
|Present value of cash inflows | 47,560 |
|Net present value (b) |$ 6,560 |
|Project profitability index (b) ÷ (a) |0.16 |
116. Rank the projects according to the profitability index, from most profitable to least profitable.
A) E,C,D
B) E,D,C
C) D,C,E
D) C,E,D
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium
Solution:
| |Project C |Project D |Project E |
|Investment required (a) |($36,000) |($41,000) |($85,000) |
|Present value of cash inflows | 39,960 | 47,560 | 92,650 |
|Net present value (b) |$ 3,960 |$ 6,560 |$ 7,650 |
|Project profitability index (b) ÷ (a) |0.11 |0.16 |0.09 |
|Ranked by project profitability index |2 |1 |3 |
Use the following to answer questions 117-118:
(Ignore income taxes in this problem.) 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.
117. The profitability index of investment project X is closest to:
A) 0.11
B) 0.88
C) 1.12
D) 0.12
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy
Solution:
| |Project X |
|Investment required (a) |($66,000) |
|Present value of cash inflows | 73,920 |
|Net present value (b) |$ 7,920 |
|Project profitability index (b) ÷ (a) |0.12 |
118. Rank the projects according to the profitability index, from most profitable to least profitable.
A) Y,W,X
B) X,Y,W
C) X,W,Y
D) W,Y,X
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Medium
Solution:
| |Project W |Project X |Project Y |
|Investment required (a) |($21,000) |($66,000) |($95,000) |
|Present value of cash inflows | 22,470 | 73,920 | 98,800 |
|Net present value (b) |$ 1,470 |$ 7,920 |$ 3,800 |
|Project profitability index (b) ÷ (a) |0.07 |0.12 |0.04 |
|Ranked by project profitability index |2 |1 |3 |
Use the following to answer questions 119-123:
(Appendix 14C) Gibboney Inc. has provided the following data to be used in evaluating a proposed investment project:
| |Initial investment |$880,000 |
| |Annual cash receipts |$660,000 |
| |Life of the project |8 years |
| |Annual cash expenses |$330,000 |
| |Salvage value |$88,000 |
| |Tax rate |30% |
For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 7 years. The company uses a discount rate of 12%.
119. When computing the net present value of the project, what are the annual after-tax cash receipts?
A) $462,000
B) $396,000
C) $198,000
D) $69,300
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)
= $660,000 × (1 − 0.30) = $462,000
120. When computing the net present value of the project, what are the annual after-tax cash expenses?
A) $429,000
B) $242,000
C) $99,000
D) $231,000
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash expenses = Annual cash expenses × (1 − Tax rate)
= $330,000 × (1 − 0.30)
= $231,000
121. When computing the net present value of the project, what is the annual amount of the depreciation tax shield? In other words, by how much does the depreciation deduction reduce taxes each year in which the depreciation deduction is taken?
A) $37,714
B) $88,000
C) $77,000
D) $33,000
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
| |Initial investment |$880,000 |
| |Life in years |7 years |
| |Annual amount of depreciation |$125,714 |
Annual amount of depreciation tax shield = $125,714 × 0.30
= $37,714
122. When computing the net present value of the project, what is the after-tax cash flow from the salvage value in the final year?
A) $0
B) $88,000
C) $26,400
D) $61,600
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
| |Gain on sale (asset fully depreciated) |$88,000 |
| |× (1 − Tax rate) |0.70 |
| |After-tax cash flow from salvage value |$61,600 |
123. The net present value of the project is closest to:
A) $464,622
B) $439,736
C) $292,494
D) $267,608
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)
= $660,000 × (1 − 0.30) = $462,000
Annual after-tax cash expenses = Annual cash expenses × (1 − Tax rate)
= $330,000 × (1 − 0.30)
= $231,000
| |Initial investment |$880,000 |
| |Life in years |7 years |
| |Annual amount of depreciation |$125,714 |
Annual amount of depreciation tax shield = $125,714 × 0.30
= $37,714
| |Year(s) |Amount |12% Factor |PV |
|Initial investment |Now |($880,000) |1.000 |($ 880,000) |
|Annual net cash receipts (after-tax) |1-8 |$462,000 |4.968 |2,295,216 |
|Annual net cash expenses (after-tax) |1-8 |($231,000) |4.968 |(1,147,608) |
|Salvage value (after-tax) |8 |$61,600 |0.404 |24,886 |
|Annual depreciation tax shield |1-7 |$37,714 |4.564 | 172,127 |
|Net present value | | | |$ 464,621 |
Use the following to answer questions 124-127:
(Appendix 14C) Shufflebarger Inc. has provided the following data to be used in evaluating a proposed investment project:
| |Initial investment |$280,000 |
| |Annual cash receipts |$196,000 |
| |Life of the project |6 years |
| |Annual cash expenses |$78,000 |
| |Salvage value |$28,000 |
The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated over 5 years without any reduction for salvage value. The company uses a discount rate of 16%.
124. When computing the net present value of the project, what are the annual after-tax cash receipts?
A) $112,000
B) $137,200
C) $29,400
D) $58,800
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)
= $196,000 × (1 − 0.30) = $137,200
125. When computing the net present value of the project, what are the annual after-tax cash expenses?
A) $101,400
B) $50,000
C) $54,600
D) $23,400
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash expenses = Annual cash expenses × (1 − Tax rate)
= $78,000 × (1 − 0.30) = $54,600
126. When computing the net present value of the project, what is the annual amount of the depreciation tax shield? In other words, by how much does the depreciation deduction reduce taxes each year in which the depreciation deduction is taken?
A) $16,800
B) $39,200
C) $14,000
D) $32,667
Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
| |Initial investment |$280,000 |
| |Life in years |5 years |
| |Annual amount of depreciation |$56,000 |
Annual amount of depreciation tax shield = $56,000 × 0.30
= $16,800
127. When computing the net present value of the project, what is the after-tax cash flow from the salvage value in the final year?
A) $28,000
B) $8,400
C) $19,600
D) $0
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
| |Gain on sale (asset fully depreciated) |$28,000 |
| |× (1 − Tax rate) |0.70 |
| |After-tax cash flow from salvage value |$19,600 |
Use the following to answer questions 128-129:
(Appendix 14C) Valentin Inc. has provided the following data concerning an investment project that has been proposed:
| |Initial investment |$890,000 |
| |Annual cash receipts |$534,000 |
| |Life of the project |5 years |
| |Annual cash expenses |$267,000 |
| |Salvage value |$45,000 |
The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated over 3 years without any reduction for salvage value. The company uses a discount rate of 10%.
128. When computing the net present value of the project, what is the after-tax cash flow from the salvage value in the final year?
A) $13,500
B) $45,000
C) $0
D) $31,500
Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
| |Gain on sale (asset fully depreciated) |$45,000 |
| |× (1 − Tax rate) |0.70 |
| |After-tax cash flow from salvage value |$31,500 |
129. The net present value of the project is closest to:
A) $39,881
B) $59,442
C) -$181,462
D) -$161,901
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
| |Gain on sale (asset fully depreciated) |$45,000 |
| |× (1 − Tax rate) |0.70 |
| |After-tax cash flow from salvage value |$31,500 |
| |Initial investment |$890,000 |
| |Depreciable life in years |3 years |
| |Annual depreciation |$296,667 |
| |× Tax rate |0.30 |
| |Annual depreciation tax shield |$89,000 |
Annual net cash inflows = Annual cash receipts − Annual cash expenses
= $534,000 − $267,000
= $267,000
After-tax cash inflows = $267,000 × (1 − 0.30)
= $186,900
| |Year(s) |Amount |10% Factor |PV |
|Initial investment |Now |($890,000) |1.000 |($890,000) |
|Annual net cash inflows (after-tax) |1-5 |$186,900 |3.791 |708,538 |
|Depreciation tax shield |1-3 |$89,000 |2.487 |221,343 |
|Salvage value (after-tax) |5 |$31,500 |0.621 | 19,562 |
|Net present value | | | |$ 59,443 |
Use the following to answer questions 130-131:
(Appendix 14C) Nunoz Inc. is considering an investment project that would require an initial investment of $250,000 and that would last for 9 years. The annual cash receipts from the project would be $175,000 and the annual cash expenses would be $79,000. The equipment used in the project could be sold at the end of the project for a salvage value of $13,000. The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated over 7 years without any reduction for salvage value. The company uses a discount rate of 10%.
130. When computing the net present value of the project, what are the annual after-tax cash receipts?
A) $52,500
B) $122,500
C) $139,286
D) $96,000
Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)
= $175,000 × (1 − 0.30) = $122,500
131. The net present value of the project is closest to:
A) $140,863
B) $137,005
C) $193,020
D) $189,162
Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)
= $175,000 × (1 − 0.30) = $122,500
Annual after-tax expenses = Annual expenses × (1 − Tax rate)
= $79,000 × (1 − 0.30) = $55,300
| |Initial investment |$250,000 |
| |Depreciable life in years |7 years |
| |Annual depreciation |$35,714 |
| |× Tax rate |0.30 |
| |Annual depreciation tax shield |$10,714 |
| |Gain on sale (asset fully depreciated) |$13,000 |
| |× (1 − Tax rate) |0.70 |
| |After-tax cash flow from salvage value |$9,100 |
| |Year(s) |Amount |10% Factor |PV |
|Initial investment |Now |($250,000) |1.000 |($250,000) |
|Annual cash receipts (after-tax) |1-9 |$122,500 |5.759 |705,478 |
|Annual cash expenses (after-tax) |1-9 |($55,300) |5.759 |(318,473) |
|Depreciation tax shield |1-7 |$10,714 |4.868 |52,156 |
|Salvage value |9 |$9,100 |0.424 | 3,858 |
|Net present value | | | |$193,019 |
Essay Questions
132. (Ignore income taxes in this problem.) Cooney Inc. has provided the following data concerning a proposed investment project:
| |Initial investment |$160,000 |
| |Life of the project |7 years |
| |Annual net cash inflows |$40,000 |
| |Salvage value |$16,000 |
The company uses a discount rate of 17%.
Required:
Compute the net present value of the project.
Ans:
| |Year(s) |Amount |17% Factor |PV |
|Initial investment |Now |($160,000) |1.000 |($160,000) |
|Annual net cash receipts |1-7 |$40,000 |3.922 |156,880 |
|Salvage value |7 |$16,000 |0.333 | 5,328 |
|Net present value | | | |$ 2,208 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
133. (Ignore income taxes in this problem.) Strausberg Inc. is considering investing in a project that would require an initial investment of $270,000. The life of the project would be 6 years. The annual net cash inflows from the project would be $81,000. The salvage value of the assets at the end of the project would be $27,000. The company uses a discount rate of 10%.
Required:
Compute the net present value of the project.
Ans:
| |Year(s) |Amount |10% Factor |PV |
|Initial investment |Now |($270,000) |1.000 |($270,000) |
|Annual net cash receipts |1-6 |$81,000 |4.355 |352,755 |
|Salvage value |6 |$27,000 |0.564 | 15,228 |
|Net present value | | | |$ 97,983 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
134. (Ignore income taxes in this problem.) Tiff Corporation has provided the following data concerning a proposed investment project:
| |Initial investment |$960,000 |
| |Life of the project |6 years |
| |Working capital required |$20,000 |
| |Annual net cash inflows |$288,000 |
| |Salvage value |$144,000 |
The company uses a discount rate of 16%. The working capital would be released at the end of the project.
Required:
Compute the net present value of the project.
Ans:
| |Year(s) |Amount |16% Factor |PV |
|Initial investment |Now |($960,000) |1.000 |($ 960,000) |
|Annual net cash inflows |1-6 |$288,000 |3.685 |1,061,280 |
|Working capital invested |Now |($20,000) |1.000 |(20,000) |
|Working capital released |6 |$20,000 |0.410 |8,200 |
|Salvage value |6 |$144,000 |0.410 | 59,040 |
|Net present value | | | |$ 148,520 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
135. (Ignore income taxes in this problem.) Mattice Corporation is considering investing $490,000 in a project. The life of the project would be 7 years. The project would require additional working capital of $34,000, which would be released for use elsewhere at the end of the project. The annual net cash inflows would be $123,000. The salvage value of the assets used in the project would be $49,000. The company uses a discount rate of 11%.
Required:
Compute the net present value of the project.
Ans:
| |Year(s) |Amount |11% Factor |PV | |
|Initial investment |Now |($490,000) |1.000 |($490,000) | |
|Annual net cash inflows |1-7 |$123,000 |4.712 |579,576 | |
|Working capital invested |Now |($34,000) |1.000 |(34,000) | |
|Working capital released |7 |$34,000 |0.482 |16,388 | |
|Salvage value |7 |$49,000 |0.482 | 23,618 | |
|Net present value | | | |$ 95,582 | |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
136. (Ignore income taxes in this problem.) Wary Corporation is considering the purchase of a machine that would cost $240,000 and would last for 9 years. At the end of 9 years, the machine would have a salvage value of $29,000. The machine would reduce labor and other costs by $63,000 per year. The company requires a minimum pretax return of 19% on all investment projects.
Required:
Determine the net present value of the project. Show your work!
Ans:
| |Year(s) |Amount |19% Factor |PV |
|Annual cost savings |1-9 |$63,000 |4.163 |$262,269 |
|Initial investment |Now |($240,000) |1.000 |(240,000) |
|Salvage value |9 |$29,000 |0.209 | 6,061 |
|Net present value | | | |$ 28,330 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
137. (Ignore income taxes in this problem.) The management of Kinion Corporation is considering the purchase of a machine that would cost $170,000, would last for 7 years, and would have no salvage value. The machine would reduce labor and other costs by $50,000 per year. The company requires a minimum pretax return of 17% on all investment projects.
Required:
Determine the net present value of the project. Show your work!
Ans:
| |Year(s) |Amount |17% Factor |PV |
|Annual cost savings |1-7 |$50,000 |3.922 |$196,100 |
|Initial investment |Now |($170,000) |1.000 |( 170,000) |
|Net present value | | | |$ 26,100 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
138. (Ignore income taxes in this problem.) Joanette, Inc., is considering the purchase of a machine that would cost $240,000 and would last for 5 years, at the end of which, the machine would have a salvage value of $48,000. The machine would reduce labor and other costs by $62,000 per year. Additional working capital of $7,000 would be needed immediately, all of which would be recovered at the end of 5 years. The company requires a minimum pretax return of 17% on all investment projects.
Required:
Determine the net present value of the project. Show your work!
Ans:
| |Year(s) |Amount |17% Factor |PV |
|Initial investment |Now |($240,000) |1.000 |($240,000) |
|Working capital needed |Now |($7,000) |1.000 |(7,000) |
|Annual cost savings |1-5 |$62,000 |3.199 |198,338 |
|Working capital released |5 |$7,000 |0.456 |3,192 |
|Salvage value |5 |$48,000 |0.456 | 21,888 |
|Net present value | | | |($ 23,582) |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy
139. (Ignore income taxes in this problem.) The management of Harling Corporation is considering the purchase of a machine that would cost $90,504 and would have a useful life of 5 years. The machine would have no salvage value. The machine would reduce labor and other operating costs by $27,000 per year.
Required:
Determine the internal rate of return on the investment in the new machine. Show your work!
Ans:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $90,504 ÷ $27,000 = 3.352
The factor of 3.352 for 5 years represents an internal rate of return of 15%.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Easy
140. (Ignore income taxes in this problem.) Maxcy Limos, Inc., is considering the purchase of a limousine that would cost $187,335, would have a useful life of 9 years, and would have no salvage value. The limousine would bring in cash inflows of $45,000 per year in excess of its cash operating costs.
Required:
Determine the internal rate of return on the investment in the new limousine. Show your work!
Ans:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $187,335 ÷ $45,000 = 4.163
The factor of 4.163 for 9 years represents an internal rate of return of 19%.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Easy
141. (Ignore income taxes in this problem.) The management of Zachery Corporation is considering the purchase of a automated molding machine that would cost $203,255, would have a useful life of 5 years, and would have no salvage value. The automated molding machine would result in cash savings of $65,000 per year due to lower labor and other costs.
Required:
Determine the internal rate of return on the investment in the new automated molding machine. Show your work!
Ans:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $203,255 ÷ $65,000 = 3.127
The factor of 3.127 for 5 years represents an internal rate of return of 18%.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Easy
142. (Ignore income taxes in this problem.) The management of an amusement park is considering purchasing a new ride for $60,000 that would have a useful life of 15 years and a salvage value of $8,000. The ride would require annual operating costs of $26,000 throughout its useful life. The company's discount rate is 10%. Management is unsure about how much additional ticket revenue the new ride would generate-particularly since customers pay a flat fee when they enter the park that entitles them to unlimited rides. Hopefully, the presence of the ride would attract new customers.
Required:
How much additional revenue would the ride have to generate per year to make it an attractive investment?
Ans:
| |Years |Amount |10%Factor |Present Value |
|Cost of asset |Now |$(60,000) |1.000 |($ 60,000) |
|Annual operating costs |1-15 |$(26,000) |7.606 |( 197,756) |
|Salvage value |15 |$8,000 |0.239 | 1,912 |
|Net present value | | | |($255,844) |
$255,844 ÷ 7.606 = $33,637 additional revenue per year would be necessary to justify the investment. This much additional revenue would result in a zero net present value. Any less than this and the net present value would be negative. Any more than this and the net present value would be positive.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Hard
143. (Ignore income taxes in this problem.) Devon Corporation uses a discount rate of 8% 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 -$496,541. 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.
Required:
a. Ignoring any salvage value, 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?
b. Ignoring any cash flows from intangible benefits, how large would the salvage value of the automated equipment have to be to make the investment in the automated equipment financially attractive?
Ans:
a. Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $496,541 ÷ 5.747 = $86,400
b. Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $496,541 ÷ 0.540 = $919,520
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
144. (Ignore income taxes in this problem.) The management of Crosson Corporation is investigating the purchase of a new satellite routing system with a useful life of 9 years. The company uses a discount rate of 17% in its capital budgeting. The net present value of the investment, excluding its intangible benefits, is -$173,055.
Required:
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?
Ans:
Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $173,055 ÷ 4.451 = $38,880
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
145. (Ignore income taxes in this problem.) Chipps Corporation uses a discount rate of 9% in its capital budgeting. Management is considering an investment in telecommunications equipment with a useful life of 5 years. Excluding the salvage value of the equipment, the net present value of the investment in the equipment is -$530,985.
Required:
How large would the salvage value of the telecommunications equipment have to be to make the investment in the telecommunications equipment financially attractive?
Ans:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $530,985 ÷ 0.650 = $816,900
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy
146. (Ignore income taxes in this problem.) Choudhury Corporation is considering the following three investment projects:
| | |Project H |Project I |Project J |
| |Investment required |$11,000 |$53,000 |$89,000 |
| |Present value of cash inflows |$12,980 |$61,480 |$96,120 |
Required:
Rank the investment projects using the project profitability index. Show your work
Ans:
| |Project H |Project I |Project J |
|Investment required (a) |($11,000) |($53,000) |($89,000) |
|Present value of cash inflows | 12,980 | 61,480 | 96,120 |
|Net present value (b) |$ 1,980 |$ 8,480 |$ 7,120 |
|Project profitability index (b) ÷ (a) |0.18 |0.16 |0.08 |
|Ranked by project profitability index |1 |2 |3 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy
147. (Ignore income taxes in this problem.) The management of Winstead Corporation is considering the following three investment projects:
| | |Project Q |Project R |Project S |
| |Investment required |$14,000 |$48,000 |$74,000 |
| |Present value of cash inflows |$14,140 |$54,720 |$82,140 |
The only cash outflows are the initial investments in the projects.
Required:
Rank the investment projects using the project profitability index. Show your work
Ans:
| |Project Q |Project R |Project S |
|Investment required (a) |($14,000) |($48,000) |($74,000) |
|Present value of cash inflows | 14,140 | 54,720 | 82,140 |
|Net present value (b) |$ 140 |$ 6,720 |$ 8,140 |
|Project profitability index (b) ÷ (a) |0.01 |0.14 |0.11 |
|Ranked by project profitability index |3 |1 |2 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 4 Level: Easy
148. (Ignore income taxes in this problem.) Hady Company is considering purchasing a machine that would cost $688,800 and have a useful life of 7 years. The machine would reduce cash operating costs by $118,759 per year. The machine would have no salvage value.
Required:
a. Compute the payback period for the machine.
b. Compute the simple rate of return for the machine.
Ans:
a. Payback period = Investment required ÷ Net annual cash flow
= $688,800 ÷ $118,759 = 5.80 years
b. The simple rate of return is computed as follows:
| |Cost of machine, net of salvage value (a) |$688,800 |
| |Useful life (b) |7 years |
| |Annual depreciation (a) ÷ (b) |$98,400 |
| | | |
| |Annual cost savings |$118,759 |
| |Less annual depreciation | 98,400 |
| |Annual incremental net operating income |$ 20,359 |
Simple rate of return = Annual incremental net operating income ÷ Initial investment = $20,359 ÷ $688,800 = 2.96%
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5,6 Level: Easy
149. (Ignore income taxes in this problem.) Ramson Company is considering purchasing a machine that would cost $756,000 and have a useful life of 8 years. The machine would reduce cash operating costs by $132,632 per year. The machine would have a salvage value of $151,200 at the end of the project.
Required:
a. Compute the payback period for the machine.
b. Compute the simple rate of return for the machine.
Ans:
a. Payback period = Investment required ÷ Net annual cash flow
= $756,000 ÷ $132,632 = 5.70 years
In this case the salvage value plays no part in the payback period since all of the investment is recovered before the end of the project.
b. The simple rate of return is computed as follows:
| |Cost of machine, net of salvage value (a) |$604,800 |
| |Useful life (b) |8 years |
| |Annual depreciation (a) ÷ (b) |$75,600 |
| | | |
| |Annual cost savings |$132,632 |
| |Less annual depreciation | 75,600 |
| |Annual incremental net operating income |$ 57,032 |
Simple rate of return = Annual incremental net operating income ÷ Initial investment = $57,032 ÷ $756,000 = 7.54%
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5,6 Level: Medium
150. (Ignore income taxes in this problem.) Ostermeyer Corporation is considering a project that would require an initial investment of $247,000 and would last for 7 years. The incremental annual revenues and expenses for each of the 7 years would be as follows:
| |Sales |$198,000 |
| |Variable expenses | 46,000 |
| |Contribution margin | 152,000 |
| |Fixed expenses: | |
| |Salaries |22,000 |
| |Rents |32,000 |
| |Depreciation | 33,000 |
| |Total fixed expenses | 87,000 |
| |Net operating income |$ 65,000 |
At the end of the project, the scrap value of the project's assets would be $16,000.
Required:
Determine the payback period of the project. Show your work!
Ans:
|Net operating income |$65,000 |
|Add noncash deduction for depreciation | 33,000 |
|Net annual cash inflow |$98,000 |
| | |
Payback period = Investment required ÷ Net annual cash inflow
= $247,000 ÷ $98,000 = 2.52 years
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Easy
151. (Ignore income taxes in this problem.) The management of Truelove Corporation is considering a project that would require an initial investment of $321,000 and would last for 7 years. The annual net operating income from the project would be $28,000, including depreciation of $42,000. At the end of the project, the scrap value of the project's assets would be $27,000.
Required:
Determine the payback period of the project. Show your work!
Ans:
|Net operating income |$28,000 |
|Add noncash deduction for depreciation | 42,000 |
|Net annual cash inflow |$70,000 |
| | |
Payback period = Investment required ÷ Net annual cash inflow
= $321,000 ÷ $70,000 = 4.59 years
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 5 Level: Easy
152. (Ignore income taxes in this problem.) Ducey Corporation is contemplating purchasing equipment that would increase sales revenues by $79,000 per year and cash operating expenses by $27,000 per year. The equipment would cost $150,000 and have a 6 year life with no salvage value. The annual depreciation would be $25,000.
Required:
Determine the simple rate of return on the investment to the nearest tenth of a percent. Show your work!
Ans:
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= [Incremental revenues − (Cash operating expenses + Depreciation)] ÷ Initial investment
=79,000 − ($27,000 + $25,000) ÷ $150,000
= 27,000 ÷ $150,000 = 18.0%
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 6 Level: Easy
153. (Ignore income taxes in this problem.) The management of Nixon Corporation is investigating purchasing equipment that would cost $518,000 and have a 7 year life with no salvage value. The equipment would allow an expansion of capacity that would increase sales revenues by $364,000 per year and cash operating expenses by $211,000 per year.
Required:
Determine the simple rate of return on the investment to the nearest tenth of a percent. Show your work!
Ans:
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= [Incremental revenues − (Cash operating expenses + Depreciation)] ÷ Initial investment
= 364,000 − ($211,000 + $74,000) ÷ $518,000
= 79,000 ÷ $518,000 = 15.3%
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 6 Level: Easy
154. (Ignore income taxes in this problem.) Russnak Corporation is investigating automating a process by purchasing a new machine for $198,000 that would have a 9 year useful life and no salvage value. By automating the process, the company would save $68,000 per year in cash operating costs. The company's current equipment would be sold for scrap now, yielding $18,000. The annual depreciation on the new machine would be $22,000.
Required:
Determine the simple rate of return on the investment to the nearest tenth of a percent. Show your work!
Ans:
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= (Cost savings - Depreciation) ÷ Initial investment
= ($68,000 − $22,000) ÷ ($198,000 − $18,000)
= $46,000 ÷ $180,000 = 25.6%
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 6 Level: Easy
155. (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!
Ans:
Depreciation on the new machine = $648,000 ÷ 9 = $72,000
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= (Cost savings − Depreciation) ÷ Initial investment
= ($186,000 − $72,000) ÷ ($648,000 - $13,000)
= $114,000 ÷ $635,000 = 18.0%
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 6 Level: Easy
156. A company is considering purchasing an asset for $70,000 that would have a useful life of 5 years and would have a salvage value of $12,000. For tax purposes, the entire original cost of the asset would be depreciated over 5 years using the straight-line method and the salvage value would be ignored. The asset would generate annual net cash inflows of $22,000 throughout its useful life. The project would require additional working capital of $8,000, which would be released at the end of the project. The company's tax rate is 40% and its discount rate is 9%.
Required:
What is the net present value of the asset?
Ans:
| |Years |Amount |Tax Effect |
|Cost of asset |Now |($70,000) | |
|Working capital needed |Now |($8,000) | |
|Net annual cash inflows |1-5 |$22,000 |0.60 |
|Depreciation tax shield |1-5 |$14,000 |0.40 |
|Salvage value |5 |$12,000 |0.60 |
|Working capital released |5 |$8,000 | |
|Net present value | | | |
| |After-Tax Cash |9% Factor |Present Value |
| |Flows | | |
|Cost of asset |($70,000) |1.000 |($70,000) |
|Working capital needed |($8,000) |1.000 |(8,000) |
|Net annual cash inflows |$13,200 |3.890 |51,348 |
|Depreciation tax shield |$5,600 |3.890 |21,784 |
|Salvage value |$7,200 |0.650 |4,680 |
|Working capital released |$8,000 |0.650 | 5,200 |
|Net present value | | |$ 5,012 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
157. Management is considering purchasing an asset for $40,000 that would have a useful life of 8 years and no salvage value. For tax purposes, the entire original cost of the asset would be depreciated over 8 years using the straight-line method. The asset would generate annual net cash inflows of $20,000 throughout its useful life. The project would require additional working capital of $5,000, which would be released at the end of the project. The company's tax rate is 40% and its discount rate is 12%.
Required:
What is the net present value of the asset?
Ans:
| |Years |Amount |Tax Effect |
|Cost of asset |Now |($40,000) | |
|Working capital needed |Now |($5,000) | |
|Net annual cash inflows |1-8 |$20,000 |0.60 |
|Depreciation tax shield |1-8 |$5,000 |0.40 |
|Working capital released |8 |$5,000 | |
|Net present value | | | |
| |After-Tax Cash |12%Factor |Present Value |
| |Flows | | |
|Cost of asset |($40,000) |1.000 |($40,000) |
|Working capital needed |($5,000) |1.000 |(5,000) |
|Net annual cash inflows |$12,000 |4.968 |59,616 |
|Depreciation tax shield |$2,000 |4.968 |9,936 |
|Working capital released |$5,000 |0.404 | 2,020 |
|Net present value | | |$26,572 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
158. Belling Inc. has provided the following data concerning a proposed investment project:
| |Initial investment |$168,000 |
| |Annual cash receipts |$126,000 |
| |Life of the project |9 years |
| |Annual cash expenses |$50,000 |
| |Salvage value |$8,000 |
The company's tax rate is 30%. For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 7 years. The company uses a discount rate of 14%.
Required:
Compute the net present value of the project.
Ans:
|Annual cash receipts |$126,000 |
|Annual cash expenses | 50,000 |
|Annual net cash receipts |$ 76,000 |
| | |
|Initial investment (a) |$168,000 |
|Tax life (b) |7 years |
|Annual depreciation deduction (a) ÷ (b) |$24,000 |
| |Year(s) |Amount |Tax Effect |After-Tax Cash |
| | | | |Flows |
|Initial investment |Now |($168,000) | |($168,000) |
|Annual net cash receipts |1-9 |$76,000 |0.70 |$53,200 |
|Salvage value |9 |$8,000 |0.70 |$5,600 |
|Annual depreciation deductions |1-7 |$24,000 |0.30 |$7,200 |
| |After-Tax Cash Flows|14% Factor |PV |
|Initial investment |($168,000) |1.000 |($168,000) |
|Annual net cash receipts |$53,200 |4.946 |263,127 |
|Salvage value |$5,600 |0.308 |1,725 |
|Annual depreciation deductions |$7,200 |4.288 | 30,874 |
|Net present value | | |$127,726 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
159. Camel Inc. is considering a project that would require an initial investment of $210,000 and would have a useful life of 6 years. The annual cash receipts would be $126,000 and the annual cash expenses would be $57,000. The salvage value of the assets used in the project would be $32,000. The company's tax rate is 30%. For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 5 years. The company uses a discount rate of 10%.
Required:
Compute the net present value of the project.
Ans:
|Annual cash receipts |$126,000 |
|Annual cash expenses | 57,000 |
|Annual net cash receipts |$ 69,000 |
| | |
|Initial investment (a) |$210,000 |
|Tax life (b) |5 years |
|Annual depreciation deduction (a) ÷ (b) |$42,000 |
| |Year(s) |Amount |Tax Effect |After-Tax Cash |
| | | | |Flows |
|Initial investment |Now |($210,000) | |($210,000) |
|Annual net cash receipts |1-6 |$69,000 |0.70 |$48,300 |
|Salvage value |6 |$32,000 |0.70 |$22,400 |
|Annual depreciation deductions |1-5 |$42,000 |0.30 |$12,600 |
| |After-Tax Cash Flows|10% Factor |PV |
|Initial investment |($210,000) |1.000 |($210,000) |
|Annual net cash receipts |$48,300 |4.355 |210,347 |
|Salvage value |$22,400 |0.564 |12,634 |
|Annual depreciation deductions |$12,600 |3.791 | 47,767 |
|Net present value | | |$ 60,747 |
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
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