GQ#3 - Acct 2220 - WCNet



30-pt Solution - Acct 2220 Zeigler - GQ #3 (Chp 10) - Review for Exam #2

____ 1. A capital investment project may provide “cash inflows” (i.e. benefits) from: 

A. incremental (new) revenues received as a result of the investment made.

B. cost savings realized due to the investment made.

C. the salvage value of the investment at the end of its useful life.

D. all of the above represent potential cash inflows (i.e. benefits).

____ 2. Which of the following statements best describes a firm’s “cost of capital”? 

A. The return that a company must pay to attract investors and satisfy creditors. (Pg 302/303)

B. The maximum acceptable rate of return on investments.

C. The calculated internal rate of return on investments.

D. The interest rate the bank charges its best customers. (No, typically called the “Prime Rate”)

____ 3. The cost of capital is frequently referred to (i.e. called) all of the following except: 

A. discount rate.

B. hurdle rate.

C. cutoff rate.

D. maximum rate. (See pg 303 for terminology discussion)

____ 4. For a capital investment project to be acceptable on a quantitative basis, it must generate a rate of return:

A. Less than the required rate of return.

B. Equal to or greater than the firm’s cost of capital.

C. Equal to or less than the initial investment.

D. Greater than the required rate of return, but less than the cost of capital.

____ 5. Vince & Palker, Inc. projects they can generate $300,000 of net cash benefits per year, for 7 years, on a

real estate investment project (i.e. after all expenses are deducted). If the company desires a pre-tax rate of

return of 7%, what is the maximum they should pay (rounded to the nearest dollar) for this real estate

investment? In essence, what is the present value of all expected benefits given the required rate of return?

A. $321,001

B. $642,653

C. $1,472,017

D. $1,616,787 (P.V of an annuity 7%, 7 yrs (Table 2) 5.389289 * $300,000 annual net cash inflow)

E. $2,100,000

____6. Two products from Wentling & Gaertner, Inc., X and Y, are alike in every way except that the sales of X will start low and rise throughout its life, while those of Y will be the same each year. Total sales volume over their five-year lives will be the same, as will selling prices, unit variable costs, cash fixed costs, and initial investment. The Net Present Value (NPV) of product X:

A. will be less than that of product Y. (This will always be the case – make up numbers to confirm)

B. will be the same as that of product Y.

C. will be greater than that of product Y.

____ 7. Which of the following cash flow patterns represents an annuity?

 [pic]  

A.  “A” Above. (an annuity represents an equal payment per period)

B.  “B” Above.

C.  “C” Above.

D.  None of the above can be described as an annuity.

Use the following for questions 8 & 9:

Wells, Smith and Walker, Inc. manufactures quality hockey sticks for professional competition. Mgmt is considering the purchase of new machinery in order to improve its manufacturing process. This capital investment is expected to provide net annual cash inflows (i.e. labor saving benefits due to improved automation of the production process) of $10,000 per year for 3 years.

8. Assuming the firm’s required rate of return is 8%, and using your choice of Table 1 or 2 P.V. factors, what is the present value of these annual cash inflows (i.e. net benefits) on a pre-tax basis? Show all computations and round to the nearest whole dollar.

Using Table 1: (10,000 * .925926) + (10,000 * .857339) + (10,000 * .793832) = $25,771

Using Table 2: 10,000 * 2.577097 = $25,771 (we can use table 2 because we have an annuity)

9. Would the present value of the above cash inflows be higher if a required rate of return of 10% was used?

Show all computations to prove your position and EXPLAIN why or why not.

NO. Using Table 1 (or Table 2 since we have an annuity), the present value would be higher at a minimum required rate of return of 8% ($25,771 at 8%, as compared to $24,869 at 10%). This is because we are discounting (i.e. stripping away earnings) at 8% rather than 10%. As such, today’s (i.e. present) value of the future cash flows would be higher at 8% (computations above). For 10%, 10,000 * 2.486852 = $24,869

____ 10. McConnell, Lydy & Imm, Inc. is considering the purchase of capital equipment that costs $5,000.

The equipment would be depreciated on a straight-line basis, with no expected salvage value, over its

5-year useful life. Assuming a tax rate of 30%, what would be the annual amount of cash tax savings

due to the depreciation deduction (i.e. “tax shield” or “tax shelter”) provided by this investment? 

A. $1,000

B. $ 700

C. $ 300 (Taxes will be reduced by 30% of the $1,000 annual depreciation amount)

D. $ -0-

____ 11. Select the incorrect statement concerning the “Present Value Index” (PVI). 

a. The PVI is computed by dividing the total present value of the cash inflows by the present value

of the cash outflows.

b. The PVI should be used to evaluate two or more projects whose initial investments differ.

c. A project whose PVI is greater than “1” will always have a positive net present value (NPV).

d. The lower the PVI, the lower the amount of investment required.

____ 12. Using Key Formula #2 (see handout #2), what would be the internal rate of return (IRR) for a $100,065

investment that provides a $9,000 annual benefit (i.e. annuity) for 15 years?  Show your work AND attach an Excel IRR template printout (see class website) to the end of this quiz to confirm your work.

A.  ~2%

B.  ~4%

C.  ~6%

D.  ~8%

E. More than 10%

Using formula #2, Investment / Periodic cash inflow = $100,065/$9,000 = 11.118333 (factor). Look on

Table #2 (Annuity table, because we have equal cash inflows) and search across the 15-period row. Confirm this by using our Excel IRR Calculator as posted on the class website. (SEE END OF QUIZ)

____ 13. Which of the following Capital Budgeting techniques does not consider time value of money principles? 

A. Payback Method.

B. Net Present Value Method.

C. Internal Rate of Return Method.

D. All of the above methods consider the time value of money.

____ 14. Which of the following statements concerning the “Payback” method of analysis is true? 

A. An investment with a longer payback is preferable to an investment with a shorter payback.

B. The payback method must adjust for any depreciation as depreciation is not a cash flow itself.

C. The payback method and the unadjusted rate of return are different approaches that will consistently lead to the same conclusion.

D. None of the above represent true statements.

____ 15. Przybylski & Clifton, Inc. has an opportunity to purchase an asset that costs $45,000. The asset is

expected to increase net income by $18,000 per year, but depreciation expense of $2,000 per year is included in this projected net income increase. Based on this data, the cash “Payback” period would be: 

A. 1.1 years

B. 2.25 years ($45,000 / $20,000). The non-cash depr amount must be added to net income.

C. 5.35 years

D. 9.0 years

16. (2 pts) What is a PostAudit of a capital investment decision, and how should the PostAudit be conducted? Answer with a complete discussion, using full sentences. 

A postaudit is a review of a capital investment project at the end of its life, performed to determine whether the project lived up to expectations for it. The postaudit should be conducted using the same analysis technique(s) used in making the investment decision, but will use actual results instead of estimated results which were used in the planning process. The PostAudit also provides a basis for performance evaluation of the decision maker(s)

Refer to H/W problem P10-18A - see me or our GA team with any questions

(1 pt each) Indicate whether each of the following statements relating to “PostAudits” is True or False:

F____ 17. A postaudit should be conducted at the time a capital investment is purchased/started.

T____ 18. The postaudit of a capital investment project should be made using the same analytical

technique that was used in deciding to make the initial investment.

T____ 19. The purpose of postaudits is to improve a company's capital investment decision process.

Use the following fact pattern for the five questions, #20-24, below (2 pts each = 10 pts total)

Bates & Dohalick (BD) Fine Dining, Inc. prepares quality meals for discriminating BGSU students. Company management is considering the purchase of new machinery to lower variable costs and increase the production quality of its “Great Accountant” brand of premium organic food products. Investment details are:

|Cash cost of machine |$320,000 |

|Expected life of the machine |10 Years |

|Expected annual savings in cash operating costs (i.e. net benefits) |$75,000 |

Straight-Line depreciation is used by the firm over the life of the asset and no salvage value is expected. The tax rate is 30% and firm’s minimum desired rate of return is 12%.

20. Draw a timeline to document all relevant cash flows and then prepare an income statement to determine the after-tax cash flows (benefits) expected per year. Next, determine the NPV of this investment opportunity and indicate whether the company should purchase the machine on a quantitative basis.

Step One: Prepare a time line and detail/sketch the cash flows.

Step Two: Prepare an Income Statement to determine annual after-tax cash flows:

|Annual benefit (savings) | $75,000 |

|Less: Depr deduction |($32,000) |

|Taxable Income | $43,000 |

|Taxes @30% |($12,900) |

|Income (Investment profit/yr) | $30,100 |

|Add-back non-cash depr | $32,000 |

|Annual after-tax cash flow | $62,100 |

Step Three: using the factor from Table 2 @ 12%

$62,100 x 5.650223 = $ 350,879 (Key Formula #1: periodic/annual Cash flow * PV factor)

Investment Cost = $ 320,000

Net Present Value $30,879 Therefore, management should accept this project on a quantitative basis. Certainly, any qualitative issues should be addressed before final approval of the investment.

21. Using a Key Formula, determine the approximate after-tax IRR of the investment. Show all work.

Key Formula 2:

Investment / periodic cash flow (see pg 308 or Key Formulas H/O & Excel template work) =

$320,000 / $62,100 = 5.152979 Table 2 factor = slightly > 14% (Per IRR Excel (see at end) = 14.313%)

22. IF the company had used the DDB depreciation method (rather than straight-line) in the above fact pattern:

a) The after-tax NPV would be lower.

b) The after-tax NPV would not change.

c) The after-tax NPV would be higher. (see P10-22A solution & class notes to confirm)

23. IF the machine was fully depreciated and then sold for $10,000 at the end of year 10:

a. The after-tax NPV would be higher.

b. The pre-tax NPV would be lower.

c. The pre-tax NPV would not change.

d. The after-tax NPV would not change.

NPV would be higher if any additional benefit was to be received (i.e. salvage value at the end of 10 yrs here).

Again, any additional cash inflow, either before or after-tax, would increase NPV (Pg 309 & 315). In this case, the one-time $7,000 after-tax sales proceeds ($10,000*(1-30%)) would be multiplied by a Table 1 factor.

24. Considering the *original* facts only and using Key Formula #3, what annual net after-tax cash

inflow (i.e. benefit) would be required if the company desired a 10% rate of return? A 16% rate of return?

1) 10% return: The required periodic (annual) net after-tax cash inflow would be:

Formula 3 is used to determine required periodic payments to achieve an exact rate of return!

Investment ($320,000) / Table factor for a 10%, 10-yr annuity (6.144567) = $52,079 per period

2) 16% return: The required periodic (annual) net after-tax cash inflow would be:

Investment ($320,000) / Table factor for a 16%, 10-yr annuity (4.833227) = $66,208 per period

Note: The above required annual benefit (i.e. net cash inflow) can always be *proven* with IRR/Excel!

Note: For Exam #2, Table 1 & 2 PV factors will be provided, but Key Formulas will not.

IRR “Proof” for Question #12:

[pic]

IRR “Proof” for Question #21:

[pic]

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download