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129. On January 1, 2016 Crane Company will acquire a new asset that costs $400,000 and that
is anticipated to have a salvage value of $30,000 at the end of four years. The new asset:
• qualifies as three-year property under the Modified Accelerated Cost Recovery System
(MACRS)
• will replace an old asset that currently has a tax basis of $80,000 and that can be sold on this
date for $60,000
• will continue to generate the same operating revenues as the old asset ($200,000 per year).
However, it is predicted that savings in cash operating costs will be experienced as follows: a
total of $120,000 in each of the first three years, and $90,000 in the fourth year.
Crane is subject to a combined income tax rate of 40% and rounds all computations to the
nearest dollar. Crane's fiscal year coincides with the calendar year. Assume that any gain or loss
affects the taxes paid at the end of the year in which the gain or loss occurs. The company uses
the net present value (NPV) method to analyze projects using the factors and rates presented
below (based on a discount rate of 14%):
Period PV of $1 at 14% PV of $1 Annuity at 14% MACRS
1 0.88 0.88 33%
2 0.77 1.65 45
3 0.68 2.33 15
4 0.59 2.92 7
The discounted net-of-tax amount that should be factored into Crane Company's analysis for the
disposal of the old asset is:
130. On January 1, 2016 Crane Company will acquire a new asset that costs $400,000 and that
is anticipated to have a salvage value of $30,000 at the end of four years. The new asset:
• qualifies as three-year property under the Modified Accelerated Cost Recovery System
(MACRS)
• will replace an old asset that currently has a tax basis of $80,000 and that can be sold on this
date for $60,000
• will continue to generate the same operating revenues as the old asset ($200,000 per year).
However, it is predicted that savings in cash operating costs will be experienced as follows: a
total of $120,000 in each of the first three years, and $90,000 in the fourth year.
Crane is subject to a combined income tax rate of 40% and rounds all computations to the
nearest dollar. Crane's fiscal year coincides with the calendar year. Assume that any gain or loss
affects the taxes paid at the end of the year in which the gain or loss occurs. The company uses
the net present value (NPV) method to analyze projects using the factors and rates presented
below (based on a discount rate of 14%):
Period PV of $1 at 14% PV of $1 Annuity at 14% MACRS
1 0.88 0.88 33%
2 0.77 1.65 45
3 0.68 2.33 15
4 0.59 2.92 7
The relevant discounted operating cash flows (cost savings) that should be factored into Crane
Company's analysis are:
131. The capital budgeting decision technique that reflects the time value of money and is
calculated as the present value of the future after-tax cash inflows by the initial cash outlay for
the investment is called the:
132. The net present value (NPV) model of a capital budgeting project is not affected by the
133. The internal rate of return (IRR) for a project can be determined
134. The internal rate of return (IRR) is the
135. For capital budgeting purposes, a depreciation tax shield
136. The after-tax cost of debt for purposes of estimating a company's weighted-average cost
of capital (WACC)
137. Sensitivity analysis is used in capital budgeting to
138. The annual tax depreciation expense on an asset reduces income taxes by an amount
equal to
139. Ignoring income tax considerations, how is depreciation handled by the following capital
budgeting techniques?
Internal Rate
of Return (IRR) Accounting Rate
of Return (ARR)
Payback
A) Excluded Included Excluded
B) Included Excluded Included
C) Excluded Excluded Included
D) Included Included Included
E) Excluded Excluded Excluded
140. In applying the Capital Asset Pricing Model (CAPM) to estimate a firm's cost of equity
capital, the beta coefficient (β) in the model represents
141. When employing the MACRS (modified accelerated cost recovery system) method of
depreciation in a capital budgeting decision, the use of MACRS as compared to the straight-line
method of depreciation will, for an asset with zero estimated salvage value at the end of its
useful life, result in
142. A characteristic of the payback method (before taxes) is that it
143. In capital budgeting, the profitability index (PI) decision model is best used to
144. Jason Company provides weather and climate forecasts to almost 100 firms in the
northwestern states of Washington, Oregon, and Idaho. New technology is available that should
improve forecast accuracy anywhere from ten to fifteen percentage points.
Required:
1. What information is likely to be most difficult to estimate in conjunction with this investment
decision?
2. Which capital budgeting decision model is the most appropriate for making this decision?
145. Acorn Corporation designs and installs fire-suppression systems in commercial buildings.
Over 90 percent of Acorn's business is in new construction, with the remainder in upgrade
installations in remodeled buildings. For planning and control purposes, Acorn's controller (Jane
Reid) is considering purchasing cost and financial accounting software from Constructor
Solutions. Costs for the software modules are shown below:
Module 1: Bidding and estimation $3750.00
Module 2: Job cost accounting 3,250.00
Module 3: General ledger package 2,875.00
Module 4: Accounts Receivable 1,840.00
Module 5: Accounts Payable 1,660.00
Module 6: Financial statement preparation 1,440.00
Or, the entire set of six modules at a 10% discount based on individual module purchases
$13,333.50
Required:
1. Jane uses value-chain analysis in evaluation of capital investments. She asks you which
method, internal rate of return (IRR) or net present value (NPV), would be best in selecting
individual software modules, and your reason(s) for the choice of method.
2. Jane says, "If we buy the entire set of six modules, we will get the equivalent of Module 6
free." Why might this savings of almost $1,500 be illusory?
3. The present value of the cost savings generated by the set of six modules, based on a five-
year life and discount rate of 18 percent, is estimated as $13,844.50. Should the set be
purchased? Explain. How would your decision be affected if Acorn's minimum rate of return were
24 percent? (No calculations are necessary to answer this question.)
146. Jason Kirby is the leader of the capital budget group charged with reviewing capital
investment opportunities for Archer Construction Corporation. Jason is an advocate of a short
payback period requirement, since "Cash flow is the bottom line in this company."
Required:
Do you agree or not? Why?
147. Paulsen Inc. purchased a $700,000 machine to manufacture a specialty tap for electrical
equipment. The tap was in high demand and Paulsen could sell all that it could manufacture for
the next five years. The government exempted taxes on profits from new investments in order to
encourage capital investments. This legislation was not expected to be altered in the foreseeable
future. The equipment was expected to have five years of useful life with no salvage value. The
company employed straight-line depreciation. The net cash inflow was expected to be $180,000
each year for five years. Olsen uses a rate of 9% in evaluating its capital investments.
Required:
Round all answers to 2 decimal places (e.g., 0.12338 = 12.34%).
1. Calculate the estimated payback period for this proposed investment. (Assume that cash
inflows occur evenly throughout the year.)
2. Calculate the project's accounting rate of return (ARR) based on the initial investment.
3. Calculate the accounting rate of return (ARR) based on average investment, where the latter
is defined as a simple average of beginning-of-project net book value and end-of-project net
book value.
4. Calculate the internal rate of return (IRR) of this proposed investment. (Note: To answer this
question, students need access either to Appendix C, Table 2 or to Excel.)
148. Harris Corporation provides the following data on a proposed capital project:
Initial investment outlay $200,000
Expected useful life 4 years
Increase in annual net cash inflow (before taxes) $66,000
Required rate of return (i.e., discount rate) 12%
Income tax rate 25%
Harris uses straight-line depreciation method with no salvage value.
Required:
Compute for this investment project:
1. NPV (the PV annuity factor for 12%, 4 years is 3.037)
2. IRR (to the nearest tenth of a percent).
Note
: PV annuity factors for 4 years: @ 8% = 3.312; @
9% = 3.240; @ 10% = 3.170; @ 11% = 3.102; @ 12% = 3.037; and, @ 13% = 2.974)
3. Payback period (assume that cash inflows occur evenly throughout the year).
4. Accounting rate of return (ARR) on the net initial investment.
5. Discounted payback period (assume that the cash inflows occur evenly throughout the year;
round your answer to 2 decimal places). The appropriate PV factors for 12% are as follows: year 1
= 0.893; year 2 = 0.797; year 3 = 0.712; year 4 = 0.636.
