86. A company is considering a 5-year project. The company plans to invest $60,000 now and it
forecasts cash flows for each year of $16,200. The company requires a hurdle rate of 12%.
Calculate the internal rate of return to determine whether it should accept this project. Selected
factors for a present value of an annuity of 1 for five years are shown below:
Interest rate Present value of an annuity of 1 factor
10% 3.7908
12% 3.6048
14% 3.4331
A. The project should be accepted.
B. The project should be rejected because it earns more than 10%.
C. The project earns more than 10% but less than 12%. If the hurdle rate is 12%, the project
should be rejected.
D. Only 9% is acceptable.
E. Only 10% is acceptable.
87. Axle Company can produce a product that incurs the following costs per unit: direct
materials, $10; direct labor, $24, and overhead, $16. An outside supplier has offered to sell the
product to Axle for $45. If Axle buys from the supplier, it will still incur 45% of its overhead
cost. Compute the net incremental cost or savings of buying.
A. $4.00 savings per unit.
B. $4.00 cost per unit.
C. $2.20 cost per unit.
D. $3.80 cost per unit.
E. $2.20 savings per unit.
25–42
88. Barnes manufactures a specialty food product that can currently be sold for $22 per unit and
has 20,000 units on hand. Alternatively, it can be further processed at a cost of $12,000 and
converted into 12,000 units of Exceptional and 6,000 units of Premium. The selling price of
Exceptional and Premium are $30 and $20, respectively. The incremental net income of
processing further would be:
A. $40,000.
B. $28,000.
C. $18,000.
D. $44,000.
E. $12,000.
89. Trescott Company had the following results of operations for the past year:
Sales (20,000 units at $22) $440,000
Direct materials and direct labor $200,000
Overhead (40% variable) 100,000
Selling and administrative expenses (all fixed) 92,000 (392,000 )
Operating income $ 48,000
A foreign company (whose sales will not affect Trescott’s market) offers to buy 3,000 units at
$17.00 per unit. In addition to variable manufacturing costs, selling these units would increase
fixed overhead by $500 and selling and administrative costs by $1,000. If Trescott accepts the
offer, its profits will:
A. Decrease by $4,500.
B. Increase by $4,500.
C. Decrease by $300.
D. Increase by $13,500.
E. Increase by $15,000.
90. Sherman Company can sell all of its products A and Z that it can produce, but it has limited
production capacity. It can produce 6 units of A per hour or 10 units of Z per hour, and it has
20,000 production hours available. Contribution margin per unit is $12 for A and $10 for Z.
What is the most profitable sales mix for this company?
A. 84,000 units of A and 60,000 units of Z.
B. 48,000 units of A and 80,000 units of Z.
C. 60,000 units of A and 100,000 units of Z.
D. 120,000 units of A and 0 units of Z.
E. 0 units of A and 200,000 units of Z.
91. A new manufacturing machine is expected to cost $286,000, have an eight-year life, and a
$30,000 salvage value. The machine will yield an annual incremental after-tax income of
$35,000 after deducting the straight-line depreciation. Compute the payback period for the
purchase.
A. 8.7 years.
B. 3.8 years.
C. 4.3 years.
D. 7.3 years.
E. 5.4 years.
92. A new manufacturing machine is expected to cost $286,000, have an eight-year life, and a
$30,000 salvage value. The machine will yield an annual incremental after-tax income of
$35,000 after deducting the straight-line depreciation. Compute the accounting rate of return for
the investment.
A. 22.2%.
B. 23.4%.
C. 46.9%.
D. 12.2%.
E. 24.5%.
93. Eagle Company is considering the purchase of an asset for $100,000. It is expected to
produce the following net cash flows. The cash flows occur evenly throughout each year.
Compute the payback period for this investment. (Round to two decimal places.)
Annual Net
Cash Flows
Year 1 $40,000
Year 2 $40,000
Year 3 $35,000
Year 4 $35,000
Year 5 $30,000
A. 2.85 years.
B. 2.57 years.
C. 3.00 years.
D. 2.50 years.
E. 3.62 years.
25–46
94. A machine costs $180,000 and is expected to yield an after-tax net income of $10,800 each
year. Management estimates the machine will have a ten-year life, a $20,000 salvage value, and
straight-line depreciation is used. Compute the accounting rate of return for the investment.
A. 12.0%.
B. 26.8%.
C. 11.8%.
D. 10.8%.
E. 28.8%.
95. Edgar Company is considering the purchase of new equipment costing $80,000. The
projected annual after-tax net income from the equipment is $10,200, after deducting $20,000 for
depreciation. The revenue is to be received at the end of each year. The machine has a useful life
of 4 years and no salvage value. Edgar requires a 10% return on its investments. The present
value of an annuity of 1 and present value of an annuity for different periods is presented below.
Compute the net present value of the machine.
Present Value Present Value of an
25–47
Periods of 1 at 10% Annuity of 1 at 10%
1 0.9091 0.9091
2 0.8264 1.7355
3 0.7513 2.4869
4 0.6830 3.1699
A. $(15,731).
B. $(4,896).
C. $15,731.
D. $4,896.
E. $32,334.
96. Edgar Company is considering the purchase of new equipment costing $80,000. The
projected net cash flows are $35,000 for the first two years and $30,000 for years three and four.
The revenue is to be received at the end of each year. The machine has a useful life of 4 years
and no salvage value. Edgar requires a 10% return on its investments. The present value of an
annuity of 1 and present value of an annuity for different periods is presented below. Compute
the net present value of the machine.
Present Value Present Value of an
Periods of 1 at 10% Annuity of 1 at 10%
1 0.9091 0.9091
2 0.8264 1.7355
3 0.7513 2.4869
4 0.6830 3.1699
A. $(15,731).
B. $(4,896).
C. $15,731.
D. $4,896.
E. $23,775.
97. Eagle Company is considering the purchase of an asset for $100,000. It is expected to
produce the following net cash flows. The cash flows occur evenly throughout each year.
Compute the break-even time (BET) period for this investment. (Round to two decimal places.)
Annual Net
Cash Flows Present Value of 1 at 10%
Year 0 1.0000
Year 1 $40,000 .9091
Year 2 $40,000 .8264
Year 3 $35,000 .7513
Year 4 $35,000 .6830
Year 5 $30,000 .6209
A. 2.85 years.
B. 2.57 years.
C. 3.17 years.
D. 2.98 years.
E. 3.62 years.
98. Presented below are terms preceded by letters a through g and followed by a list of
definitions 1 through 7. Match the letter of the term with the definition. Use the space provided
preceding each definition.
(a) Net Present Value
(b) Capital Budgeting
(c) Accounting Rate of Return
(d) Net Cash Flow
(e) Internal Rate of Return
(f) Payback Period
(g) Hurdle Rate
______ (1) A discount rate that results in a net present value of zero.
______ (2) Cash inflows minus cash outflows for the period.
______ (3) A minimum acceptable rate of return.
______ (4) The time expected to pass before the net cash flows from an investment equals its
initial cost.
______ (5) Annual after-tax net income divided by annual average investment.
______ (6) A process of analyzing alternative long-term investments.
______ (7) Initial cost of an investment subtracted from discounted future cash flows from
the investment.
99. Presented below are terms preceded by letters a through f and followed by a list of definitions
1 through 6. Match the letter of the terms with the definitions. Use the space provided preceding
each definition.
(a) Incremental cost
(b) Opportunity cost
(c) Out-of-pocket cost
(d) Net present value
(e) Sunk cost
(f) Accounting rate of return
______ (1) A cost that requires a current outlay of cash.
______ (2) A rate used to evaluate the acceptability of an investment; equals the after-tax
periodic income divided by the average investment in the asset.
______ (3) An estimate of an asset’s value to the company; calculated by discounting the future
cash flows from the investment at a satisfactory rate and then subtracting the initial cost of the
investment.
______ (4) A cost that cannot be avoided or changed in any way because it arises from past
decision; irrelevant to current and future decisions.
______ (5) An additional cost incurred only if a particular action is taken.
______ (6) The potential benefits of one alternative that are lost by choosing an alternative
course of action.
100. What is capital budgeting? Why are capital budgeting decisions often difficult and risky?
101. Briefly describe the time value of money. Why is the time value of money important in
capital budgeting?
102. In using the internal rate of return method, management must consider a hurdle rate in
making its decisions. What is a hurdle rate? What factors does management have to consider in
selecting a hurdle rate?
103. Identify the five steps involved in managerial decision making.
104. Good management accounting indicates that projects be evaluated using relevant data. In
choosing among alternatives, what factors (considerations) are relevant?
105. How does the calculation of break-even time (BET) differ from the calculation of payback
period (PBP)?
25–53
106. Briefly describe both the payback period method and the net present value method of
comparing investment alternatives.
107. When making capital budgeting decisions, companies usually prefer shorter payback
periods. Explain why shorter payback periods are desirable.
108. What is one advantage and one disadvantage of using the accounting rate of return to
evaluate investment alternatives?
109. You have evaluated three projects using the net present value (NPV) method. How would
you decide which one of the projects to select?
110. Identify at least three reasons for managers to favor the internal rate of return (IRR) over
other capital budgeting approaches.
Problems
111. For each of the capital budgeting methods listed below, place an X in the correct column,
indicating the measurement basis of each, the ability to make comparison among projects, and
whether each method reflects or ignores the time value of money.
Measurement Basis Comparison among
projects Time value of money
Cash
flows Accrual
income Allows
comparison Difficult
to
compare Reflects time value
of money Ignores
time value
of money
Payback period
Accounting rate of
return
Net present value _
Internal rate of
return
112. A company inadvertently produced 6,000 defective portable CD players. The CD players
cost $20 each to be manufactured. A salvage company will purchase the defective units as they
are for $16 each. The production manager reports that the defects can be corrected for $9 per
unit, enabling the company to sell them at the regular price of $30.00. The repair operations
would not affect other production operations. Prepare an analysis that shows which action should
be taken.
113. A company manufactures two products. Each unit of product X requires 10 machine hours
and each unit of product Y requires 4 machine hours. The company’s productive capacity is
limited to 180,000 machine hours. Each unit of product X sells for $15 and has variable costs of
$7. Each unit of product Y sells for $8 and has variable costs of $3. If the company can sell all
that it produces of both products, what should the sales mix be?
25–58
114. Fleming Company had the following results of operations for the past year:
Sales (10,000 units at $6.80) $ 68,000
Materials and direct labor (20,000)
Overhead (40% variable) (10,000)
Selling and administrative expenses (all fixed) (6,000)
Operating income $ 32,000
A foreign company (whose sales will not affect Fleming’s regular sales) offers to buy 2,000 units
at $5.00 per unit. In addition to variable manufacturing costs, there would be shipping costs of
$1,200 in total on these units. Should Fleming take this order? Explain.
115. A company produces three different products that all require processing on the same
machines. There are only 27,000 machine hours available in each year. Production information
for each product is:
A B C
Sales price per unit $20.00 $38.00 $35.00
Variable costs per unit $12.00 $26.00 $17.00
Machine hours necessary to produce one unit 2.5 4.0 4.50
Required:
(1) Determine the preferred sales mix if there are no market constraints on any of the products.
(2) Determine the preferred sales mix if the demand is limited to 5,000 units for each product.
(3) Determine the preferred sales mix if the demand is limited to 3,000 units for each product.
116. A company puts four products through a common production process. This process costs
$100,000 each year. The four products can be sold when they emerge from this process at the
“split-off point”, or processed further and then sold. Data about the four products for the coming
period are:
Unit Sales Unit Sales
Price per Price per
pound pound Additional
at Split-Off after Further Processing
Product Volume Point Processing Costs
Singer 20,000 lb. $28.00 $42.00 $400,000
Talker 10,000 lb. 7.00 28.00 144,000
Walker 5,000 lb. 36.00 58.00 120,000
Sayer 5,000 lb. 18.00 22.00 40,000
Determine which products should be sold at the split-off point and which should be processed
further.