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Calculate the profitability index for each project. Based on the profitability index, which project
should the company pursue and why?
131. A company is considering the purchase of new equipment for $45,000. The projected after-
tax net income is $3,000 after deducting $15,000 of depreciation. The machine has a useful life
of 3 years and no salvage value. Management of the company requires a 12% return on
investment. The present value of an annuity of 1 for various periods follows:
Period Present value of an annuity of 1 at 12%
1 ......................... 0.8929
2 1.6901
3 2.4018
What is the net present value of this machine assuming all cash flows occur at year-end?
132. A company is trying to decide which of two new product lines to introduce in the coming
year. The company requires a 12% return on investment. The predicted revenue and cost data for
each product line follows:
Product A Product B
Unit sales 25,000 20,000
Unit sales price $ 30 $ 30
Direct materials $ 15,000 $ 8,000
Direct labor $ 120,000 $
80,000
Other cash operating expenses $ 30,000 $ 25,000
New equipment costs $2,500,000 $1,500,000
Estimated useful life (no salvage) 5 years 5 years
The company has a 30% tax rate and it uses the straight-line depreciation method. The present
value of an annuity of 1 for 5 years at 12% is 3.6048. Compute the net present value for each
piece of equipment under each of the two product lines. Which, if either of these two investments
is acceptable?
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133. A company is considering two alternative investment opportunities, each of which requires
an initial cash outlay of $110,000. The expected net cash flows from the two projects follow:
Project A Project Z
Year 1 ……………… $ 30,000 $ 44,000
Year 2 ……………… 44,000 70,000
Year 3 ……………… 70,000 30,000
Totals ……………… $144,000 $144,000
Required:
(1) Based on a comparison of their net present values, and assuming the same discount rate
(greater than zero) is required for both projects, which project is the better investment? (2) Use
the table values below to find the net present value of the cash flows associated with Project A,
discounted at 12%:
Periods Present value of 1 at 12%
1………………. 0.8929
2………………. 0.7972
3………………. 0.7118
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134. A company has a decision to make between two investment alternatives. The company
requires a 10% return on investment. Predicted data is provided below:
Investment Y Investment Z
Projected after-tax net income .................................... $ 40,000 $ 42,000
Investment costs .......................................................... $600,000 $675,000
Estimated life ............................................................. 6 years 6 years
The present value of an annuity for 6 years at 10% is 4.3553. This company uses straight-line
depreciation.
Required:
(a) Calculate the net present value for each investment.
(b) Which investment should this company select? Explain.
135. A company is considering a 5-year project. It 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
136. Casco Company is considering the purchase of equipment that would allow the company to
add a new product to its line. The equipment is expected to cost $280,000 with a 7-year life, no
salvage value, and will be depreciated using straight-line depreciation. The expected annual
income related to this equipment follows. Compute the (a) payback period and (b) accounting
rate of return for this equipment.
Sales $900,000
Costs:
Manufacturing $545,000
Depreciation on machine 40,000
Selling and administrative expenses 249,000 (834,000 )
Income before taxes 66,000
Income tax (30%) ( 19,800 )
Net income $ 46,200
137. Braybar Company is deciding between two projects. Each project requires an initial
investment of $350,000. The projected net cash flows for the two projects are listed below. The
revenue is to be received at the end of each year. Braybar requires a 10% return on its
investments. The present value of an annuity of 1 and present value of an annuity factors for
10% are presented below. Use net present value to determine which project should be pursued
and explain why.
Project 1 Project 2 Present Value Present Value of an
Periods Cash Flows Cash Flows of 1 at 10% Annuity of 1 at 10%
1 $50,000 $160,000 0.9091 0.9091
2 $200,000 $175,000 0.8264 1.7355
3 $250,000 $175,000 0.7513 2.4869
138. A company inadvertently produced 3,000 defective products. The product cost $15 each to
be manufactured and normally sells for $35 each. A salvage company will purchase the defective
units as they are for $12 each. The production manager reports that the defects can be corrected
for $5 per unit, enabling the company to sell them at a discounted price of $22.00. The repair
operations would not affect other production operations. Prepare an analysis that shows which
action should be taken.
139. Sherman Company can sell all of product A that it produces but only 160,000 units of Z and
it has limited production capacity. It can produce 6 units of A per hour or 10 units of Z per hour,
and it has 30,000 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?
140. Fields Company currently manufactures one of its parts at a cost of $3.25 per unit. This cost
is based on a normal production rate of 50,000 units. Variable costs are $2.10 per unit, fixed
costs related to making this part are $40,000 per year, and allocated fixed costs are $45,000 per
year. Allocated fixed costs are unavoidable whether the company makes or buys the part. Fields
is considering buying the part from a supplier for a quoted price of $2.80 per unit guaranteed for
a three-year period. Should the company continue to manufacture the part, or should it buy the
part from the outside supplier? Support your answer with analyses.
Fill in the Blank Questions
141. _____________________ is the process of analyzing alternative long-term investments and
deciding which assets to acquire or sell.
142. The minimum acceptable rate of return on an investment is called the _________________.
143. Relevant costs are also known as ___________________.
144. An ________________________ requires a future outlay of cash and is relevant for current
and future decision making.
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145. An _____________________ is the potential benefit lost by taking a specific action when
two or more alternative choices are available.
146. A _____________________ arises from a past decision and cannot be avoided or changed;
it is irrelevant to future decisions.
147. In this chapter, you examined several short-term managerial decision tasks. Identify (list)
any three of these types of decision tasks:
_________________________; _________________________; _________________________
148. A capital budgeting method that considers how quickly a project recovers costs is known as
______________. An enhancement to this method that considers the time value of money is
called ____________.
149. In evaluating capital budgeting alternatives, there are two primary methods that do not
consider the time value of money. These methods are _______________ and
__________________. There are also two primary methods that consider the time value of
money; these are ___________________ and _______________________.
150. The ____________________ is computed by dividing a project's after-tax net income by
the average amount invested in it.
151. The ___________ is computed by discounting the future net cash flows from the
investment at the project's required rate of return and then subtracting the initial amount
invested.
152. The net present value decision rule requires that when an asset's expected cash flows are
discounted at the required rate and yield a positive net present value, the project should be
____________________.
153. The __________________________ is the rate that yields a net present value of zero for an
investment.
