New equipment costs
75,000
100,000
Estimated useful life (no salvage)
5 years
5 years
The company has a 30% tax rate, it uses the straight-line depreciation method, and it predicts that
cash flows will be spread evenly throughout each year. Calculate each product’s payback period. If
the company requires a payback period of three years or less, which, if either, product should be
chosen?
Year 1
$ 6,500
Year 2
12,700
Year 3
15,000
Year 4
12,800
164) A company is considering a proposal to invest $40,000 in a project that would provide the following
net cash flows:
Compute the project’s payback period.
New investment
Flyer
$424,000
Skimmer
$380,000
Expected 3-year net cash flows:
Year 1
150,000
130,000
Year 2
160,000
130,000
Year 3
170,000
130,000
165) A company produces two boat models, Flyer and Skimmer. Both products are being considered for
major investment projects next year. Relevant data follow:
Required:
Use the payback period to evaluate these two investment projects.
166) A company is evaluating the purchase of a machine for $750,000 with a six-year useful life and no
salvage value. The company uses straight-line depreciation and it assumes that the annual net cash
flow from using the machine will be received uniformly throughout each year. In calculating the
accounting rate of return, what is the company’s average investment?
167) A company purchases a machine for $800,000. The machine has an expected life of 9 years and no
salvage value. The company anticipates a yearly after-tax net income of $60,000 to be received
uniformly throughout each year. What is the accounting rate of return?
168) A company can buy a machine that is expected to have a three-year life and a $30,000 salvage
value. It will be depreciated using the straight-line method. The machine will cost $1,800,000 and
is expected to produce a $200,000 after-tax net income to be received at the end of each year. If a
table of present values of $1 at 12% shows values of 0.8929 for one year, 0.7972 for two years, and
0.7118 for three years, what is the net present value of the cash flows from the investment,
discounted at 12%?
$1,800,000 – $30,000
169) A company is considering two projects, Project A and Project B. The following information is
available for each project:
Project A Project B
Investment $500,000 $2,000,000
Net present value of cash flows …… $300,000 $800,000
Calculate the profitability index for each project. Based on the profitability index, which project
should the company pursue and why?
170) A company is considering the purchase of new equipment for $42,000. The projected annual cash
inflow is $18,000. 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?
171) 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?
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
1……………….
0.8929
2……………….
0.7972
3……………….
0.7118
172) 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:
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%
Investment A
Investment Z
Projected after-tax net income
$ 40,000
$ 42,000
Investment costs
Estimated life
$600,000
6 years
$675,000
6 years
173) A company has a decision to make between two investment alternatives. The company requires a
10% return on investment. Predicted data is provided below:
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.
174) A company is considering a 5-year project. It plans to invest $62,000 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
165
175) Dracor 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
176) Trevoline 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. Trevoline 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 A
Project B
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
177) 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 $13 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.
178) Mays 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?
179) Marshall 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. Marshall 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.
SHORT ANSWER QUESTIONS
180) ________ is the process of analyzing alternative long-term investments and deciding which assets
to acquire or sell.
181) The minimum acceptable rate of return on an investment, often the company’s cost of capital, is
called the ________.
182) Relevant costs are also known as ________.
183) A(n) ________ requires a future outlay of cash and is relevant for current and future decision
making.
184) A(n) ________ is the potential benefit lost by taking a specific action when two or more alternative
choices are available.
185) A(n) ________ arises from a past decision and cannot be avoided or changed; it is irrelevant to
future decisions.
186) In this chapter, you examined several short-term managerial decision tasks. Identify (list) any three of
these types of decision tasks:
________; ________; ________
187) A capital budgeting method that considers how quickly a project recovers costs is known as
. An enhancement to this method that also considers the time value of money is called
________.
188) 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 ________.
189) The ________ is computed by dividing a project’s annual after-tax net income by the annual
average amount invested.
190) 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.
191) 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
________.
192) The ________ is the rate that yields a net present value of zero for an investment.