86. Heckrwee Industries is considering a project that would require an initial investment of $101,000. The
project would result in cost savings of $62,000 in year 1 and $70,000 in year 2. The internal rate of return is
87. Ursula Company is considering the purchase of a new machine for $160,000. The machine would generate
an annual cash flow before depreciation and taxes of $62,588 for four years. At the end of four years, the
machine would have no salvage value. The company’s cost of capital is 12 percent. The company uses straight-
line depreciation with no mid-year convention and has a 40 percent tax rate.
What is the internal rate of return for the machine rounded to the nearest percent?
88. Chinchilla Company is considering the purchase of a new machine for $57,000. The machine would
generate an annual cash flow of $18,228 for five years. At the end of five years, the machine would have no
salvage value. The company’s cost of capital is 12 percent. The company uses straight-line depreciation with no
mid-year convention.
What is the internal rate of return for the machine rounded to the nearest percent, assuming no taxes are paid?
89. A firm is considering a project requiring an investment of $200,000. The project would generate an annual
cash flow of $55,478 for the next five years. The company uses the straight-line method of depreciation with no
mid-year convention. Ignore income taxes. The approximate internal rate of return for the project is
90. Callendula Company is considering the purchase of a new machine for $80,000. The machine would
generate an annual cash flow before depreciation and taxes of $28,778 for five years. At the end of five years,
the machine would have no salvage value. The company’s cost of capital is 12 percent. The company uses
straight-line depreciation with no mid-year convention and has a 40 percent tax rate.
What is the internal rate of return for the machine rounded to the nearest percent?
91. A firm is considering a project requiring an investment of $27,000. The project would generate an annual
cash flow of $6,296 for the next seven years. The company uses the straight-line method of depreciation with no
mid-year convention. Ignore income taxes. The approximate internal rate of return for the project is
92. Which of the following capital investment models would be preferred when choosing among mutually
exclusive alternatives?
93. Five mutually exclusive projects had the following information:
V
W
X
Y
Z
NPV
$(6,000)
$40,000
$30,000
$10,000
$20,000
IRR
8%
11%
13%
10%
12%
Which project is preferred?
94. NPV differs from IRR:
95. Five mutually exclusive projects had the following information:
A
B
C
D
E
NPV
$200
$400
$2,000
$1,000
$(400)
IRR
11%
13%
10%
12%
8%
Which project is preferred?
96. A firm is considering two mutually exclusive projects with the following cash flows:
Project X
Project Y
$ 40,000
$120,000
80,000
80,000
120,000
40,000
Each project requires an investment of $100,000. The cost of capital is 10 percent.
Which project will have the higher net present value?
97. Macadamia Company is considering an investment in equipment for $55,000. Chocolate uses the straight-
line method of depreciation with no mid-year convention. In addition, its tax rate is 40 percent, and the life of
the equipment is five years with no salvage value. The expected income before depreciation and taxes is
projected to be $30,000 per year.
What is the annual cash flow for Year 1?
98. If the tax rate is 40 percent and a company has $800,000 of income, a depreciation deduction of $100,000
would result in a tax savings of
99. A machine with a book value of $60,000 could be sold for $80,000. The corporation that owns the machine
has taxable income of $670,000 and a 40 percent tax rate. What would be the tax on the sale of the machine?
100. If the tax rate is 40 percent and a company has $800,000 of income, a depreciation deduction of $160,000
would result in a tax savings of
101. Monocle Corporation is considering an investment in equipment for $50,000. Data related to the
investment is as follows:
Cash Flow before
Year
Depreciation and Taxes
1
$25,000
2
25,000
3
25,000
4
25,000
Monocle uses the straight-line method of depreciation with no mid-year convention. In addition, its tax rate is 35 percent and the life of the
equipment is four years with no salvage value. Cost of capital is 12 percent.
What is the annual cash flow for Year 1?
102. A corporation with taxable income of $400,000 and a 40 percent tax rate is considering the sale of an asset.
The original cost of the asset is $20,000, with $12,000 of it depreciated. How much total after-tax cash will be
produced from the sale of the asset for $24,000?
103. Bodacious Company is considering the purchase of a new machine for $80,000. The machine would
generate an annual cash flow before depreciation and taxes of $28,778 for five years. At the end of five years,
the machine would have no salvage value. The company’s cost of capital is 12 percent. The company uses
straight-line depreciation with no mid-year convention and has a 40 percent tax rate.
What is the annual net after-tax cash flow (rounded)?
104. Clementine Company is considering the purchase of a new machine for $160,000. The machine would
generate an annual cash flow before depreciation and taxes of $62,588 for four years. At the end of four years,
the machine would have no salvage value. The company’s cost of capital is 12 percent. The company uses
straight-line depreciation with no mid-year convention and has a 40 percent tax rate.
What is the annual net after-tax cash flow per year?
105. Vendome Company is considering the purchase of the following computer equipment, which is considered
5-year property for tax purposes:
Acquisition cost
$500,000
Annual cash flow
$180,000
Annual operating costs
$30,000
Expected salvage value
$-0-
Cost of capital
12%
Tax rate
40%
Vendome plans to use MACRS and keep the production equipment for seven years. (Round amounts to dollars.)
The MACRS deduction in Year 2 would be
106. Vendome Company is considering the purchase of the following computer equipment, which is considered
5-year property for tax purposes:
Acquisition cost
$500,000
Annual cash flow
$180,000
Annual operating costs
$30,000
Expected salvage value
$-0-
Cost of capital
12%
Tax rate
40%
Vendome plans to use MACRS and keep the production equipment for seven years. (Round amounts to dollars.)
The tax savings from depreciation in Year 3 would be
107. Colorform Company is considering the purchase of the following computer equipment, which is
considered 5-year property for tax purposes:
Acquisition cost
$400,000
Annual cash flow
$140,000
Annual operating costs
$20,000
Expected salvage value
0
Cost of capital
10%
Tax rate
40%
Colorform Company plans to use MACRS and keep the production equipment for seven years. (Round amounts to dollars.)
Tax savings from depreciation in Year 3 would be
108. Information about a project Wunderbar Company is considering is as follows:
Investment
$600,000
Revenues
$380,000
Variable costs
$100,000
Fixed out-of-pocket costs
$50,000
Cost of capital
8%
Tax rate
40%
The property is considered 5-year property for tax purposes. The company plans to use MACRS and dispose of the property at the end of the sixth
year; no salvage value is expected. Assume all cash flows occur at the end of the year. Round amounts to dollars.
The tax savings from depreciation in Year 2 would be
109. Under the current tax law, an asset that is classified as 7-year property and has a cost of $400,000 would
result in a depreciation deduction in Year 3 of
110. Under the current tax law, an asset that is classified as 5-year property and has a cost of $200,000 would
result in a depreciation deduction in Year 2 of
111. Information about a project Dalwhinnie Company is considering is as follows:
Investment
$1,500,000
Revenues
$700,000
Variable costs
$140,000
Fixed out-of-pocket costs
$80,000
Cost of capital
12%
Tax rate
40%
The property is considered 5-year property for tax purposes. The company plans to use MACRS and dispose of the property at the end of the sixth
year. No salvage value is expected. Assume all cash flows occur at the end of the year. Round amounts to dollars.
The tax savings from depreciation in Year 2 would be
112. Bellamy Company is considering the purchase of a computerized manufacturing system. The after-tax cash
benefits/savings associated with the system are as follows:
Decreased waste
$300,000
Increased quality
400,000
Decrease in operating costs
600,000
Increase in on-time deliveries
200,000
The system will cost $9,000,000 and will last ten years. The company’s cost of capital is 12 percent.
What is the payback period for the computerized manufacturing system?
113. Bellamy Company is considering the purchase of a computerized manufacturing system. The after-tax cash
benefits/savings associated with the system are as follows:
Decreased waste
$300,000
Increased quality
400,000
Decrease in operating costs
600,000
Increase in on-time deliveries
200,000
The system will cost $9,000,000 and will last ten years. The company’s cost of capital is 12 percent.
What is the NPV for the computerized manufacturing system?
114. Bellamy Company is considering the purchase of a computerized manufacturing system. The after-tax cash
benefits/savings associated with the system are as follows:
Decreased waste
$300,000
Increased quality
400,000
Decrease in operating costs
600,000
Increase in on-time deliveries
200,000
The system will cost $9,000,000 and will last ten years. The company’s cost of capital is 12 percent.
Which of the following best describes the IRR for this project?
115. A postaudit compares
116. Explain what a capital investment decision is. In your answer, distinguish between independent and
mutually exclusive capital investment decisions.
117. A capital investment project requires an investment of $450,000. It has an expected life of six years with
an annual cash flow of $90,000 received at the end of each year. The company uses the straight-line method of
depreciation with no mid-year convention. Ignore income taxes.
Required:
a.
Compute payback for the project.
b.
Compute the net present value of the project using a 12 percent discount rate.
c.
Would you recommend this project be accepted? Why or why not?
Present value of cash flow ($90,000 ´ 4.111)
369,990
Net present value
$ (80,010)
therefore, the project should be rejected.
118. Fill in the lettered blanks in the following table:
Investment A
Investment B
Investment C
Amount of investment
$80,000
(a)
$20,000
Economic life in years
10
5
8
Annual cash flow
$10,000
(b)
$ 2,500
Payback period in years
(c)
4
(d)
Present value of cash flows
(e)
$66,000
(f)
Net present value
$ 5,500
$ 6,000
($1,000)
119. Absentia Company is evaluating a capital expenditure proposal that has the following predicted cash flows:
Original investment
$45,000
Cash flow:
Year 1
$17,500
Year 2
25,000
Year 3
15,000
Salvage value
-0-
Discount rate
14%
Required:
Determine the following values:
a.
Net present value of the investment
b.
Proposal’s internal rate of return
c.
Payback period
Period
Cash Flow
Present Value Factor
Present Value
1
$17,500
0.877
$15,347.50
2
25,000
0.769
19,225.00
3
15,000
0.675
10,125.00
Total present value
$44,697.50
Less original investment
45,000.00
Net present value
$ (302.50)
Approximately 14%
a.
$66,000 – $6,000 = $60,000
b.
$60,000/4 = $15,000
c.
$80,000/$10,000 = 8
$20,000/$2,500 = 8
e.
$80,000 + $5,500 = $85,500
$20,000 – $1,000 = $19,000
120. Wastenot Production Company is considering the purchase of a flexible manufacturing system. The after-
tax cash benefits/savings associated with the system are as follows:
Decreased waste
$ 82,500
Increased quality
110,000
Decrease in operating costs
68,750
Increase in on-time deliveries
13,750
The system will cost $825,000 and will last ten years.
The company’s cost of capital is 10 percent.
Required:
a.
What is the payback period for the flexible manufacturing system?
b.
What is the NPV for the flexible manufacturing system?
c.
What is the IRR for the flexible manufacturing system?
a.
$825,000/$275,000 = 3 years
b.
6.145 ´ $275,000 – $825,000 = $864,875 (PVAF n=10, 10%)
c.
$825,000/$275,000 = 3.000, which is the present value factor for n = 10, and the interest rate is slightly greater than 30%.
121. Bertram Corporation is considering an investment in equipment for $150,000.
Data related to the investment are as follows:
Income before
Year
Depreciation and Taxes
1
$60,000
2
60,000
3
60,000
4
60,000
5
60,000
Cost of capital is 10 percent.
Bertram uses the straight-line method of depreciation with mid-year convention for tax purposes. In addition, its tax rate is 40 percent and the
depreciable life of the equipment is four years with no salvage value. The equipment is sold at the end of the fifth year.
Required:
Determine the following amounts using after-tax cash flows:
a.
Payback period
b.
Accounting rate of return on original investments for each year
c.
Net present value
Years
1
2
3
4
5
Income before
deprec. and taxes
$60,000
$60,000
$60,000
$60,000
$60,000
Less: Depreciation
18,750
37,500
37,500
37,500
18,750
Pretax income
$41,250
$22,500
$22,500
$22,500
$41,250
Income taxes
16,500
9,000
9,000
9,000
16,500
Net income
$24,750
$13,500
$13,500
$13,500
$24,750
Add: Depreciation
18,750
37,500
37,500
37,500
18,750
Cash flow
$43,500
$51,000
$51,000
$51,000
$43,500
a.
Cumulative
Investment
Year
Cash Flow
Cash Flow
Yet to Recover
1
$43,500
$ 43,500
$106,500
2
51,000
94,500
55,500
3
51,000
145,500
4,500
4
51,000
b.
Years 1 and 5: $24,750/$150,000 = 16.5%
Years 2, 3 and 4: $13,500/$150,000 = 9.0%
122. Missoula Office Services is considering the purchase of a new server to replace the one in operation. Data
on the new server are as follows:
Cost
$12,000
Salvage value at the end of five years
$1,000
Useful life, in years
5
Annual operating cost
$4,000
If the existing server is kept and used, it would require the purchase of additional hardware a year from now costing $2,000. After the use of the
server for five years, the salvage value would be $300. Additional information on the existing system is as follows:
Additional years of use
5
Annual operating costs
$9,000
Remaining book value
$12,000
Current salvage value
$3,000
Cost of capital
12%
The company uses the straight-line method of depreciation with no mid-year convention.
Required:
Should the new server be purchased? Why or why not?
Present
New Computer
Period
Cash Flow
Value Factor
Server
Comment
0
$(12,000)
1.000
$(12,000)
Outlay cost
0
3,000
1.000
3,000
Salvage of old
1
2,000
0.893
1,786
Purchase of
hardware avoided
1-5
5,000
3.605
18,025
Lower operating
costs
5
0.567
397
Difference in
salvage value
Net present value of
new server
$ 11,208
Period
Cash Flow
PV Factor
Present Value
0
$(150,000)
1.000
$(150,000.00)
1
43,500
0.909
39,541.50
2
51,000
0.826
42,126.00
3
51,000
0.751
38,301.00
4
51,000
0.683
34,833.00
5
43,500
0.621
27,013.50
Net present value
$ 31,815.00
123. Santander Company is considering a project that requires an investment of $700,000. The project is
expected to generate an annual cash flow of $280,000 for six years. The cash flow would be received at the end
of each year.
The asset is considered 5-year property for depreciation purposes and would be disposed of at the end of the
sixth year, at which time it is expected to have no salvage value. The company plans to use MACRS.
Assume the cost of capital is 12 percent and the income tax rate is 40 percent.
Required:
a.
Determine the net present value of the asset. (Round amounts to dollars.)
b.
State your recommendation to the management of the company.
a.
0
1
2
3
4
>
Investment
$(700,000)
>
>
after taxes
>
>
Tax savings –
>
56,000
89,600
53,760
32,256
>
Net cash flow
>
>
PV factors, 12%
´ 0.893
0.797
0.712
0.636
>
Present values
897,493
$200,032
$205,307
$157,893
$127,363
>
NPV
$197,493
>
<
5
6
<
<
<
<
$168,000
$168,000
<
<
<
32,256
16,128
<
<
$200,256
$184,128
<
0.567
0.507
<
$113,545
$ 93,353
124. Marion Dexter Company is evaluating a proposal to purchase a new machine that would cost $100,000 and
have a salvage value of $10,000 in four years. It would provide annual operating cash savings of $10,000, as
follows:
Old Machine
New Machine
Salaries
$40,000
$36,000
Supplies
7,000
5,000
Maintenance
9,000
5,000
Total
$56,000
$46,000
If the new machine is purchased, the old machine will be sold for its current salvage value of $20,000. If the new machine is not purchased, the old
machine will be disposed of in four years at a predicted salvage value of $2,000. The old machine’s present book value is $40,000. If kept, in one year
the old machine will require repairs predicted to cost $35,000.
Marion Dexter’s cost of capital is 14 percent.
Required:
Should the new machine be purchased? Why or why not?
Present
Period
Cash Flow
Value Factor
New Machine
Comment
0
$100,000
1.000
$(100,000)
Outlay cost
0
20,000
1.000
20,000
Salvage of old
1
35,000
0.877
30,695
Repairs avoided
1-4
10,000
2.914
29,140
Lower operating
costs
4
8,000
0.592
4,736
Difference in
salvage value
Net present value of
new machine
$(15,429)
125. Local Construction Company is considering the purchase of a bulldozer for $280,000. The expected life is
four years. The company is comparing the depreciation tax shield using MACRS versus the straight-line
method. If MACRS is used, the MACRS life is three years with a depreciation rate of 200 percent annually.
Regardless of the method of depreciation used, the mid-year convention will be observed. The company’s tax
rate is 40 percent. The straight-line method assumes mid-year convention, and the cost of capital is 14 percent.
Required: (Round all calculations to the nearest dollar.)
a.
Calculate the tax savings from depreciation for each year using both the MACRS and straight-line methods.
b.
Calculate the present value of the tax savings for both depreciation methods.
c.
Which method should be used to minimize the firm’s tax liability? Why?
Depreciation
Depreciation
Annual
Tax
Tax
Year
Base
Rate
Depreciation
Rate
Saving
1
$280,000
0.3333
$ 93,324
0.40
$ 37,330
2
280,000
0.4445
124,460
0.40
49,784
3
280,000
0.1481
41,468
0.40
16,587
4
280,000
0.0741
20,748
0.40
__8,299
$280,000
$112,000
Depreciation
Depreciation
Annual
Tax
Tax
Year
Base
Rate
Depreciation
Rate
Saving
1
$280,000
0.125
$ 35,000
0.40
$ 14,000
2
280,000
0.250
70,000
0.40
28,000
3
280,000
0.250
70,000
0.40
28,000
4
280,000
0.250
70,000
0.40
28,000
5
280,000
0.125
35,000
0.40
14,000
$280,000
$112,000
b.
MACRS Rates
Straight-Line Rates
Present
Present
Present
Value
Tax
Value of
Tax
Value of
Year
Factor
Savings
Tax Svgs.
Savings
Tax Svgs.
1
0.877
$ 37,330
$32,738
$ 14,000
$12,278
2
0.769
49,784
38,284
28,000
21,532
3
0.675
16,587
11,196
28,000
18,900
4
0.592
8,299
4,913
28,000
16,576
5
0.519
-0-
-0-
14,000
7,266
$112,000
$87,131
$112,000
$76,552
126. What are the differences that affect capital investment decisions regarding advanced technology and
environmental considerations?