61. Stanley Company invested in an asset with a useful life of 4 years and no salvage value. The company’s
expected rate of return is 12%. The cash inflows and present value factors for 4 years are as follows:
Present Value of an
Period
Cash inflows
Annuity of $1 at 12%
1
$ 9,000
0.8929
2
$ 9,900
0.7972
3
$10,800
0.7118
4
$11,700
0.6355
If the asset generates a positive net present value of $3,000, what was the amount of the original investment?
62. Windham Company is considering a project with annual cash inflows of $3,000 a year, an estimated life of
12 years, no salvage value, and a net present value of $(7,088). If the present value of an annuity factor used to
calculate the net present value was 6.222, the initial investment is:
63. Which of the following is NOT typically a qualitative factor that management must consider in strategic and
capital investment decisions?
64. A company may decide to invest in a project even if the investment returns less than the cost of capital. The
qualitative reasons for doing so include all BUT which of the following?
65. Sensitivity analysis can be used to evaluate the uncertainty of:
66. The technique used to consider a range of possibilities in capital budgeting decisions is called:
67. An asset is purchased for $50,000. It is expected to provide an additional $12,000 of annual net cash
inflows. The asset has a 10-year life and an expected salvage value of $4,000. The hurdle rate is 10%. The
present value of an annuity factor of 10% for 10 years is 6.1446, and the present value of $1 discounted for 10
years at 10% is 0.3855. Given the data provided, the minimum amount of annual cash inflows that would
provide the 10% return is approximately:
68. An asset is purchased for $120,000. It is expected to provide an additional $28,000 of annual net cash
inflows. The asset has a 10-year life and an expected salvage value of $12,000. The hurdle rate is 10%. The
present value of an annuity factor of 10% for 10 years is 6.1446, and the present value of $1 discounted for 10
years at 10% is 0.3855. The present value of annuity factors at 10% for 3, 4, 5, 6, 7, 8, and 9 years are 2.4869,
3.1699, 3.7908, 4.3553, 4.8684, 5.3349, and 5.7590, respectively. The minimum useful life that would provide a
10% return is between:
69. Boggs Corporation is considering the purchase of a machine with an initial cost of $26,000, a useful life of
10 years, and a salvage value of $2,000. The company desires a 12% rate of return. Given the data provided, at
a present value of an annuity for 10 years at 12% of 5.650 and a present value of $1 for 10 years at 12% of
0.322, the machine should be purchased only if annual net cash inflows are:
70. A profitability index is a method of:
71. The use of a profitability index is required when ranking projects for capital rationing under which method?
72. When a company has an opportunity to invest in several projects but has limited resources, it should select
those projects with the highest:
73. Which of the following are correct capital budgeting decision rules when using the profitability index (PI)?
74. The process of determining which investment is best among acceptable alternatives is:
75. Which method is preferred for capital rationing?
76. Allin Company is considering two projects. Project W has an investment cost of $15,000 and a present
value of net cash inflows of $21,000. Project T has an investment cost of $20,000 and a present value of net
cash inflows of $29,000. Due to limited resources, Allin can invest in only one project. What should Allin do?
77. Collins Company is considering the purchase of a new machine. The initial investment in the machine was
$39,000 and the present value of net cash inflows is $45,500. The profitability index is:
78. Pulaski Corporation is considering a capital investment that has a profitability index of 1.2. If the initial
investment is $1,200,000, the net present value must be:
79. Blakeley Company is considering the following six capital investment projects:
Expected Rate
Project
of Return
A
14%
B
10%
C
17%
D
18%
E
11%
F
12%
Blakeley has a minimum required rate of return of 12%. Given this information, what ranking should Blakeley use on the capital investment
projects?
80. Which of the following items would NOT have an impact on income taxes related to a capital budgeting
decision?
81. In general, which of the following is true of the impact of income taxes on the internal rate of return?
82. A machine with a book value of $8,000 can be sold for $9,500. The corporation that owns the machine has
taxable income of $50,000 and a tax rate of 40%. What would be the tax on the sale of the machine?
83. A corporation with taxable income of $100,000 and a tax rate of 40% is selling a machine. The original cost
of the machine is $8,000, and the machine has been depreciated $4,000. If the machine is sold for $6,000, the
amount of after-tax cash generated by this sale would be:
84. A company with an average income tax rate of 35% sold a piece of equipment with a book value of $80,000
for $70,000 cash. What is the after-tax cash flow of this transaction?
85. If the tax rate is 40% and a company has $400,000 of pre-tax income, a depreciation deduction of $25,000
would result in a tax savings of:
86. If the tax rate is 40% and a company has $200,000 of pre-tax income, a depreciation deduction of $40,000
would result in a tax savings of:
87. If the tax rate is 40% and a company has $400,000 of pre-tax income, the company would have an after-tax
income of:
88. A company has a tax rate of 40% and a pre-tax net income of $200,000. Other than depreciation expense of
$40,000, all other revenues and expenses used to calculate this income are on a cash basis. What is the
company’s after-tax cash flow?
89. Frosty-O-Cereal Company is considering the purchase of a new piece of production machinery to replace
old machinery. This replacement will reduce labor and maintenance costs. Data related to the purchase follows:
Salvage value of old machine
Book value of old machine
Initial investment in new machine
Useful life of new machine
Annual cash savings of new machine
Salvage value of new machine
Frosty-O-Cereal’s cost of capital
Assume that all cash flows occur at the end of the year and will last for a period of ten years. Frosty-O-Cereal’s average income tax rate is 40%. Also
assume that for tax purposes the new machine will be depreciated on a straight-line basis for 10 years. What is the net present value of this purchase
(rounded to the nearest 10 dollars)?
90. List and describe the three aspects of capital investment decisions that are critical to long-run profitability.
91. You are considering the purchase of a car to use for pizza delivery. The owner of the car will let you pay for
it in 4 monthly payments of $600. You expect to earn $300 per week with gas and related expenses of $60 per
week. How long will it take for the car to pay for itself?
92. The owner of the pizza parlor you are working for has asked for your help. He is trying to decide whether to
buy an ice cream machine. The cost of the machine is $45,000. The revenue generated by the machine is
expected to be $19,600 and the costs will be $14,200. The owner has no more information available. Ignoring
taxes, calculate the unadjusted rate of return to help him make his decision.
93. Green Acre Farms wants to buy a machine that costs $750,000 and will increase net income an average of
$200,000 per year. What is the rate of return without considering the time value of money?
94. Carroll Corporation is considering the purchase of a new machine that costs $144,000, has an expected
useful life of 10 years, and has no salvage value. Merriam estimates that the machine will give the company a
net income of $24,000 per year over the 10-year life. The company’s hurdle rate is 12%.
a.
What is the payback period for the new machine?
b.
What is the unadjusted rate of return on the new machine?
c.
Should the Carroll Corporation purchase the new machine?
95. Parkways Inc. is considering the purchase of a new machine. The machine will cost $60,000 to purchase and
will generate $15,000 of revenues per year for the next 8 years. The machine will cost $1,000 per year to
maintain and have a salvage value of $5,000 at the end of the 8 years. From a quantitative standpoint, should
Parkways purchase the machine if its cost of capital is 15%?
Period
Cash Flow
PV Factor
Inflows:
Revenues
1-8
$15,000
$67,310
Salvage value
8
5,000
1,635
Total inflows
$68,945
Initial cost
Today
$60,000
$60,000
Total outflows
$64,487
a.
Investment cost: $144,000
Net cash inflows: $24,000 + $14,400 (depreciation) = $38,400
Payback period: $144,000 ¸ $38,400 = 3.75 years
b.
Increase in future average net income: $24,000
Initial investment cost: $144,000
Unadjusted rate of return: $24,000 ¸ $144,000 = 16.67%
96. Marketing Group Ltd. wants to know the net present value of a machine that will cost $60,000 today and
will generate the following cash flows:
Year 1
$45,000
Year 2
$30,000
Year 3
$20,000
Year 4
$15,000
Year 5
$ 3,000
The machine has a salvage value of $5,000 at the end of year 5. The cost of capital is 12%.
97. Kankakee Company wants to buy a machine that will cost $770,124 and provide an annual cash income of
$120,000 for 10 years. What is the company’s internal rate of return? Assume the following present value
factors:
Percent
of $1 for 10 years
Annuity of $1 for 10 years
8%
0.4632
6.7101
9%
0.4224
6.4177
10%
0.3855
6.1446
12%
0.3220
5.6502
98. Rocky’s Packaging Company is considering the purchase of a new piece of production machinery that will
reduce labor and maintenance costs. Data related to the new machine follows:
Initial investment
Useful life
Salvage value of old machine
Annual cash savings
Salvage value of new machine
Cost of capital
PV Factor
Period
Cash Flow
(12%)
PV Flow
Initial outflow
Today
$(60,000)
1.0000
$(60,000)
Annual savings
1
45,000
0.8929
40,181
2
30,000
0.7972
23,916
3
20,000
0.7118
14,236
4
15,000
0.6355
9,533
5
3,000
0.5674
1,702
Salvage value
5
5,000
0.5674
2,837
Net present value
$ 32,405
Assume all cash flows occur at the end of the year and ignore income taxes.
a.
Calculate the net present value of the investment.
b.
Determine the effect on net present value if the cost of capital is 16% and the new machine’s salvage value is $22,000.
c.
Return to the original data, and determine the effect on net present value if annual cash flows are reduced by 10% and the useful life is 12
years.
99. List 10 qualitative factors that could be taken into account when making capital budgeting decisions.
Annual cash inflow ($35,000)
5.6502
197,757
Net present value
$ 13,553
Initial investment
1.0
$(190,000)
Annual cash inflow ($35,000)
4.8332
169,162
Net present value
$ (15,851)
Annual cash inflow ($31,500)
6.1944
195,124
Net present value
$ 9,745
100. Macoupin Company purchased an asset for $275,000. It is expected to provide an additional $66,000 of
annual net cash inflows. The asset has a 10-year life and an expected salvage value of $22,000. The hurdle rate
is 12%. The present value of an annuity factor of 12% for 10 years is 5.65, and the present value of $1
discounted for 10 years at 12% is 0.322. Given the data provided, calculate the minimum amount of annual cash
inflows that would provide the 12% return.
101. Cottages 4U is considering several long-term investment projects. Management wants to accept the two
best projects, given the following data:
Project identifier
A
B
C
D
E
Investment cost
50,000
32,000
48,000
40,000
80,000
Present value of cash inflows
$46,500
$30,000
$60,000
$48,000
$88,000
a.
Calculate the net present value and the profitability index for each project.
b.
Which projects are acceptable based on the profitability index?
c.
What is the ranking of the acceptable projects?
a.
Project identifier
A
B
C
D
E
Present value of cash
inflows
$46,500
$30,000
$60,000
$48,000
$88,000
Investment cost
50,000
32,000
48,000
40,000
80,000
Net present value
$ (3,500)
$ (2,000)
$12,000
$ 8,000
$ 8,000
Profitability index
0.9300
0.9375
1.2500
1.2000
1.100
c.
Ranking is C, D, E.
102. Schuyler Company is considering the following six capital investment projects:
Expected Rate
Project
of Return
R
16%
S
8%
T
14%
U
10%
V
12%
W
13%
´ 0.322)
Net cost of asset
$267,916
Schuyler has a minimum required rate of return of 11%.
a.
Which projects are acceptable based on the internal rate of return?
b.
What is the ranking of the acceptable projects?
103. Speedy Movers is considering the purchase of a new moving truck that will reduce fuel and maintenance
costs as well as increase revenues. Data related to the new truck follows:
Initial investment
Useful life
Annual cash savings
Salvage value at end of useful life
Cost of capital
Income tax rate
Assume all cash flows occur at the end of the year and the company will depreciate the truck using straight-line depreciation. Calculate the net
present value of the truck. Should the company purchase the new truck? Explain your answer.
Annual cash inflow ($18,200*)
1-7
4.2883
78,047
Depreciation tax savings ($4,200**)
1-7
4.2883
18,011
Salvage value of new machine ($8,400***)
7
0.3996
3,357
Net present value
$ 1,415
*
After-tax earnings: $26,000 ´ (1 – .3) = $18,200
Depreciation tax savings: ($98,000 ¸ 7) ´ .3 = $4,200
***
After-tax salvage value: $12,000 ´ (1 – .3) = $8,400
a.
Projects R, T, V, and W are acceptable (internal rate of return is greater than hurdle rate).
Ranking is R, T, W, V.