d.
$22,740.
36. Chicago Co. is interested in purchasing a machine that would improve its operational efficiency. The
cost is $200,000 with an estimated residual value of $20,000 and a useful life of eight years. Cash
inflows are expected to increase by $40,000 a year. The company’s minimum rate of return is 10
percent. The present value of $1 for eight years at 10 percent is 0.467, and the present value of an
annuity of $1 at 10 percent and eight years is 5.335.
The project earns a rate of return of
a.
Unable to determine from the data given
b.
greater than 10 percent.
c.
less than 10 percent.
d.
10 percent.
37. Memphis Co. is going to purchase a machine for $83,200 that will increase cash flows by $40,000 in
the first year, $30,000 the second year, and $25,000 the third year. The machine will have no residual
value. The minimum rate of return is 10 percent. The present value factors for the three years are
0.909, 0.826, and 0.751, respectively.
The machine’s net present value is
a.
$21,800.
b.
($3,285).
c.
$79,915.
d.
($4,286).
38. Memphis Co. is going to purchase a machine for $83,200 that will increase cash flows by $40,000 in
the first year, $30,000 the second year, and $25,000 the third year. The machine will have no residual
value. The minimum rate of return is 10 percent. The present value factors for the three years are
0.909, 0.826, and 0.751, respectively.
The machine’s actual rate of return is
a.
Unable to determine from the data given
b.
greater than 10 percent.
c.
less than 10 percent.
d.
10 percent.
39. The method of project selection that brings the time value of money into capital investment analysis is
the
a.
rate of return on initial investment.
b.
net present value method.
c.
payback method.
d.
accounting rate-of-return method.
40. Which of the following evaluation methods disregard the time value of money?
a.
The accounting rate-of-return and discounted cash flow methods
b.
The net present value and discounted cash flow methods
c.
The payback period and net present value methods
d.
The accounting rate-of-return and payback period methods
41. The payback period method measures
a.
the profitability of an investment.
b.
the cash flows from an investment.
c.
how quickly investment dollars may be recovered.
d.
the economic life of an investment.
42. Boston Corp. is evaluating three projects. Each project will return a total of $600,000 to the company
in cash flows over a three-year period. The cash flows for the three projects are as follows:
Year 1
Year 2
Year 3
Total
Project A
$300,000
$200,000
$100,000
$600,000
Project B
200,000
200,000
200,000
600,000
Project C
100,000
200,000
300,000
600,000
Which project represents the best investment for Boston?
a.
Project A
b.
Project B
c.
Project C
d.
All projects are equally good investments.
43. Seattle, Inc., is contemplating a project that costs $180,000. Expectations are that annual cash revenues
will be $70,000 and annual expenses (including depreciation) will total $30,000. The project has a
six-year useful life and a residual value of $30,000. Assume Seattle Inc. uses straight line method of
depreciation.
The accounting rate of return for the project is
a.
53.3 percent.
b.
22.2 percent.
c.
66.7 percent.
d.
38.1 percent.
44. Seattle, Inc., is contemplating a project that costs $180,000. Expectations are that annual cash revenues
will be $70,000 and annual expenses (including depreciation) will total $30,000. The project has a
six-year useful life and a residual value of $30,000. Assume Seattle Inc. uses straight line method of
depreciation.
The project’s payback period is
a.
2.31 years.
b.
2.77 years.
c.
2.14 years.
d.
2.57 years.
SHORT ANSWER
1. Discuss the qualitative factors that should be considered in the evaluation of proposals in addition to
the quantitative factors.
2. What criteria must be met for accepting any capital expenditure proposal with respect to minimum rate
of return on investment?
3. Why is the book value of equipment irrelevant when considering the replacement of equipment?
4. Why the residual value of equipment is relevant when considering the replacement of equipment?
5. The following data have been gathered for a capital investment decision. The amounts relate to a 14
percent discount factor.
End of Period
Present Value of $1
Present Value of an Annuity of $1
1
.877
.877
2
.769
1.646
3
.675
2.321
4
.592
2.913
5
.519
3.432
6
.456
3.888
a. Compute the present value of the following cash flows. Use a discount rate of 14 percent.
Year 1
$50,000
Year 2
60,000
Year 3
40,000
Year 4
50,000
Year 5
40,000
b. What would have been the present value of the cash flows if they were received in equal
installments over the five-year period at the same discount rate?
c. If the answers to parts (a) and (b) differ, explain the reason(s) why.
$ 50,000 .877 =
$240,000
6. The following data have been gathered for a capital investment decision. The amounts relate to a 14
percent discount factor.
End of Period
Present Value of $1
Present Value of an
Annuity of $1
1
.877
.877
2
.769
1.646
3
.675
2.321
4
.592
2.913
5
.519
3.432
6
.456
3.888
a. Compute the present value of the following cash flows. Use a discount rate of 14 percent.
Year 1
$40,000
Year 2
60,000
Year 3
50,000
Year 4
50,000
Year 5
40,000
b. What would have been the present value of the cash flows if they were received in equal
installments over the five-year period at the same discount rate?
c. If the answers to parts (a) and (b) differ, explain the reason(s) why.
$ 40,000 .877 =
=
$240,000
7. The Wyckoff Company specializes in decorative fruit baskets. Currently, the company is analyzing
purchase alternatives for a fruit-polishing machine. Data relevant to the decision are as follows:
Machine X
Machine Y
Cost
$80,000
$72,000
Useful life
5 years
5 years
Residual value
$2,000
$3,000
Estimated annual net cash flows
$32,000
$28,000
Present value multipliers at 12 percent:
Dollar received at the end of five years
.567
Dollar received at the end of each of the next five years
3.605
a. Compute the payback period for each of the alternatives. Round answers to two decimal places.
b. Using the net present value method, prepare an analysis to determine which machine the company
should purchase. (The company uses a 12 percent minimum desired rate of return.)
8. The Cal-Fruit Company specializes in decorative fruit baskets. Currently, the company is analyzing
purchase alternatives for a fruit-polishing machine. Data relevant to the decision are as follows:
Machine A
Machine B
Cost
$90,000
$82,000
Useful life
5 years
5 years
Residual value
$2,000
$3,000
Estimated annual net cash flows
$35,000
$30,000
Present value multipliers at 12 percent:
Dollar received at the end of five years
.567
Dollar received at the end of each of the next five years
3.605
a. Compute the payback period for each of the alternatives. Round answers to two decimal places.
Present value of cash flows:
Machine X: ($32,000 3.605)
Machine Y: ($28,000 3.605)
Present value of residual value:
Machine X: ($2,000 .567)
Machine Y: ($3,000 .567)
Total present value
Less cost of machine
72,000
Positive net present value
$ 36,494
b. Using the net present value method, prepare an analysis to determine which machine the company
should purchase. (The company uses a 12 percent minimum desired rate of return.)
9. Valprado Industries is thinking of purchasing a machine that will produce plastic kitchenware. The
machine would be used for five years, would cost $35,000, would have a $5,000 residual value, and
would increase annual net cash inflows by $8,800. Valprado uses the straight-line method of
depreciation. Using the above facts and the present value factors below, calculate (a) the payback
period (if necessary, round off and carry to one decimal place), (b) the accounting rate of return (if
necessary, round off and carry to one decimal place), and (c) the machine’s net present value (use
parentheses to indicate a negative net present value) based on a 12 percent minimum desired rate of
return (if necessary, round to the nearest dollar).
End of Period
Present Value of $1
at 12 Percent
Present Value of an
Annuity of $1
at 12 Percent
1
.893
.893
2
.797
1.690
3
.712
2.402
4
.636
3.038
5
.567
3.605
10. The Pink Thai Restaurant is considering the purchase of a second oven that would accommodate its
new take-out business. The oven would cost $17,000, have an estimated $5,000 residual value, and
would be kept for six years. Annual net cash inflows would increase by $3,960. Pink Thai uses the
straight-line method of depreciation. Using the above facts and the present value factors given below,
calculate (a) the payback period (if necessary, round off and carry to one decimal place), (b) the
accounting rate of return (if necessary, round off and carry to one decimal place), and (c) the oven’s net
present value (use parentheses to indicate a negative net present value) based on a 15 percent minimum
desired rate of return (if necessary, round to the nearest dollar).
End of Period
Present Value of $1
at 15 percent
Present Value of an
Annuity of $1
at 15 percent
1
.870
.870
2
.756
1.626
3
.658
2.284
4
.572
2.856
5
.497
3.3532
6
.432
3.785
= $3,960 – $2,000*
Present value of net cash inflows
Present value of residual value
Less purchase price
11. You are given the following present value factors at 8 percent, the Rogers Company’s minimum
desired rate of return:
End of Period
Present Value of $1
Present Value of an
Annuity of $1
1
.926
.926
2
.857
1.783
3
.794
2.577
4
.735
3.312
5
.681
3.993
6
.630
4.623
The Rogers Company is considering the replacement of a piece of equipment. The old machine has a
carrying value of $800 and a remaining estimated life of five years, with no residual value at that time.
Present residual value is $200. The new equipment will cost $1,200, including transportation and
installation. It has an estimated life of five years, with no residual value then. Annual cash operating
costs are $400 for the old machine and $150 for the new machine.
a. Compute the present value of the operating cash outflows for the old machine.
b. Compute the present value of the operating cash outflows for the new machine.
c. Compute the present value of the cash operating savings if the new machine is purchased.
d. What is the net present value of the replacement alternative?
12. You are given the following present value factors at 8 percent, the Tehachapi Glass Company’s
minimum desired rate of return:
End of Period
Present Value of $1
Present Value of an
Annuity of $1
1
.926
.926
2
.857
1.783
3
.794
2.577
4
.735
3.312
5
.681
3.993
6
.630
4.623
The Tehachapi Glass Company is considering the replacement of a piece of equipment. The old
machine has a carrying value of $800 and a remaining estimated life of five years, with no residual
value at that time. Present residual value is $200. The new equipment will cost $1,200, including
transportation and installation. It has an estimated life of five years, with no residual value then.
Annual cash operating costs are $405 for the old machine and $165 for the new machine. Round
answers to two decimal places.
a. Compute the present value of the operating cash outflows for the old machine.
b. Compute the present value of the operating cash outflows for the new machine.
c. Compute the present value of the cash operating savings if the new machine is purchased.
d. What is the net present value of the replacement alternative?
13. Fresno Manufacturing Company specializes in the production of precision tools. Management is in the
process of selecting a new drill press. The press under consideration will cost $92,000 plus necessary
installation charges of $5,000. Experience indicates that the press will last for five years and should
have a residual value at the end of that period of about $10,000. Expected annual cash revenues from
the press should average $45,000, and related cash operating costs should be around $20,000.
Management has decided on a minimum desired before-tax rate of return of 10 percent.
Present value multipliers:
6 Percent
10 Percent
12 Percent
Present value of $1 at end of five years
.747
.621
.567
Present value of $1 received in each of the next
five years
4.212
3.791
3.605
a. Using before-tax information and the net present value method to evaluate this capital investment,
determine whether the company should purchase the drill press. Support your answer.
b. If management has decided on a minimum desired before-tax rate of return of 12 percent, should the
drill press be purchased? Show all computations to support your answer.
14. Management of the Krausse Savings and Loan Association is in the process of evaluating the purchase
of a new check sorting machine. The model under review will cost $70,000 and will require
installation costs of $10,000. Similar machines have a ten-year life, and management has estimated
that this sorter will have a residual value of $10,000 at the end of its life. Annual cost savings to be
generated by the sorter will average $14,000 over the ten-year period. Management’s minimum desired
rate of return is 12 percent.
Present value multipliers:
8 Percent
12 Percent
14 Percent
Present value of $1 at end of ten years
.463
.322
.270
Present value of $1 received in each of the next ten
years
6.710
5.650
5.216
a. Using before-tax information and the net present value method to evaluate this capital investment,
determine whether the company should purchase the check sorting machine. Support your answer.
b. If management had decided on a minimum desired before-tax rate of return of 14 percent, should the
check sorting machine be purchased? Show all computations to support your answer.
Purchase price of machine
Useful life
15. Management of Moore City Trust is in the process of evaluating the purchase of a new check sorting
machine. The model under review will cost $44,000 and will require installation costs of $5,000.
Similar machines have a ten-year life, and management has estimated that this sorter will have a
residual value of $2,500 at the end of its life. Annual cost savings to be generated by the sorter will
average $9,500 over the ten-year period. Management’s minimum desired before-tax rate of return is
14 percent.
Present value multipliers:
9 Percent
14 Percent
16 Percent
Present value of $1 at end of ten years
.422
.270
.227
Present value of $1 received in each of the next
ten years
6.418
5.216
4.833
a. Using before-tax information and the net present value method to evaluate this capital investment,
determine whether the company should purchase the check sorting machine. Support your answer.
b. If management had decided on a minimum desired before-tax rate of return of 16 percent, should the
check sorting machine be purchased? Show all computations to support your answer. Round answers
to nearest dollar.
16. San Joaquin Manufacturing Company specializes in the production of precision tools. Management is
in the process of selecting a new drill press. The press under consideration will cost $180,000 plus
necessary installation charges of $25,000. Past experience indicates that the press will last for ten years
and should have a residual value at the end of that period of about $15,000. Expected annual cash
revenues from the press should average $66,000, and related cash operating costs should be around
$30,000. Management has decided on a minimum desired before-tax rate of return of 12 percent.
Present value multipliers:
6 Percent
12 Percent
14 Percent
Present value of $1 at end of ten years
.558
.322
.270
Present value of $1 received in each of the next ten
years
7.360
5.650
5.216
a. Using before-tax information and the net present value method to evaluate this capital investment,
determine whether the company should purchase the drill press. Support your answer.
b. If management had decided on a minimum desired before-tax rate of return of 14 percent, should the
drill press be purchased? Show all computations to support your answer.
Residual value
17. Special Industries is considering investing $40 million in plant expansion. Management needs to know
the average cost of capital to use in evaluating this capital investment decision. The company’s capital
structure consists of $4,000,000 of debt at 3 percent interest and $6,000,000 of stockholders’ equity at
4 percent. What is the average cost of capital of Special Industries.