Chapter 12 – The Capital Budgeting Decision
107. A firm utilizes a strategy of capital rationing, which is currently $375,000 and is
considering the following 2 projects: Project A has a cost of $335,000 and the following cash
flows: year 1 $140,000; year 2 $150,000; and year 3 $100,000. Project B has a cost of
$365,000 and the following cash flows: year 1 $220,000; year 2 $110,000; and year 3
$150,000. Using a 12% cost of capital, which decision should the financial manager make?
Chapter 12 – The Capital Budgeting Decision
108. Technology Corp. is considering a $200,000 investment in a new marketing campaign
which they anticipate will provide annual cash flows of $52,000 for the next 5 years. The firm
has a 10% cost of capital. What should the analysis indicate to the firm’s managers?
Chapter 12 – The Capital Budgeting Decision
109. Match the following with the items below:
Concerns the rate of return that can be earned
on the cash flow generated by capital budgeting
2. internal rate of return
Occurs when a corporation has more dollars of
capital budgeting projects with positive net present
values than it has money allocated to invest in
Has defined asset lives of 3 to 39 years for
A discounted cash flow method for evaluating
capital budgeting projects where the present value
of the cash inflows are equal to the present value
The time it takes to depreciate an asset under
The length of time it takes to conceive,
develop, and complete a project and to recover the
cost of the project on a discounted cash flow
8. modified accelerated cost
recovery system
Indicates the length of time required to recoup
A graphical presentation of the potential net
present values of a project at different discount
Chapter 12 – The Capital Budgeting Decision
110. Match the following with the questions below:
1. net present value
Equals the present value of the cash inflows minus the
present value of the cash outflows when the cost of
Is calculated by taking the depreciable cost of an asset
3. asset depreciation
The selection of one choice precludes the selection of
This value is multiplied by the tax rate to determine
5. straight-line
The capital budgeting decision on whether or not to
6. incremental
The expected physical life of an asset or class of
7. replacement
Writing off an asset in the year of purchase for tax
Chapter 12 – The Capital Budgeting Decision
111. The law firm of Bushmaster, Cobra and Asp is considering investing in a complete small
business computer system. The initial investment will be $50,000. The computer is in the 5-
year MACRS category, and the firm’s tax rate is 34%. The computer system is expected to
provide additional revenue of $32,000 per year for the next six years, and to reduce expenses
by $7,000 per year for the same period.
a) Calculate the net after-tax cash flows from this investment.
b) Calculate the net present value of the system, given that the law firm’s weighted average
cost of capital is 12%.
c) Should they buy the computer system?
Chapter 12 – The Capital Budgeting Decision
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112. Tabletop Ranches, Inc. is considering the purchase of a new helicopter for $400,000. The
firm’s old helicopter has a book value of $90,000, but can only be sold for $60,000. It was
being depreciated at the rate of $13,500 per year for four more years under an old depreciation
method.
The new helicopter will be depreciated using the 5-year MACRS schedule. It is expected to
save $75,000 after taxes through reduced fuel and maintenance expenses. Tabletop Ranch is
in the 34% tax bracket and has a 12% cost of capital. Assume a 6 year time horizon.
a) Calculate the cash inflows from selling the old helicopter.
b) Calculate the net cost of the new helicopter.
c) Calculate the incremental depreciation for the new helicopter.
d) Calculate the net cash flows for the purchase.
e) Calculate the net present value of the helicopter purchase and of the helicopter purchase
and state whether or not the firm should buy it.
Chapter 12 – The Capital Budgeting Decision
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Chapter 12 – The Capital Budgeting Decision
Chapter 12 – The Capital Budgeting Decision
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113. The Taylor Corporation is using a machine that originally cost $88,000. The machine is
being depreciated by the straight-line method over 8 years ($11,000 per year) and has 4 years
of depreciation remaining. The machine has a book value of $44,000 and a current market
value of $40,000.
Jacqueline Elliott, the Chief Financial Officer of Taylor, is considering replacing this machine
with a newer model costing $75,000. The new machine will save $5,000 in after-tax earnings
each year for the next six years. The new machine is in the 5-year MACRS category. Taylor
Corporation is in the 34% tax bracket and has a 10 percent cost of capital.
a) Calculate the cash inflows from the sale of the old machine.
b) Calculate the net cost of the new machine.
c) Calculate the incremental depreciation on the new versus the old machine.
d) Determine the net present value of the new machine. Should they purchase the new
machine?
Chapter 12 – The Capital Budgeting Decision
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Chapter 12 – The Capital Budgeting Decision
Chapter 12 – The Capital Budgeting Decision
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114. A&B Enterprises is trying to select the best investment from among four alternatives.
Each alternative involves an initial outlay of $100,000. Their cash flows follow:
Chapter 12 – The Capital Budgeting Decision
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Chapter 12 – The Capital Budgeting Decision