Chapter 25 – Capital Budgeting and Managerial Decisions
PROBLEM SET A
Problem 25-1A (50 minutes)
Part 1
Annual straight-line depreciation = = $115,000
Part 2
Net Net Cash
Income Flow
Expected annual sales of new product……………....$1,840,000 $1,840,000
Expected costs of new product
Direct materials…………………………………..…………. (480,000) (480,000)
Direct labor……………………………………..…………….. (672,000) (672,000)
Overhead excluding depr. on new asset………….. (336,000) (336,000)
* Alternatively, annual net cash flow can be computed as
Net income + Depreciation = $53,900 + $115,000 = $168,900
Part 3
Part 4
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$480,000 – $20,000
4 years
Chapter 25 – Capital Budgeting and Managerial Decisions
Accounting rate of return = = 21.56%
* Average investment
Part 5
Present Value of Net Cash Flows
Present Present
Net Cash Value of Value of Net
Flows 1 at 7% Cash Flows
Year 1…………………………………………………..$168,900 0.9346 $ 157,854
Year 2…………………………………………………..168,900 0.8734 147,517
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$53,900
$250,000*
Chapter 25 – Capital Budgeting and Managerial Decisions
Problem 25-2A (55 minutes)
Part 1
PROJECT Y
Net income……………………………………………………………………….…….. $ 56,000
Depreciation expense*…………………………………………………………….. 87,500
Part 2
PROJECT Y
Payback Period = = 2.44 years
PROJECT Z
Problem 25-2A (Continued)
Part 3
PROJECT Y
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$350,000
$143,500
Chapter 25 – Capital Budgeting and Managerial Decisions
PROJECT Z
Accounting rate of return = = 20.8%
Part 4
PROJECT Y
Present Value of Net Cash Flows
Present Present
Value of Value of
Net Cash
Flows
1 at 8%
Annuity
Net Cash
Flows
Years 1-4………………………………………………. $143,500 3.3121 $475,286
PROJECT Z
Present Value of Net Cash Flows
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$36,400
$175,000*
Chapter 25 – Capital Budgeting and Managerial Decisions
Present Present
Net present value……….……………..…………. $ 44,469
Part 5
Recommendation to management is to pursue Project Y. This is because
Project Y has a positive net present value, which means that we expect it to
earn at least 8% on our cash investment in the machine. Project Z also has
a positive net present value, but its present value is less than that of
Project Y. We also note that the accounting rate of return is higher for
Project Y compared with Project Z.
Problem 25-3A (60 minutes)
Part 1
RESULTS USING STRAIGHT-LINE DEPRECIATION
(a)
Income
Before
Deprec.
(b)
Straight-
Line
Deprec.
(c)
Taxable
Income
(a) – (b)
(d)
40%
Income
Taxes
(e)
Net Cash
Flows
(a) – (d)
Year 6………………..………66,000 9,000 57,000 22,800 43,200
Part 2
RESULTS USING MACRS DEPRECIATION
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Chapter 25 – Capital Budgeting and Managerial Decisions
(a)
(b)
(c)
(d)
(e)
Year 3………………..………66,000 17,280 48,720 19,488 46,512
Year 4………………..………66,000 10,368 55,632 22,253 43,747
Year 5………………..………66,000 10,368 55,632 22,253 43,747
Year 6………………..………66,000 5,184 60,816 24,326 41,674
Problem 25-3A (Continued)
Part 3
NET PRESENT VALUE OF ASSET USING STRAIGHT–LINE DEPRECIATION
Present
Present Value of
Net Cash
Flows
Value of
1 at 10%
Net Cash
Flows
Year 1………………………………………………….. $ 43,200 0.9091 $ 39,273
Year 2………………………………………………….. 46,800 0.8264 38,676
Year 3………………………………………………….. 46,800 0.7513 35,161
Year 4………………………………………………….. 46,800 0.6830 31,964
Chapter 25 – Capital Budgeting and Managerial Decisions
Year 5………………………………………………….. 43,747 0.6209 27,163
Chapter 25 – Capital Budgeting and Managerial Decisions
Overtime per unit (50%)………………………....…..…..…….. 0.18
New business direct labor cost per unit....…..….......... $ 0.54
New business volume……………………………………..…..… 50,000
New business direct labor cost………………………………. $ 27,000
Total overhead……………………………………..…..……..….... $320,000
Fixed overhead (25%)…………………………………………….. 80,000
Problem 25-5A (55 minutes)
Part 1
Product G Product B
Selling price per unit……………………………………………… $120 $160
Variable costs per unit……………………………………….….. 40 90
Contribution margin per unit………………………..……….. $ 80 $ 70
Part 2
Sales Mix Recommendation. To the extent allowed by production and
market constraints, the company should produce as much of Product G as
possible. With a single shift yielding 176 hours per month (8 x 22), the
company can produce these units of Product G:
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Chapter 25 – Capital Budgeting and Managerial Decisions
Contribution Margin at Recommended Sales Mix
Contribution margin = 440 units x $80 per unit = $35,200 per month
Problem 25-5A (Continued)
Part 3
Sales Mix Recommendation with Second Shift. If the second shift is added,
the maximum possible output of G will double
Hours per unit……………………………………………………..…….. 0.4
Hours used for Product G………………..……………………..…. 240 hours
Hours available for Product B (352 hrs – 240 hrs)………..….…..
112 hours
The output of Product B with 112 production hours is
Management decision. The contribution margin of $40,840 exceeds the
contribution margin of $35,200 generated by one shift alone (see part 2).
Therefore, management should add the second shift.
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Education.
352 hrs. per mo.
112 hrs. per mo.
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