Exam 16: Capital Expenditure Decisions

Tanner Corporation is considering the acquisition of a new machine that is expected to produce annual savings in cash operating costs of $30,000 before income taxes. The machine costs $100,000, has a useful life of five years, and no salvage value. Tanner uses straight-line depreciation on all assets, is subject to a 30% income tax rate, and has an after-tax hurdle rate of 8%. Required: A. Compute the machine's accounting rate of return on the initial investment. B. Compute the machine's net present value.

Consider the following statements about capital budgeting postaudits: I. Postaudits can be used to detect desirable projects that were rejected. II. Postaudits can be used to detect undesirable projects that were accepted. III. Postaudits may reveal shortcomings in cash-flow projections, providing insights that allow a company to improve future predictions. Which of the above statements is (are) correct?

A depreciation tax shield is a(n):

The payback method is a popular way to analyze investment proposals. Required: A. Explain how the payback period is determined. Generally speaking, from a payback perspective, which projects are viewed to be the most attractive? B. Can the payback method take income taxes into consideration? Explain. C. What are the deficiencies of the payback method?

Generally speaking, which of the following would not directly affect a company's income tax payments?

Canton Corporation is considering the acquisition of a new machine that costs $149,040. The machine is expected to have a four-year service life and will produce annual savings in cash operating costs of $45,000. Canton evaluates investments by using the internal rate of return and ignores income taxes. Required: A. Briefly define the internal rate of return. B. What relationship holds true at the internal rate of return with respect to discounted cash inflows and discounted cash outflows? With respect to net present value? C. Compute the machine's internal rate of return, using the tables that follow.

When preparing an NPV analysis on the disposal of an asset, like equipment, capital gains and losses are taxed at the same rate as ordinary income in the analysis.

The internal rate of return on an asset can be calculated:

In 10 years, Hopkins Company plans to receive $9,000 cash from the sale of a machine that has a $5,000 book value. If the firm is subject to a 30% income tax rate and has an 8% after-tax hurdle rate, the correct discounted net cash flow would be:

Randi Corp. is considering the replacement of some machinery that has zero book value and a current market value of $2,800. One possible alternative is to invest in new machinery that costs $30,000. The new equipment has a four-year service life and an estimated salvage value of $3,500, will produce annual cash operating savings of $9,400, and will require a $2,200 overhaul in year 3. The company uses straight-line depreciation. Required: Prepare a net-present-value analysis of Randi’s replacement decision, assuming an 8% hurdle rate and no income taxes. Should the machinery be acquired? Note: Round calculations to the nearest dollar.

Use the following information to answer the following Questions Carmen Company has an asset that cost $5,000 and currently has accumulated depreciation of $2,000. Suppose the firm sold the asset for $2,500 and is subject to a 30% income tax rate. -The loss on disposal would be:

Consider the following statements about depreciation tax shields: I. A depreciation tax shield provides distinct benefits to a business. II. A depreciation tax shield should be ignored when doing a net-present-value analysis. III. A depreciation tax shield can occur in more than one year. Which of the above statements is (are) correct?

Consider the following statements about taxes and after-tax cash flows: I. Capital budgeting analyses should incorporate after-tax cash flows rather than before-tax cash flows. II. Added company revenues will result in lower taxes for a firm. III. Operating expenses may actually provide a tax benefit for an organization. Which of the above statements is (are) correct?

Consider the five items that follow, which are related to independent investment opportunities. Purchase price of a new machine: $850,000 Annual straight-line depreciation: $75,000 Annual savings in cash operating costs: $120,000 Advertising expenses related to a new marketing campaign in year 2: $35,000 Sale of an asset in year 6: Loss on sale, $60,000; proceeds received by seller, $23,000 Required: Complete the following table, inserting the (pre-discounted) cash flow amounts that would be used in a net-present-value analysis. Column A should be completed based on the assumption of no income taxes; in contrast, Column B should be completed assuming the relevant company is subject to a 30% income tax rate. Be sure to note cash outflows in parentheses.

Consider the following statements about the investment in working capital in a capital budgeting analysis: I. Working capital often increases as the result of higher balances in accounts receivable or inventory necessary to support a project. II. Working capital increases are sources of cash and should be included in a discounted-cash-flow analysis. III. The time 0 cash investment in working capital is included in a discounted-cash-flow analysis as a cash outflow. Which of the above statements is (are) correct?

A company's hurdle rate is generally influenced by whether management uses the net-present-value method or the internal-rate-of-return method.

Consider the following statements about the accounting for inflation in a capital budgeting analysis: I. An analyst can use nominal dollars in conjunction with a nominal interest rate. II. An analyst can use real dollars in conjunction with a real interest rate. III. An analyst can use nominal dollars in conjunction with a real interest rate. Which of the above statements is (are) correct?

Which of the following would not involve a capital-budgeting analysis?

Which of the following is taken into account by the net-present-value method?

Inflation is defined as a decline in the general purchasing power of a monetary unit, such as a dollar, across time.