Exam 16: Capital Expenditure Decisions

Carlin Company, which uses net present value to analyze investments, requires a 10% minimum rate of return. A staff assistant recently calculated a $500,000 machine's net present value to be $86,400, excluding the impact of straight-line depreciation. If Carlin ignores income taxes and the machine is expected to have a five-year service life, the correct net present value of the machine would be:

Marcus & Tyler sells frozen custard and sandwiches. It is considering a new site that will require a $2 million investment for land acquisition and construction costs. The following operating results are expected: Disregard income taxes. Required: A. If management requires a payback period of four years or less, should the new site be opened? Why? B. Compute the accounting rate of return on the initial investment. C. What significant limitation of payback and the accounting rate of return is overcome by the net-present-value method?

Krate Inc. is considering a $600,000 investment in new equipment that is anticipated to produce the following net cash inflows: If cash flows occur evenly throughout a year, the equipment's payback period is:

The payback period is best defined as:

The incremental-cost approach looks at the difference in the NPVs of the cost of each relevant item under two alternatives in an analysis.

All expenses represent cash outflows.

A company used the net-present-value method to analyze an investment and found the investment to be very attractive. If the firm used straight-line depreciation and changes to the Modified Accelerated Cost Recovery System (MACRS), the investment's net present value will:

Bowers Company plans to incur $190,000 of salaries expense and produce $320,000 of additional sales revenue if a capital project is implemented. Assuming a 30% tax rate, these two items collectively should appear in a capital budgeting analysis as:

Capital-budgeting decisions primarily involve:

A piece of equipment costs $30,000, and is expected to generate $8,500 of annual cash revenues and $1,500 of annual cash expenses. The disposal value at the end of the estimated 10-year life is $3,000. Ignoring income taxes, the payback period is:

Consider the following statements about the accounting rate of return: I. The accounting rate of return focuses on a project's income rather than its cash flows. II. Companies can figure the accounting rate of return on either the initial investment figure or an average investment figure. III. The accounting rate of return considers the time value of money. Which of the above statements is (are) correct?

The decision process that has managers select from among several acceptable investment proposals to make the best use of limited funds is known as:

MACRS depreciation is based on straight-line depreciation and is typically used for published financial statements.

Capital budgeting tends to focus primarily on:

Ocean Wave Packaging is considering a $600,000 investment in new equipment that is anticipated to produce the following data over a five-year life: Ignoring income taxes and assuming that cash flows occur evenly throughout a year, the equipment's approximate payback period is:

When income taxes are considered in capital budgeting, the cash flows related to a company's advertising expense would be correctly figured by taking the cash paid for advertising and subtracting the result of multiplying [or advertising expense * (1 ‒ tax rate)].

Consider the following statements about the payback period: I. As shown in your text, the payback period considers the time value of money. II. The payback period can only be used if net cash inflows are uniform throughout a project's life. III. The payback period ignores cash inflows that occur after the payback period is reached. Which of the above statements is (are) correct?

Donata Company purchased equipment for $30,000 in December 20x1. The equipment is expected to generate $10,000 per year of additional revenue and incur $2,000 per year of additional cash expenses, beginning in 20x2. Under MACRS, depreciation in 20x2 will be $3,000. If the firm's income tax rate is 40%, the after-tax cash flow in 20x2 would be:

Fulton Township is studying a 700-acre site for a new landfill. The new site will save $70,000 in annual operating costs for 10 years, as Fulton currently uses the landfill of a neighboring municipality. Other data are: Purchase price per acre: $550 Site preparation costs: $110,000 Hurdle rate: 6% Ignore income taxes. Required: A. Use the net-present-value method and determine whether the landfill should be acquired. B. Determine the landfill's approximate internal rate of return, using the tables above.

A profitability index can be used to rank investment proposals. Required: A. Define the profitability index. B. Two projects are under consideration. Project I has a net present value of $20,000 whereas project II has a net present value of $200,000. Which project is better? Explain. What weakness in a net-present-value analysis does the profitability index address?