Exam 14: Capital Expenditure Decisions

Post-audits are an important part of capital budgeting. Required: A. What is a post-audit of a capital investment project? B. What are the benefits of a post-audit? C. A manager prepared an unsuccessful proposal for a capital project, as her firm decided not to fund and pursue the project. The manager observed, "The company's post-audit process will show that this project should have been funded." Comment on the manager's understanding of the post-audit process.

A new machine that costs $79,860 is expected to save annual cash operating costs of $20,000 over each of the next five years. The machine's internal rate of return is:

You are reviewing some material that deals with investment analysis, preparing for your first day on the job at Franklin Enterprises. Consider the cash flows that follow. 1. The immediate payment required to purchase a $600,000 milling machine. 2. Straight-line depreciation of $20,000 in year 2 of a long-term investment. 3. Annual savings in cash operating costs of $50,000 over the next eight years. 4. Sale of a machine for $35,000 at the end of its six-year service life. The machine has a book value of $25,000. 5. A $6,000 equipment overhaul in year 5 that is fully deductible for income tax purposes. Required: Calculate the discounted cash flow that is appropriate for each of the preceding items. Assume a 10% after-tax hurdle rate and a 30% income tax rate, and round to the nearest dollar.

Of the five expenses that follow, which one is most likely treated differently than the others when income taxes are considered in a discounted-cash-flow analysis?

A piece of equipment costs $50,000, and is expected to generate $2,500 of annual cash revenues and $500 of annual cash expenses. The disposal value at the end of the estimated 25-year life is $2,000. Ignoring income taxes, the payback period is:

Landau Spandex Inc. ranks investments by using the profitability index (PI). The following data relate to Product A and Product B: Product A Product B Initial investment \ 900,000 \ 1,500,000 Present value of inflows 800,000 2,000,000 Which Product would be more attractive as judged by its ranking, and why?

Winterwise Corporation is contemplating the purchase of $181,230 machine that is expected to produce annual savings in operating cash flow of $70,000 over the next four years. If Winterwise uses the internal rate of return (IRR) to evaluate new investments and the company has a hurdle rate of 16%, which of the following statements is correct?

If income taxes are ignored, which of the following choices correctly notes how a project's depreciation is treated under the net-present-value method and the internal-rate-of-return method? Net Present Value Internal Rate of Return 1 Considered Considered 2 Considered Ignored 3 Ignored Considered 4 Ignored Ignored 5 The correct answer depends on the depreciation method (straight line or accelerated) that is used.

The mayor of Elizabethtown, Ontario is considering the purchase of a new computer system for the municipality's tax department. The system costs $75,000 and has an expected life of five years. The mayor estimates the following savings will result if the system is purchased: Year Savings 1 \ 20.000 2 25.000 3 30.000 4 15.000 5 12.000 What can be said about the internal rate of return of Elizabethtown's new computer system if the net present value at 12% is positive?

MacEwen Brothers Ltd., which is subject to an 18% income tax rate, is considering investing in a $300,000 asset that will result in the following over its five-year life: Average revenue: $805,000 Average operating expenses (excluding depreciation): $620,000 Average depreciation: $80,000 The accounting rate of return on the initial investment is:

The accounting rate of return focuses on the:

Reinhold Corporation has a $3,500,000 investment in equipment and is subject to a 20% income tax rate. Cash inflows are expected to average $320,000 before tax over the next few years; in contrast, average income before tax is anticipated to be $220,000. The company's accounting rate of return is:

Hunter Corporation will evaluate a potential investment in an advanced manufacturing system by use of the net-present-value (NPV) method. Which of the following system benefits is least likely to be omitted from the NPV analysis?

Worrell Industries is currently purchasing Part No. 456 from an outside supplier for $90 per unit. Because of supplier reliability problems, the company is considering producing the part internally in a currently idle manufacturing plant. Annual volume over the next five years is expected to total 400,000 units at variable manufacturing costs of $88 per unit. Worrell must acquire $200,000 of new equipment if it reopens the plant. The equipment has a five-year service life and a $20,000 salvage value, and will be depreciated by the straight-line method. (Note: Worrell ignores salvage values in depreciation calculations.) Normal equipment maintenance is expected to total $12,000 in year 4, and the equipment will be sold at the end of its life. Required: Rounding to the nearest dollar, use the net-present-value method (total-cost approach) and a 12% after-tax hurdle rate to determine whether Worrell should make or buy Part No. 456. The company is subject to a 30% income tax rate.

The hurdle rate that is used in a net-present-value analysis is the same as the firm's:

A machine was sold in December 2012 for $9,000. It was originally purchased in January 2010 for $15,000, and depreciation of $12,000 was recorded from the date of purchase through to the date of disposal. Assuming a 40% income tax rate, the after-tax cash inflow at the time of sale is:

James 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:

The mayor of Elizabethtown, Ontario is considering the purchase of a new computer system for the municipality's tax department. The system costs $75,000 and has an expected life of five years. The mayor estimates the following savings will result if the system is purchased: Year Savings 1 \ 20.000 2 25.000 3 30.000 4 15.000 5 12.000 If Elizabethtown uses a 10% discount rate for capital-budgeting decisions, the net present value of the computer system would be:

Which of the following tools is sometimes used to rank investment proposals?

Mick Greene Co. (MG) is considering the replacement of some equipment that has a book value equal to zero and a current market value of $4,600. One possible alternative is to invest in new equipment that costs $20,000. The new equipment has a three-year service life and an estimated salvage value of $5,000, will produce annual cash operating savings of $10,800, and will require a $4,500 overhaul in year 2. The company uses straight-line depreciation. Required: Prepare a net-present-value analysis of MG's replacement decision, assuming a 12% hurdle rate and no income taxes. Should the equipment be acquired? Note: Round calculations to the nearest dollar.