Exam 20: Capital Budgeting: Methods of Investment Analysis

Use the information below to answer the following question(s).Wet Water Company drills residential and commercial wells.The company is in the process of analyzing the purchase of a new drill.Information on the proposal is provided below: Note: Other than the initial investment, cash flows are end of period.The working capital is returned at the end of the investment period. -Saturn Ltd.wants to automate one of its production processes.The new equipment will cost $180,000.In addition, Saturn will incur installation and testing costs of $5,000 and $8,500 respectively.The expected life of the equipment is 8 years and the salvage value of the equipment is estimated at $18,000.The annual cash savings are estimated at $32,000.The company's required rate of return is 14%.Ignore income taxes.What is the net present value of this investment?

Pender Ltd.is analyzing two proposals for cleaning contracts for the next 3 year period.The company has 200,000 square metres of floor space which is currently 75% occupied.It expects that occupancy will increase to 82% in year 2, and 90% in year 3.The proposal from Company A is as follows: Six janitors will be used at a budgeted annual salary of $26,000/each.These salaries are expected to remain static over the 3 year period.One supervisor will be used at an annual salary of $38,000.Salary increases for the supervisor will be $1,500 per year.Indirect labour costs are at 12.5% of salaries.Indirect material costs will be at a rate of $0.20 per square metre occupied.Fixed costs of $7,200 per year will also be charged to Pender by the contractor.The proposal from Company B is as follows: A rate of $1.40 per square metre occupied will be charged.In addition a part time supervisor will be required at an annual cost of $24,000 plus benefits at 15%.Fixed costs of $4,600 per year will be charged to Pender by Company B.No increases are forecast through the three year period.Additional information: Company A is the existing contractor.If the agency does not choose Company A, it must pay Company A a flat $8,000 on termination of its services.This payment would be made immediately.Assume cash flows occur at the end of the year unless otherwise stated.The discount rate to be used is 6% and is not expected to change in the next 3 years.Required: Evaluate these two proposals using the net present value method.

Opportunity cost is a cost of capital for which of the following sources of funds?

Accrual accounting measures income on a year-to-year basis.

The difference between the yield on local government bonds and the yield on corresponding domestic government treasury bonds is known as

The tax effects are significant in capital budgeting decisions.

Sam's Structures desires to buy a new crane and accessories to help move and install modular buildings.The machine sells for $75,000 and requires working capital of $10,000.Its estimated useful life is six years and it will have a salvage value of $17,560.Recovery of working capital will be $10,000 at the end of its useful life.Annual cash savings from the purchase of the machine will be $20,000.Required: a.Compute the net present value at a 12% required rate of return. b.Compute the internal rate of return. c.Determine the payback period of the investment.

Use the information below to answer the following question(s).Hawkeye Cleaners has been considering the purchase of an industrial dry-cleaning machine.The existing machine is operable for three more years and will have a zero disposal price.If the machine is disposed of now, it may be sold for $30,000.The new machine will cost $200,000, an additional cash investment in working capital of $60,000 will be required and will be returned at the end of the project.The machine is expected to last 3 years and has an estimated disposal value at that time of $20,000.The new machine will reduce the average amount of time required to wash clothing and will decrease labour costs.The investment is expected to net $50,000 in additional cash inflows during the year of acquisition and $150,000 each additional year of use.These cash flows will generally occur throughout the year and are recognized at the end of each year.Income taxes are not considered in this problem. -Investment A requires a net investment of $600,000.The required rate of return is 10 percent for the three-year annuity.What are the annual cash inflows if the net present value equals 0?

Use the information below to answer the following question(s).Neptune Ltd.wants to expand its operations by manufacturing a new product line.New equipment will cost $225,000.Incremental sales are estimated at $150,000 per year for 6 years.Variable costs of producing the new product line are 52% of sales and incremental annual fixed costs are $25,000.The equipment can be salvaged after 6 years for 16% of its original cost.The company's required rate of return for new projects is 18%.Ignore income taxes. -What is the net present value of the Neptune Ltd.investment?

If the internal rate of return is less than the hurdle rate, the net present value of the project will be negative.

Fisher Ltd.is considering the purchase of new equipment.Details of the investment follow: Depreciation method: straight line Required: a.Calculate the payback period. b.Calculate the accrual accounting rate of return based on the initial investment. c.Calculate the net present value.

Life cycle costing is the accounting system that corresponds to

Which of the following is NOT one of the methods that aid management in analyzing the expected results of capital budgeting decisions?

Which of the following is NOT a major category of cash flows in capital budgeting?

Capital budgeting emphasizes the role of financial information in investment decisions.

Windpower Systems Maintenance Ltd.purchased a CCA Class 10 (CCA rate of 30%)vehicle for $360,000.The vehicle was the only item in the Class 10 capital cost allowance pool.The vehicle is expected to generate net cash income, excluding any tax effects, in the amount of $70,000 per year.The company uses straight-line depreciation, estimates a 6 year useful life with a $40,000 salvage value for the new vehicle at the end of year 6.The marginal tax rate is 35% and the company's average tax rate is 25%.Management requires a rate of return of 15.0%.Assume that cash flows occur at the end of the year.Required: a.What is the unamortized capital cost at the beginning of year 2 if the maximum capital cost allowance that is allowed is taken in the first year? b.What is the net present value of the investment in the vehicle?

Use the information below to answer the following question(s).Wet Water Company drills residential and commercial wells.The company is in the process of analyzing the purchase of a new drill.Information on the proposal is provided below: Note: Other than the initial investment, cash flows are end of period.The working capital is returned at the end of the investment period. -Which of the following is TRUE, concerning NPV?

In capital budgeting decisions, relevant cash flows

The three factors that generally influence depreciation under IFRS/ASPE are: amount allowable for depreciation, allowable life of asset, and allowable methods of depreciation.In Canada, for tax purposes

In capital budgeting the relevant tax rate is the average tax rate for the company.