Exam 20: Capital Budgeting: Methods of Investment Analysis

Hentgen and Ferraro, baseball consultants, are in need of a microcomputer network for their staff.They have received three proposals, with related facts as follows: Annual cash increase in operations: The company uses straight-line depreciation for all capital assets.Ignore income taxes.Required: a.Compute the payback period, net present value, and accrual accounting rate of return using average annual income, for each proposal.Use a discount rate of 14 percent. b.Rank each proposal 1, 2, and 3 using each method separately.Which proposal is best? Why?

Relevant cash flows are expected future cash flows that differ among the alternative uses of investment funds.

The disposal of a machine (or any depreciable asset)results in a lost tax shield.

The net present value method calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time using the hurdle rate.

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. -When the net present value method is used, only projects with ________ are ________.

Companies should make decisions concerning investing in computer-integrated technology, based solely on the relevant costs.

When all future cash inflows and outflows are discounted to the present using the required rate of return, the method used is

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. -What is the net present value (rounded to the nearest thousand)of the investment assuming the required rate of return is 24 percent? Would Hawkeye Cleaners want to purchase the new machine?

The acquisition cost of the assets in a class, minus the CCA claimed to date for that class, is referred to as the UCC of a particular class.

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. -The time value of money refers to the concept that

A capital budgeting project will have a positive net present value if its return is less than the hurdle rate.

A Company wants to buy a moulding machine that can be integrated into its computerized manufacturing process.It has received three bids for the machine and related manufacturer's specifications.The bids range from $3,500,000 to $3,550,000.The estimated annual savings of the machines range from $260,000 to $270,000.The payback periods are almost identical and the net present values are all within $8,000 of each other.The president just doesn't know what to do about which vendor to choose; all the selection criteria are so close together.Required: What suggestions do you have for the president?

A capital investment project typically has three categories of cash flows: (1)net initial investment; (2)cash flow from operations; and (3)terminal disposal and recovery of investment(s) Required: Complete the following list of components for each category: Net initial investment 1.cost of asset acquisition 2.________ 3.________ Cash flow from operations 1.________ 2.________ Terminal disposal and recovery of investment(s) 1.________ 2.________

A project's net present value is increased if

Identify capital expenditures relevant to accomplishing strategic goals is the first step in the capital budgeting decision process model.

Advantages from using the payback method when capital budgeting include

West Coast Manufacturing Ltd.is considering buying an automated machine that costs $250,000.It requires working capital of $5,000.Annual cash savings are anticipated to be $55,000 for five years.The company uses straight-line depreciation.The salvage value at the end of five years is expected to be $10,000.The working capital will be recovered at the end of the machine's life.Required: 1.Compute the accrual accounting rate of return based on the initial investment.2.Compute the internal rate of return.

Janet Manufacturing Ltd.is considering buying an automated machine that costs $500,000.It requires working capital of $50,000.Annual cash savings are anticipated to be $206,000 for five years.The company uses straight-line depreciation.The salvage value at the end of five years is expected to be $20,000.The working capital will be recovered at the end of the machine's life.Required: Compute the accrual accounting rate of return based on the initial investment.

Clock Manufacturing Company purchased a new piece of equipment at a cost of $60,000 at the beginning of the year.For tax purposes the machine is a Class 8 asset (20% declining balance).The company has a 34 percent income tax rate.Assume that the company has no other Class 8 assets during the period.Required: a.Compute the amount of tax savings from CCA for the first three years. b.Compute the amount of tax savings from CCA for the first three years using a required rate of return of 12 percent.

Sources of funding for capital projects include the proceeds of debt and equity securities sold in capital markets as well as internally generated cash.