Exam 25: Capital Budgeting and Managerial Decisions

Cornish Company had the following results of operations for the past year: Sales (20,000 units at \ 22) \4 40,000 Direct materials and cirect 1 abor \ 200,000 Overhead (40\% variable) 100,000 Selling and administrative expenses (all fixed) 92,000 (392,000) Operating income \4 8,000 A foreign company (whose sales will not affect Cornish's market) offers to buy 3,000 units at $17.00 per unit. In addition to variable manufacturing costs, selling these units would increase fixed overhead by $500 and selling and administrative costs by $1,000. If Cornish accepts the offer, its profits will:

Nestor Company is considering the purchase of an asset for $100,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year. Compute the break-even time (BET) period for this investment. Annual Net Present Value Cash Flows of \ 1 at 10\% Year 0 1.0000 Year 1 \ 40,000 .9091 Year 2 \ 40,000 .826 Year 3 \ 35,000 .7513 Year 4 \ 35,000 .6830 Year 5 \ 30,000 .6209

A cost that requires a future outlay of cash, and is relevant for current and future decision making, is a(n):

The internal rate of return equals the rate that yields a net present value of zero for an investment.

Presented below are terms preceded by letters a through f and followed by a list of definitions 1 through 6. Match the letter of the terms with the definitions. Use the space provided preceding each definition. (a) Sunk cost (b) Opportunity cost (c) Out-of-pocket cost (d) Net present value (e) Incremental cost (f) Annuity ________ (1) A cost that requires a future outlay of cash and is relevant for current and future decision making. ________ (2) A series of cash flows of equal dollar amount over equal time periods. ________ (3) An estimate of an asset's value to the company; computed by discounting the future net cash flows from the investment the project's required rate of return and then subtracting the initial amount invested. ________ (4) A cost that cannot be avoided or changed because it arises from past decision; irrelevant to future decisions. ________ (5) An additional cost incurred if a company pursues a certain course of action. ________ (6) The potential benefits lost by taking a specific action when two or more alternative choices are available.

Significant sunk costs are relevant to decisions about the future.

Restating future cash flows in terms of their future value is called discounting.

The process of restating future cash flows in today's dollars is known as:

Bluebird Mfg. has received a special one-time order for 15,000 bird feeders at $3 per unit. Bluebird currently produces and sells 75,000 units at $7.00 each. This level represents 80% of its capacity. These bird feeders would be marketed under the wholesaler's name and would not affect Bluebird's sales through its normal channels. Production costs for these units are $3.50 per unit, which includes $2.25 variable cost and $1.25 fixed cost. -If Bluebird accepts this additional business, the effect on net income will be:

Which one of the following methods considers the time value of money in evaluating alternative capital expenditures?

A company has the choice of either selling 1,000 defective units as scrap or rebuilding them. The company could sell the defective units as they are for $4.00 per unit. Alternatively, it could rebuild them with incremental costs of $1.00 per unit for materials, $2.00 per unit for labor, and $1.50 per unit for overhead, and then sell the rebuilt units for $8.00 each. What should the company do?

Watson Corporation is considering buying a machine for $25,000. Its estimated useful life is 5 years, with no salvage value. Watson anticipates annual net income after taxes of $1,500 from the new machine. What is the accounting rate of return assuming that Watson uses straight-line depreciation and that income is earned uniformly throughout each year?

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and be depreciated over a six-year period with no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the payback period for this machine? Sales \9 0,000 Costs: Manufacturing \5 2,000 Depreciation on machine 4,000 Selling and administrative expenses 30,000 (86,000) Income before taxes \4 ,000 Income tax (50 \%) (2,000) Net income \2 ,000

In a make or buy decision, management should focus on costs that are the same under the two alternatives.

Granfield Company is considering eliminating its backpack division, which reported an operating loss for the recent year of $42,000. The division sales for the year were $960,000 and the variable costs were $475,000. The fixed costs of the division were $527,000. If the backpack division is dropped, 40% of the fixed costs allocated to that division could be eliminated. The impact on Granfield's operating income for eliminating this business segment would be:

A company has the choice of either selling 600 defective units as scrap or rebuilding them. The company could sell the defective units as they are for $2.00 per unit. Alternatively, it could rebuild them with incremental costs of $0.60 per unit for materials, $1.00 per unit for labor, and $0.80 per unit for overhead, and then sell the rebuilt units for $5.00 each. -What should the company do?

The expected amount of time to recover the initial amount of an investment is called the:

Part of the decision to accept additional business should be based on a comparison of the incremental (differential) costs of the added production with the additional revenues to be received.

Carmel Corporation is considering the purchase of a machine costing $36,000 with a 6-year useful life and no salvage value. Carmel uses straight-line depreciation and assumes that the annual cash inflow from the machine will be received uniformly throughout each year. In calculating the accounting rate of return, what is Carmel's average investment?

A company is considering purchasing a machine for $21,000. The machine will generate an after-tax net income of $2,000 per year. Annual depreciation expense would be $1,500. What is the payback period for the new machine?