Exam 21: Capital Budgeting: Methods of Investment Analysis

Which of the following is true concerning capital budgeting analysis?

Both financial and nonfinancial factors associated with proposed capital budgeting opportunities need to be considered as part of the capital budgeting decision process.

Cast Iron Stove Company wants to buy a molding 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 since all of the selection criteria are so close together. Required: What suggestions do you have for the president?

Return on investment (ROI) is also known as

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 with initial investment, 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?

Crofton Inc. is evaluating new machinery in its foundry. The machinery would replace existing equipment. The new machinery would cost $230,000, would last 5 years, and would have a salvage value of $28,000. The existing machinery currently has a net book value of $52,000 and could be sold for $38,000. If kept, the old machine would have a salvage value of $6,000 in 5 years' time. The new machinery is expected to lower direct labour costs by $18,000 per year. The current variable overhead rate is 120% of direct labour. Annual fixed cost savings are projected to be $30,000. Due to the reduction in the production cycle time, working capital requirements will decrease by $25,000 during the life of the new machine. Ignore income taxes. Required: a. Compute the net present value at a 9 percent required rate of return. b. Compute the internal rate of return.

EIF Manufacturing company needs to overhaul its drill press or buy a new one. The facts have been gathered, and are as follows: Required: Based on present value analysis, which alternative is the most desirable with a current required rate of return of 20 percent? Show computations.

Fabian Company is considering the purchase of a piece of materials-handling equipment: Depreciation method: straight line Required: a. Calculate payback. b. Calculate accrual accounting rate of return based on the initial investment.