Exam 20: Capital Budgeting: Methods of Investment Analysis

Which of the following statements is TRUE?

The net present value method can on occasion indicate erroneous decisions as it implicitly assumes that project cash flows can be reinvested at the project's rate of return.

An advantage of the internal rate of return method is that it can be used when the required rate of return varies over the life of the project.

Cost analysis has two dimensions,which are

Lion Enterprises Inc.is evaluating 3 investment alternatives.Each alternative requires a cash outflow of $102,000.The cash inflows are summarized below (ignore taxes): The company has a required rate of return of 9%. Required: Evaluate and rank each alternative using net present value (NPV).

Jefferson Ltd.is considering the acquisition of new production equipment.If purchased,the new equipment would cost $1,850,000.Installation and testing costs would be $35,000 and $25,000 respectively.Once operational,the equipment will cause an increase in working capital of $120,000.The new equipment is expected to generate increased annual sales of $720,000.Variable costs to operate the machine are estimated at 42% of sales and annual fixed costs would be lowered by $75,000.The equipment has an estimate 6 year life and a salvage value of $90,000.The company requires an 11% return on its investments.Ignore income taxes. Required: a.Compute the net present value. b.Compute the internal rate of return. c.Determine the payback period of the investment.

The net present value method is preferable over the internal rate of return method when an organization does not require the same rate of return each year of the project.

Which of the following are not considered in capital-budgeting?

Use the following information to determine which machines to purchase based on net present value. Cost of capital is 10 percent.

Many new capital projects are investments in new technologies.Both benefits and costs of these new technologies are hard to estimate. Required: Discuss some of the difficulties in quantifying the expected benefits and costs of new technologies.

Capital cost allowance tax deductions result in tax savings that partially offset the cost of acquiring the capital asset.

If the net present value analyses of a project resulted in a positive value and the company does not accept the project,it may be assumed that

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.

The net present value method is better than the internal rate of return because

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

Wilf Company acquired an additional Class 10 (30% declining balance)asset for $60,000.The UCC at the beginning of the year was $100,000.The maximum CCA in the current year is

In capital budgeting decisions,relevant cash flows

The payback method allows for managers to highlight liquidity.

Easton Ltd.is considering investing in a new piece of machinery for its factory.The machine costs $340,000 and is expected to last 7 years.It estimates that annual cash flows would be $82,000 and the equipment would have a salvage value of $13,000.The company's hurdle rate is 11%.What is the net present value of this investment? (Ignore income taxes. )

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?