Exam 20: Capital Budgeting: Methods of Investment Analysis

A project has a net initial investment of $500,000 and the cash flows cover five years.The project involves replacing an old machine with a new machine at the same time.Which of the following is TRUE based on the above assumptions,in NPV analysis?

In capital budgeting decisions,revenues and costs are analyzed over the short-run.

The method that measures the time it will take to recoup,in the form of cash inflows,the total dollars invested in a project is called the

Next Service Centre is considering purchasing a new computer network for $82,000.It will require additional working capital of $13,000.Its anticipated eight-year life will generate additional client revenue of $33,000 annually with operating costs,excluding depreciation,of $15,000.At the end of eight years,it will have a salvage value of $9,500 and return $5,000 in working capital.Taxes are not considered. Required: a.If the company has a required rate of return of 14%,what is the net present value of the proposed investment? b.What is the internal rate of return?

The use of an accelerated method of depreciation for tax purposes would usually increase the present value of the investment.

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: 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?

CCA reduces taxable income,and therefore reduces tax payments and increases the firm's cash flow.

Capital cost allowance is the income tax version of financial reporting depreciation.

Bock Construction Company is considering four proposals for the construction of new loading facilities that will include the latest in ship loading/unloading equipment.After careful analysis,the company's accountant has developed the following information about the four proposals: Required: How can this information be used in the decision making process for the new loading facilities? Does it cause any confusion?

Describe the purpose,features and benefits of a post investment audit for a capital budgeting project.

Capital budgeting focuses on projects over their entire lives to consider all the cash flows or cash savings from investing in a single project.

The internal rate of return method may result in erroneous decisions when used to compare mutually exclusive projects with unequal lives or unequal levels of initial investment.

A new machine will cost $500,000.It is in a CCA class pool that uses a declining balance rate of 30%.The company's tax rate is 40% and it requires a 15% rate of return on investments.Calculate the present value of the the tax shield the first year assuming the savings occur at year end.

The Income Tax Act does not permit a company to deduct depreciation expense in the calculation of taxable income.

The minimum capital cost allowance (CCA)that a corporation may claim in a given year is the undepreciated capital cost of a particular pool times the CCA rate for that pool.

The net initial investment for a new mainframe computer is $2,000,000.Annual cash flows are expected to increase by $800,000 per year.The equipment has a 10-year useful life.What is the payback period?

In determining whether to keep a machine or replace it,the original cost of the machine is always a relevant factor.

Net present value is calculated using the

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

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.Other annual 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 of replacing the existing equipment at a 9 percent required rate of return. b.Compute the internal rate of return.