Exam 10: Planning for Capital Investments

Indicate whether each of the following statements is true or false. The further into the future a cash receipt is expected to occur,the higher is its present value.______ The return on investment measures the compensation a company expects to receive from investing in capital assets.______ Most companies use their cost of capital to estimate the minimum return on investment required from capital investments.______ When a company invests in capital assets,it sacrifices present dollars for the opportunity to receive future dollars.______ The required rate of return on a capital investment is also referred to as the hurdle rate or discount rate.______

Levin Company is considering two new machines that should produce considerable cost savings in its assembly operations.The cost of each machine is $14,000 and neither is expected to have a salvage value at the end of a 4-year useful life.Levin's required rate of return is 12% and the company prefers that a project return its initial outlay within the first half of the project's life.The annual after-tax cash savings for each machine is provided in the following table: $\text { Annulual After-tax Cash Savings }$ Year Machine A Machine B 1 \ 5,000 \ 8,000 2 5,000 6,000 3 5,000 4,000 4 Total (PV of $1 and PVA of $1)(Use appropriate factor(s)from the tables provided.) Required: 1)Compute the payback period for each machine using the incremental approach and comment on the results. 2)Compute the unadjusted rate of return based on average investment for each machine.The machines will be depreciated on a straight-line basis. 3)Compute the net present value for each machine. 4)Which machine would you recommend? Explain your reasoning. 5)Use the present value table to compute the approximate internal rate of return for Machine A.

An annuity is a series of equal payments over equal time intervals that earn a constant rate of return.

Garrison Company has two investment opportunities.A cash flow schedule for the investments is provided below: Year Investment A Investment B 0 (5,000) (6,000) 1 2,000 3,000 2 2,000 2,000 3 2,000 2,000 4 2,000 1,000 Considering the unequal investments,which of the following techniques would be most appropriate for choosing between Investment A and Investment B?

A customary assumption in capital budgeting analysis is that:

The payback method shows how long will be required to recover the cost of an investment in a capital asset.

What is a postaudit of a capital investment decision,and how should the postaudit be conducted?

Indicate whether each of the following statements is true or false. A capital investment is a purchase of a long-term operational asset.______ Investments in capital assets normally are recovered by selling the assets.______ The profitability of a business is greatly influenced by the quality of its capital investment decisions.______ A capital investment decision exchanges current cash inflows for future cash outflows.______ The time value of money concept is often used in making capital investment decisions.______

The time value of money concept recognizes the fact that the present value of a dollar to be received in the future is worth more than a dollar.

The cost of capital represents the maximum acceptable rate of return that a capital investment should earn.

Generro Company is considering the purchase of equipment that would cost $36,000 and offer annual cash inflows of $10,500 over its useful life of 5 years.Assuming a desired rate of return of 12%,is the project acceptable? (PV of $1 and PVA of $1)(Use appropriate factor(s)from the tables provided.)

Which capital budgeting technique defines returns in terms of income instead of cash flows?

Chico Company is considering the purchase of a new high-speed machine for its factory.The machine will cost $160,000 and will save the company $45,000 per year in cash operating costs.The machine has an estimated useful life of five years and no expected salvage value.The company's cost of capital is 12%. (PV of $1 and PVA of $1)(Use appropriate factor(s)from the tables provided.) Required: 1)Compute the net present value of this investment. 2)What is the maximum amount that Chico should be willing to pay for the machine? 3)What are the minimum annual cash savings that will make the machine acceptable on a net present value basis if the purchase price is $160,000?

The cost of capital is called all of the following except:

Seven Day Mini Mart is considering installing video games in its stores.The machines cost $300,000 and have an estimated six-year useful life.Ignore income taxes.The following projected income statement is provided: Video game revenue \1 00,000 Tess exnenses: Electricity, Supplies, etc. \ 2,000 Insurance 7,000 Maintenance 1,000 Depreciation Net income Required: 1)Seven Day Mini Mart would like to recoup its original investment in less than five years.Compute the payback period for the video game machine investment.Would you recommend that the machines be purchased? Why or why not? 2)Seven Day Mini Mart's target unadjusted rate of return is 12%.Compute the unadjusted rate of return on the original investment.Would you recommend that the machines be purchased? Why or why not?

Evergreen Company has two investment opportunities.Both investments cost $5,000 and will provide the same total future cash inflows.The cash receipt schedule for each investment is given below: Investment I Investment II Period 1 Period 2 1,000 2,000 Period 3 2,000 2,000 Period 4 1,000 Total Select the correct statement.

The instantaneous computation power of spreadsheet software makes it ideal for answering "what-if" questions regarding present values.

A capital investment with an internal rate of return equal to or greater than the required rate of return is considered to be an acceptable investment.

Columbus Company is considering a project that requires an initial investment of $400,000.Its incremental cash flows are expected to be $150,000 per year for 5 years.The project would be depreciated on a straight-line basis over 5 years with no expected salvage value.The company has a stated policy that all projects must return their required investment dollars within the first 75% of the project's life.The company is subject to a 40% income tax rate,and its cost of capital is 10%. (PV of $1 and PVA of $1)(Use appropriate factor(s)from the tables provided.) Required: 1)Compute the project's after-tax net cash flows (NCF)by completing the following table: Year Cash Inflows Depreciation Taxable Income Cash Outflows for Taxes After-tax NCF 1-5 2)Compute the project's net present value by completing the following table.(Round the present value amounts to the nearest whole number.) Year After-tax NCF Present Value Factor Total Present Value 0 1-5 3)Compute the project's payback period. 4)Should the project be accepted? Why or why not?

Harvey wants to determine the net present value for a proposed capital investment.He has determined the desired rate of return,the expected investment time period,a series of cash inflows of equal amount,the salvage value of the investment,and the required cash outflows.Which of the following tables would most likely be used to calculate the net present value of the investment?