Exam 10: Planning for Capital Investments

Bruce Company is considering replacing one of its delivery trucks.The truck in question was purchased two years ago at a cost of $41,000.At the time of purchase the truck was expected to have a $5,000 salvage value at the end of its six-year life.Given the use of straight-line depreciation,the truck has a current book value of $29,000.If sold today,the company could get $22,000 for the truck.It costs $20,000 per year to operate the existing truck.The new truck would cost $46,000 and would cost only $14,000 per year to operate.The new truck would be depreciated on a straight-line basis over its four-year useful life to its expected salvage value of $10,000.The company's required rate of return is 14%.Ignore income taxes. (PV of $1 and PVA of $1)(Use appropriate factor(s)from the tables provided.) Required: 1)Identify the cash flows for each alternative by completing the following table: Keep Existing Truck Replace Existing Truck Year Cash Outflows Cash Inflows Cash Outflows Cash Inflows 0 1 2 3 4 2)The company's objective is to minimize costs.Complete the following table to determine whether the existing truck should be replaced.Ignore income taxes.What is your recommendation? Keep Existing Truck Replace Existing Truck 14\% Net Cash Present Value of Net Cash Present Value of Year Factor Outflows Net Cash Outflows Outflows Net Cash Outflows 0 1 2 3 4

What amount of cash must be invested today in order to have $60,000 at the end of one year assuming the rate of return is 9%? (PV of $1 and PVA of $1)(Use appropriate factor(s)from the tables provided.)

Describe the approach that managers may take in making capital investment decisions.

Which of the following does not represent an advantage of the unadjusted rate of return over the payback method for evaluating capital projects?

A capital investment decision is essentially a decision to exchange current cash outflows for future cash inflows.

Grayson Company is considering a purchase of equipment that costs $49,000 and is expected to offer annual cash inflows of $13,000.Grayson's minimum required rate of return is 10%.How many years must the cash flows last for the investment to be acceptable? (PV of $1 and PVA of $1)(Use appropriate factor(s)from the tables provided.Do not round your intermediate calculations.Round to the nearest whole year.)

Indicate whether each of the following statements is true or false: A postaudit should be conducted at the time a capital investment is purchased.______ The postaudit of a capital investment project should be made using the same analytical technique that was used in deciding to make the investment.______ The purpose of postaudits is to improve a company's capital investment decision process.______ The postaudit process uses expected cash flows and the company's cost of capital.______ Making good estimates of future cash flows is important in making capital investment decisions.______

Describe the decision rules management should use for accepting and rejecting capital projects under each of the following capital budgeting models: net present value model,internal rate of return model,payback period,and the unadjusted rate of return model.

Which one of the following statements best describes an ordinary annuity?

The future value of $1 table should be used to discount lump sum cash flows expected to occur in the future.

The payback method of evaluating capital investments measures the recovery of the investment,but it does not measure profitability.

Indicate whether each of the following statements is true or false. When unequal cash inflows are expected from a capital investment,the payback period can be calculated by accumulating incremental cash inflows or by using average annual cash inflows.______ The unadjusted rate of return is also called the simple rate of return.______ The unadjusted rate of return can be calculated as average increase in cash inflows divided by net cost of the original investment.______ The unadjusted rate of return does not take the time value of money into account.______ The unadjusted rate of return should be calculated using the initial cost of the investment,rather than the average invested capital.______

Indicate whether each of the following statements is true or false. An ordinary annuity assumes that cash flows occur at the beginning of each period.______ To say that an investment earns the desired rate of return assumes that all cash flows generated by the investment are reinvested at the desired rate of return.______ Managers should not use two different methods in evaluating capital investment decisions because different methods generally give different results.______ Copley Corporation uses a required rate of return of 10% for its capital investment decisions.A particular project had a negative net present value.For this project,the actual rate of return was expected to be more than 10%.______ The net present value of a capital investment project is calculated by subtracting the present value of expected cash inflows from the cost of the investment.______

Indicate whether each of the following statements is true or false. The payback method does not take the time value of money into account.______ The unadjusted rate of return indicates the length of time required to recover the initial cost of an investment.______ The payback period can only be calculated for capital investments that are expected to provide equal annual cash inflows over their useful lives.______ Generally,investments with shorter payback periods are preferred.______ Use of the payback method to analyze capital investments is the best way of identifying the projects that will make the greatest contribution to a company's profits.______

Cash inflows generated by capital investments include all of the following except:

For a capital investment project to be acceptable,it must generate a rate of return:

How does depreciation serve as a tax shield? How is the amount of the annual tax shield calculated?

Sources of cash outflows from capital investments include incremental expenses and installation costs.

Which statement characterizes the time value of money concept?

Which of the following would be considered a cash inflow in determining the value of a capital investment?