Exam 10: Planning for Capital Investments

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 five 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%.Required: 1) Compute the project's after-tax net cash flows (NCF) by completing the following table: 2) Compute the project's net present value by completing the following table. (Round the present value amounts to the nearest whole number.)3) Compute the project's payback period.4) Should the project be accepted? Why or why not? Cash Taxable Cash Outflow After-tax Year Inflows Depreciation Income for Taxes NCF 1.5 After-tax Present Value Total Year NCF Factor Present Value 0 1.5

An investment that cost $30,000 provided annual cash inflows of $9,000 per year for five years. The desired rate of return is 10%. What is the internal rate of return from the investment?

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

Butch's Barbecue thinks that offering delivery will increase their sales. Butch's is considering whether to purchase a used delivery truck costing $12,000. Additional net income from the delivery service will be $1,400 per year. The truck will last approximately 5 years. What is the unadjusted rate of return based on the average investment?

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

Burgess Corporation is considering purchasing equipment that costs $235,000. The equipment has an estimated useful life of 5 years and no salvage value. Burgess believes that the annual cash inflows from using the equipment will be $65,000.Required: 1) Calculate the net present value of the equipment assuming that Burgess's cost of capital is 12%. Is the equipment an acceptable investment? 2) Calculate the net present value of the equipment assuming that Burgess's cost of capital is 10%. Is the equipment an acceptable investment? 3) Based on your results to parts 1) and 2), estimate the internal rate of return for the investment in the equipment.

Investment projects A and B offer equal cash inflows over their lives, but the cash inflows for project A occur sooner than those for project B. B. The two projects are otherwise identical (the cost is the same, for example) Based on this information, the internal rate of return for A is lower than for

Kerwin Company is considering purchase of equipment that costs $50,000. If the useful life is expected to be 5 years and Crown's required rate of return is 12%, what is the minimum annual cash inflow that the equipment must offer for the investment to be acceptable? (Do not round your intermediate calculations. Round your final answer to the nearest dollar.)

The length of time required to recover the initial investment in a capital asset is known as the:

The difference between an ordinary annuity and an annuity due is:

Theresa is considering starting a small business. She plans to purchase equipment costing $145,000. Rent on the building used by the business will be $26,000 per year while other operating costs will total $30,000 per year. A market research specialist estimates that Theresa's annual sales from the business will amount to $80,000. Theresa plans to operate the business for 6 years. Disregarding the effects of taxes, what will be the amount of annual net cash flow generated by the business?

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

Generally, a company should use the MACRS method to calculate depreciation on its income tax return, due to the effects of the time value of money.

Omicron Company is considering purchasing equipment that would cost $60,000 and have a useful life of 5 years. The equipment is expected to provide net cash inflows of $16,000 per year. Omicron's cost of capital is 12%.Required: Estimate the internal rate of return for this capital investment. Is this an acceptable investment?

Mr. J's Bagels invested in a new oven for $14,000. The oven reduced the amount of time for baking which increased production and sales for five years by the following amounts of cash inflows: Using the averaging method, the payback period for the investment in the oven would be: Year 1 Year 2 Year 3 Year 4 Year 5 \ 8,000 \ 6,000 \ 5,000 \ 6,000 \ 5,000

Janelle Bates has just inherited $250,000 from her uncle's estate. She is considering opening a small sewing and fabric shop. She would need to purchase inventory costing $50,000. Janelle plans to rent a shop in a local shopping center for $12,000 per year. Fixtures, display equipment, and furniture will cost $18,000 and will be depreciated $3,000 per year for 5 years to its expected salvage value of $3,000. Operating costs will amount to $25,000 per year. Janelle estimates her revenues from sales and sewing services will total $65,000. Because Janelle believes she can earn a 10% return by investing in mutual funds, she does not want to start the business unless she can earn at least this rate. Ignore income taxes.Required: 1) Prepare a schedule of expected cash flows for the proposed investment by completing the table provided below. In column 1 enter a brief description of the cash flow. In column 2 indicate whether the cash flow is an inflow (I) or an outflow (O). In column 3 enter the years in which the cash flow will occur. For example, if the cash flow occurs immediately enter a 0. If the cash flow occurs each year enter 1-5, etc. In column 4 enter the cash flow amount.2) What is the initial outlay for this capital investment (the amount of the cash flow at time = 0)? 3) What is the amount of the annual net cash flow for this capital investment? 4) What is the net present value of the proposed venture? Should Janelle proceed? Item Description Inflow/Outflow Years Amount (Col 1) (Col 2) (Col 3) (Col 4)

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 amount of the depreciation tax shield can be calculated by multiplying the amount of depreciation expense by the tax rate.

In Year 1, Chandler Company purchased equipment with an expected useful life of 5 years. The initial cost of the equipment was $85,000. Chandler's cost of capital is 12%. At the time it purchased the equipment, Chandler projected the following cash inflows from use of the equipment: At the end of Year 5, the equipment had reached the end of its useful life. Chandler determined that it had actually generated the following cash flows: Required: 1) What was the net present value that Chandler calculated for the equipment when the company purchased the asset? 2) Calculate the net present value that the equipment achieved, based on the actual cash inflows.3) Comment on the pattern of actual cash inflows, compared to the cash flows that had been projected.4) Was the equipment in fact an acceptable investment, based on the cash flows actually achieved? Year Projected cash inflow 1 \ 20,000 2 \ 30,000 3 \ 35,000 4 \ 25,000 5 \ 15,000 Year Actual cash inflow 1 \ 10,000 2 \ 20,000 3 \ 30,000 4 \ 30,000 5 \ 30,000

A capital investment project may provide cash inflows from: