Exam 16: Capital Expenditure Decisions

Consider the five items that follow, which are related to independent investment opportunities. Purchase price of a new machine: $850,000 Annual straight-line depreciation: $75,000 Annual savings in cash operating costs: $120,000 Advertising expenses related to a new marketing campaign in year 2: $35,000 Sale of an asset in year 6: Loss on sale, $60,000; proceeds received by seller, $23,000 Required: Complete the following table, inserting the (pre-discounted) cash flow amounts that would be used in a net-present-value analysis. Column A should be completed based on the assumption of no income taxes; in contrast, Column B should be completed assuming the relevant company is subject to a 30% income tax rate. Be sure to note cash outflows in parentheses.

St. Andrews School ranks investments by using the profitability index (PI). The following data relate to Project X and Project Y: Project X Project Y Initial investment \ 400,000 \ 1,300,000 Present value of inflows 600,000 1,800,000 Which project would be more attractive as judged by its ranking, and why?

The payback period is best defined as:

A cash flow measured in nominal dollars is:

The rule for project acceptance under the internal rate of return method is that:

Braselton Company plans to incur $190,000 of salaries expense and produce $320,000 of additional sales revenue if a capital project is implemented. Assuming a 30% tax rate, these two items collectively should appear in a capital budgeting analysis as:

Pinero is considering a $600,000 investment in new equipment that is anticipated to produce the following net cash inflows: Year Net Cash Inflows 1 \ 120,000 2 250,000 3 110,000 4 80,000 5 160,000 If cash flows occur evenly throughout a year, the equipment's payback period is:

The true economic yield produced by an asset is summarized by the asset's:

An increased number of companies are investing in advanced manufacturing systems. Required: A. Many proposed advanced manufacturing systems have a negative net present value when discounted-cash-flow analysis is used. Explain several causes of this situation. B. Two major benefits of advanced systems are greater flexibility in the manufacturing process and improvements in product quality. Explain how these benefits can create problems when performing discounted-cash-flow analysis.

When a company is analyzing a capital project by a discounted-cash-flow approach and income taxes are being considered, depreciation:

A piece of equipment costs $30,000, and is expected to generate $8,500 of annual cash revenues and $1,500 of annual cash expenses. The disposal value at the end of the estimated 10-year life is $3,000. Ignoring income taxes, the payback period is:

Depreciation is often described as a "tax shield." Required: A. Explain how depreciation provides such a shield. B. MACRS is an accelerated depreciation system. Explain how an accelerated system can provide a more beneficial tax shield than, say, a straight-line depreciation system.

Consider the following statements about capital budgeting postaudits: I. Postaudits can be used to detect desirable projects that were rejected. II. Postaudits can be used to detect undesirable projects that were accepted. III. Postaudits may reveal shortcomings in cash-flow projections, providing insights that allow a company to improve future predictions. Which of the above statements is (are) correct?

Cones & Moore sells frozen custard and sandwiches. It is considering a new site that will require a $2 million investment for land acquisition and construction costs. The following operating results are expected: Disregard income taxes. Required: A. If management requires a payback period of four years or less, should the new site be opened? Why? B. Compute the accounting rate of return on the initial investment. C. What significant limitation of payback and the accounting rate of return is overcome by the net-present-value method?

Puck Company received $18,000 cash from the sale of a machine that had a $13,000 book value. If the company is subject to a 30% income tax rate, the net cash flow to use in a discounted-cash-flow analysis would be:

The accounting rate of return focuses on the:

If a proposal's profitability index is greater than one then the net present value is positive.

Capital-budgeting decisions primarily involve:

Jenkins plans to generate $650,000 of sales revenue if a capital project is implemented. Assuming a 30% tax rate, the sales revenue should be reflected in the analysis by a:

San Remo has a $4,000,000 asset investment and is subject to a 30% income tax rate. Cash inflows are expected to average $600,000 before tax over the next few years; in contrast, average income before tax is anticipated to be $500,000. The company's after-tax accounting rate of return is: