Exam 16: Capital Expenditure Decisions

Postaudits are an important part of capital budgeting. Required: A. What is a postaudit of a capital investment project? B. What are the benefits of a postaudit? C. A manager prepared an unsuccessful proposal for a capital project, as her firm decided not to fund and pursue the project. The manager observed, "The company's postaudit process will show that this project should have been funded." Comment on the manager's understanding of the postaudit process.

Which of the following choices correctly states the rules for project acceptance under the net-present-value method and the internal-rate-of-return method? Net Present Value Internal Rate of Return A. Positive total Greater than hurdle rate B. Positive total Less than hurdle rate C. Negative total Greater than hurdle D. Negative total Less than hurdle rate E. Greater than hurdle rate Positive number

Consider the following statements about depreciation tax shields: I. A depreciation tax shield provides distinct benefits to a business. II. A depreciation tax shield should be ignored when doing a net-present-value analysis. III. A depreciation tax shield can occur in more than one year. Which of the above statements is (are) correct?

The Warren Machine Tool Company is considering the addition of a computerized lathe to its equipment inventory. The initial cost of the equipment is $600,000, and the lathe is expected to have a useful life of five years and no salvage value. The cost savings and increased capacity attributable to the machine are estimated to generate increases in the firm's annual cash inflows (before considering depreciation) of $180,000. The machine will be depreciated using MACRS for tax purposes. The 5-year MACRS depreciation percentages as computed by the IRS are: Year 1 = 20.00%; Year 2 = 32.00%; Year 3 = 19.20%; Year 4 = 11.52%; Year 5 = 11.52%; Year 6 = 5.76%. Warren is currently in the 40% income tax bracket. A 10% after-tax rate of return is desired. Required: A. What is the net present value of the investment? Round to the nearest dollar. B. Should the machine be acquired by the firm? C. Assume that the equipment will be sold at the end of its useful life for $100,000. If the depreciation amounts are not revised, calculate the dollar impact of this change on the total net present value.

Wrangler Company is considering a five-year project that requires a typical investment in working capital, in this case, $100,000. Consider the following statements about this situation: I. Wrangler should include a $100,000 outflow that occurs at time 0 in a discounted-cash-flow analysis. II. Wrangler should include separate $100,000 outflows in each year of the project's five-year life. III. Wrangler should include a $100,000 recovery of its working-capital investment in year 5 of a discounted-cash-flow analysis. Which of the above statements is (are) correct?

The payback period can only be used if net cash inflows are uniform throughout a project's life.

A company's cash flows for income taxes are normally affected by:

Consider the following statements about the investment in working capital in a capital budgeting analysis: I. Working capital often increases as the result of higher balances in accounts receivable or inventory necessary to support a project. II. Working capital increases are sources of cash and should be included in a discounted-cash-flow analysis. III. The time 0 cash investment in working capital is included in a discounted-cash-flow analysis as a cash outflow. Which of the above statements is (are) correct?

Spiers Corporation is considering the acquisition of a new machine that costs $149,040. The machine is expected to have a four-year service life and will produce annual savings in cash operating costs of $45,000. Gotham evaluates investments by using the internal rate of return and ignores income taxes. Required: A. Briefly define the internal rate of return. B. What relationship holds true at the internal rate of return with respect to discounted cash inflows and discounted cash outflows? With respect to net present value? C. Compute the machine's internal rate of return.

Lasley Corporation is considering the acquisition of a new machine that is expected to produce annual savings in cash operating costs of $30,000 before income taxes. The machine costs $100,000, has a useful life of five years, and no salvage value. Lasley uses straight-line depreciation on all assets, is subject to a 30% income tax rate, and has an after-tax hurdle rate of 8%. Required: A. Compute the machine's accounting rate of return on the initial investment. B. Compute the machine's net present value.

Which of the following choices correctly depicts whether discounted cash flows are used by the method noted when evaluating long-term investments? Net Present Value Internal Rate of Return Accounting Rate of Return A. No No Yes B. Yes No Yes C. Yes No No D. Yes Yes No E. Yes Yes Yes

Consider the following factors related to an investment: I. The net income from the investment. II. The cash flows from the investment. III. The timing of the cash flows from the investment. Which of the preceding factors would be important considerations in a net-present-value analysis?

A cash flow measured in real dollars:

Generally speaking, which of the following would not directly affect a company's income tax payments?

If a proposal's profitability index is greater than one:

A company used the net-present-value method to analyze an investment and found the investment to be very attractive. If the firm used straight-line depreciation and changes to the Modified Accelerated Cost Recovery System (MACRS), the investment's net present value will:

Discounted-cash-flow analysis focuses primarily on:

The rule for project acceptance under the net-present-value method is that:

A company that is using the internal rate of return (IRR) to evaluate projects should accept a project if the IRR:

Of the five expenses that follow, which one is most likely treated differently than the others when income taxes are considered in a discounted-cash-flow analysis?