Exam 25: Capital Budgeting and Managerial Decisions

Barnes manufactures a specialty food product that can currently be sold for $22 per unit and has 20,000 units on hand. Alternatively, it can be further processed at a cost of $12,000 and converted into 12,000 units of Exceptional and 6,000 units of Premium. The selling price of Exceptional and Premium are $30 and $20, respectively. The incremental net income of processing further would be:

Bower Co. is reviewing a capital investment of $50,000. This project's projected cash flows over a five-year period are estimated at $20,000 each year. Required: (a) Calculate the payback period. (b) Calculate the break-even time. Assume a 12% hurdle rate and use the table below: (c) Using the results in (a) and (b), make a recommendation for the project.

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and be depreciated over a three-year period with no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the payback period for this machine?

A company produces two boat models, Montauk and Orient. Both products are being considered for major investment projects next year. Relevant data follow: Required: Use the payback period to evaluate these two investment projects.

The decision to accept an additional volume of business should be based on a comparison of the revenue from the additional business with the sunk costs of producing that revenue.

An advantage of the break-even time (BET) method over the payback period method is that it recognizes the time value of money.

If the straight-line depreciation method is used, the annual average investment amount used in calculating rate of return is calculated as (beginning book value + ending book value)/2.

The net present value decision rule is: When an asset's expected cash flows are discounted at the required rate and yield a positive net present value, the asset should be acquired.

A company has a decision to make between two investment alternatives. The company requires a 10% return on investment. Predicted data is provided below: The present value of an annuity for 6 years at 10% is 4.3553. This company uses straight-line depreciation. Required: (a) Calculate the net present value for each investment. (b) Which investment should this company select? Explain.

Parker Plumbing has received a special one-time order for 1,500 faucets (units) at $5 per unit. Parker currently produces and sells 7,500 units at $6.00 each. This level represents 75% of its capacity. Production costs for these units are $4.50 per unit, which includes $3.00 variable cost and $1.50 fixed cost. To produce the special order, a new machine needs to be purchased at a cost of $1,000 with a zero salvage value. Management expects no other changes in costs as a result of the additional production. Should the company accept the special order?

A company inadvertently produced 3,000 defective products. The product cost $15 each to be manufactured and normally sells for $35 each. A salvage company will purchase the defective units as they are for $12 each. The production manager reports that the defects can be corrected for $5 per unit, enabling the company to sell them at a discounted price of $22.00. The repair operations would not affect other production operations. Prepare an analysis that shows which action should be taken.

Significant sunk costs are relevant to decisions about the future.

A company has just received a special, one-time order for 1,000 units. Producing the order will have no effect on the production and sales of other units. The buyer's name will be stamped on each unit, at a total cost of $2,000. Normal cost data, excluding stamping, follows: What selling price per unit will this company require to earn $3,000 on the order?

A company purchases a machine for $1,000,000. The machine has an expected life of 9 years and no salvage value. The company anticipates a yearly net income of $60,000 after taxes of 30% to be received uniformly throughout each year. What is the accounting rate of return?

Sherman Company can sell all of its products A and Z that it can produce, but it has limited production capacity. It can produce 6 units of A per hour or 10 units of Z per hour, and it has 20,000 production hours available. Contribution margin per unit is $12 for A and $10 for Z. What is the most profitable sales mix for this company?

Edgar Company is considering the purchase of new equipment costing $80,000. The projected annual after-tax net income from the equipment is $10,200, after deducting $20,000 for depreciation. The revenue is to be received at the end of each year. The machine has a useful life of 4 years and no salvage value. Edgar requires a 10% return on its investments. The present value of an annuity of 1 and present value of an annuity for different periods is presented below. Compute the net present value of the machine.

In using the internal rate of return method, management must consider a hurdle rate in making its decisions. What is a hurdle rate? What factors does management have to consider in selecting a hurdle rate?

You have evaluated three projects using the net present value (NPV) method. How would you decide which one of the projects to select?

A company is considering the purchase of new equipment for $45,000. The projected after-tax net income is $3,000 after deducting $15,000 of depreciation. The machine has a useful life of 3 years and no salvage value. Management of the company requires a 12% return on investment. The present value of an annuity of 1 for various periods follows: What is the net present value of this machine assuming all cash flows occur at year-end?

If the internal rate of return (IRR) of an investment is below the hurdle rate, the project should be accepted.