Exam 25: Capital Budgeting and Managerial Decisions

_____________________ is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

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.

The __________________________ is the rate that yields a net present value of zero for an investment.

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.

A company must decide between scrapping or rebuilding units that do not pass inspection. The company has 15,000 such units that cost $6 per unit to manufacture. The units were built to satisfy a special order, which must still be satisfied if the defective units are scrapped. The units can be sold as scrap for $2.50 each or they can be reworked for $4.50 each and sold for the full price of $9.00 each. If the units are sold as scrap, the company will have to build 15,000 replacement units and sell them at the full price. Required: (1) What is the net return from selling the units as scrap? (2) What is the net return from reworking and selling the units? (3) Should the company sell the units as scrap or rework them?

Identify at least three reasons for managers to favor the internal rate of return (IRR) over other capital budgeting approaches.

A company is planning to introduce a new portable TV to its existing product line. Management must decide whether to make the TV case or buy it from an outside supplier. The lowest outside price is $100. If the case is produced internally, the company will have to purchase new equipment that will yield annual depreciation of $130,000. The company will also need to rent a new production facility at $200,000 a year. At 20,000 cases per year, a preliminary analysis of production costs shows the following: Required: (1) Determine whether the company should make the cases or buy them from the outside supplier. (2) What decision should be made if only 15,000 cases are needed? (3) What other factors, besides cost, should the company consider?

The internal rate of return equals the rate that yields a net present value of zero for an investment.

A company is considering a 5-year project. The company plans to invest $60,000 now and it forecasts cash flows for each year of $16,200. The company requires a hurdle rate of 12%. Calculate the internal rate of return to determine whether it should accept this project. Selected factors for a present value of an annuity of 1 for five years are shown below:

A special order of goods or services should always be accepted when the incremental revenue exceeds the incremental costs.

The hurdle rate is often set at:

A company is considering the purchase of a new machine for $48,000. Management predicts that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. The company's tax rate is 40%. What is the payback period for the new machine?

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?

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 accounting rate of return for this machine?

The payback method, unlike the net present value method, does not ignore cash flows after the point of cost recovery.

Eagle Company is considering the purchase of an asset for $100,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year. Compute the break-even time (BET) period for this investment. (Round to two decimal places.)

An opportunity cost:

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?

Part of the decision to accept additional business should be based on a comparison of the incremental (differential) costs of the added production with the additional revenues to be received.

A company is considering two projects, Project A and Project B. The following information is available for each project: Calculate the profitability index for each project. Based on the profitability index, which project should the company pursue and why?