Exam 11: Capital Budgeting and Investment Analysis

The following relates to a proposed equipment purchase: Assuming that net cash flows are received evenly throughout the year, the accounting rate of return is (ignore income taxes):

A company buys a machine for $76,000 that has an expected life of 6 years and no salvage value. The company uses straight-line depreciation. The company anticipates a yearly after tax net income of $1,805. What is the accounting rate of return?

After-tax net income divided by the average amount invested in a project, is the:

In ranking choices with the break-even time (BET) method, the investment with the highest BET measure gets the highest rank.

Projects with a profitability index of greater than 1 have a return that is greater than the hurdle rate.

The profitability index is computed by dividing the present value of net cash flows by the initial investment.

The calculation of the payback period for an investment when net cash flow is even (equal) is:

What is capital budgeting? Why are capital budgeting decisions often difficult and risky?

In using a capital budgeting method that takes the time value of money into consideration, 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?

The following relates to a proposed equipment purchase: Ignoring income taxes, the annual net income amount used to calculate the accounting rate of return is:

For projects financed from borrowed funds, the hurdle rate must exceed the interest rate paid on the borrowed funds.

A company is planning to purchase a machine that will cost $24,000 with a six-year life and 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 wishes to buy new equipment for $9,000. The equipment is expected to generate an additional $2,800 in cash inflows for six years. All cash flows occur at year-end. A bank will make a $9,000 loan to the company at a 10% interest rate so that the company can purchase the equipment. Use the table below to determine break-even time for this equipment:

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

Carmel Corporation is considering the purchase of a machine costing $36,000 with a 6-year useful life and no salvage value. Carmel uses straight-line depreciation and assumes that the annual cash inflow from the machine will be received uniformly throughout each year. In calculating the accounting rate of return, what is Carmel's average investment?

Poe Company is considering the purchase of new equipment costing $80,000. The projected net cash flows are $35,000 for the first two years and $30,000 for years three and four. 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. Poe requires a 10% return on its investments. The present value of $1 and present value of an annuity of $1 for different periods is presented below. Compute the net present value of the machine.