Exam 26: Capital Budgeting

The management of Salem Corporation is considering the purchase of equipment costing $109,000,which has an estimated life of 3 years and no salvage value.The net after tax cash flow from the project for each of the three years is expected to be $45,000.The company's cost of capital is 10%.Compute the net present value of the equipment.(Present value of $1 due in three years,discounted at 10%,is 0.751;present value of $1 received annually for three years,discounted at 10% is 2.487. )

Return on average investment vs.discounting cash flows The computation of return on average investment ignores one characteristic of the earnings stream,which is considered in discounting cash flows.What is this characteristic? Why is it important?

Capital budgeting proposals often require input from all of the following stakeholders except:

The recognition of depreciation expense often causes the annual net income of an investment to be less than the amount of its annual net cash flows.

To compute a future amount from a present value,we need to know:

A cost that has been incurred irrevocably by past actions is a(n):

The payback period considers total profitability over the life of an investment and takes into consideration the timing of an investment's future cash flows.

Sterling Corporation has borrowed $75,000 that must be repaid in two years.This $75,000 is to be invested in an eight-year project with an estimated annual net cash flow of $15,000.The payback period for this investment is:

The return on average investment computation ignores the timing of an investment's future cash flows.

The present value of money is always less than its future value.

Non-financial factors are relevant in capital budgeting.

Accounting terminology Listed below are eight technical accounting terms introduced or emphasized in this chapter. Each of the following statements may (or may not)describe one of these technical terms.In the space provided beside each statement,indicate the accounting term described,or answer "None" if the statement does not correctly describe any of the terms. ________ (a)The process of analyzing investments in plant assets. ________ (b)The number of years required to recover the entire cost of an investment from its net cash flows. ________ (c)A stream of equal cash flows to be received or paid. ________ (d)The estimated average annual income of an investment expressed as a percentage of its average initial cost. ________ (e)The numerator in the return on average investment computation. ________ (f)The amount an investor should be willing to pay today for the right to receive a specified amount of cash at a specified future date. ________ (g)The process of computing the present value of future cash flows.

Capital budgeting Golden Flights,Inc.is considering buying some specialized machinery,which would enable the company to obtain a six-year government contract for the design and engineering of a futuristic plane.The machinery costs $975,000 and must be destroyed for security reasons at the end of the six-year contract period.The estimated annual operating results of the project are as follows: All revenue from the contract and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.You are to compute the following three factors for this project: (a)Payback period: ________ years (b)Return on average investment: ________% (c)Net present value of the investment in this machinery,discounted at an annual rate of 12% (an annuity table shows that the present value of $1 received annually for six years discounted at 12% is 4.111): $________

On the basis of the above data,which of the following is false?

Which of the following is not considered a capital investment?

If an investment costs $140,000 with no residual value,an expected increase in net income of $35,000 and a 5-year useful life,the payback period would be:

The management of Trylon Farms is considering the purchase of equipment costing $320,000.The equipment has a useful life of eight years,with $20,000 residual value.The use of this equipment will produce positive annual cash flow of $60,000 for eight years,as well as $20,000 from sale of the equipment at the end of the eighth year.Compute the net present value of this investment,discounted at an annual rate of 10%.(Present value of $1 due in eight years,discounted at 10%,is 0.467;present value of $1 received annually for eight years,discounted at 10% is 5.335. )

Capital investment refers to large expenditures to purchase plant assets,develop new products,or sell more company stock.

The payback period:

[The following information applies to the questions displayed below.] Lazar Corporation is evaluating a proposal to invest in a machine costing $89,000.The machine has an estimated useful life of ten years,and an estimated salvage value of $14,000.The machine will increase the company's net income by approximately $9,600 per year.All revenue and expenses other than depreciation will be received and paid in cash. -The payback period of the machine is approximately: