Exam 26: Capital Budgeting

Capital budgeting Mason Co.is evaluating two alternative investment proposals.Below are data for each proposal: The following information was taken from present value tables: All revenue and expenses other than depreciation will be received and paid in cash.The company uses a discount rate of 12% in evaluating all capital investments. Compute the following for each proposal (round payback period to the nearest tenth of a year and round return on average investment to the nearest tenth of a percent): (f)Based on your analysis,which proposal appears to be the best investment?

The higher the required rate of return of an investment,the less an investor will be willing to pay for the investment.

The difference between the present value and future value depends on the rate of interest and the length of time that interest accumulates.

Capital budgeting computations A project costing $80,000 has an estimated life of 3 years and no salvage value.The estimated net income and net after tax cash flows from the project are as follows: The company's minimum desired rate of return for discounted cash flow analysis is 10%.The present value of $1 at compound interest of 10% at 1,2,and 3 years is 0.909,0.826,and 0.751,respectively.The present value of a $1 annuity for three years at 10% is 2.487.The company uses straight-line depreciation. Compute (a)Net present value of the project.________ (b)The rate of return on average investment ________(rounded) Calculations

Discounting cash flows Determine the present value of the following cash flows discounted at an annual rate of 10%: (a)$96,000 to be received five years from today (the present value of $1 at a 10% compound interest rate for five years is 0.621): $________ (b)$37,000 to be received annually for five years (the present value of $1 at 10% received annually for five years is 3.791): $________ (c)$58,000 to be received annually for six years,with an additional $16,000 salvage value to be received at the end of the sixth year (the present value of $1 at 10% received annually for six years is 4.355,and the present value of $1 due six years hence at 10% is 0.564): $________

The present value of a future cash flow is the amount you would pay today for the right to receive that future amount.

[The following information applies to the questions displayed below.] Neville Company is considering an investment of $380,000 in heavy equipment,which will enable the company to be more competitive in the construction industry.The useful service life of the equipment is estimated to be 10 years,with $30,000 salvage value.Straight-line depreciation is used.The company estimates that net income will increase by $41,000 per year as a result of the company's ability to handle a wider range of projects with the new equipment. -The expected rate of return on average investment will be approximately:

Which of the following is generally not considered a capital budgeting technique?

The selection of an appropriate discount rate for determining net present value of a particular investment proposal does not depend upon:

Perhaps the most important financial considerations in a capital budgeting decision are the decision's effects upon future cash flow and future profitability.

[The following information applies to the questions displayed below.] The Terme Corporation is contemplating the purchase of new equipment,which may potentially increase revenues by 25%.Currently,sales are $750,000 per year and variable costs are 55% of sales.The equipment is expected to last for 5 years with no residual value.The cash outflow expected at the beginning of the year is $ 357,500. -What is the amount of depreciation deduction the company could expense annually assuming the straight-line depreciation method is used?

The above data indicate that:

In capital budgeting,the investment proposal with the shortest payback period always has the highest rate of return.

Capital budgeting Carry-Along is debating whether or not to invest in new equipment to manufacture a line of high-quality luggage.The new equipment would cost $850,000,with an estimated four-year life and no salvage value.The estimated annual operating results with the new equipment are as follows: All revenue from the new luggage line 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 for the investment in the new equipment to produce the new luggage line: (rounded) (a)Annual cash flow: $________ (b)Payback period: ________ (c)Return on average investment: ________% (d)Total present value of the expected future annual cash flows,discounted at an annual rate of 12%: (An annuity table shows that the present value of $1 received annually for four years discounted at 12% is 3.037. )$________ (e)Net present value of the proposed investment: $________

[The following information applies to the questions displayed below.] Newman Labs is considering buying equipment,which would enable the company to obtain a five-year research contract.The specialized equipment costs $650,000 and will have no salvage value when the five-year contract period is over.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. -The return on average investment for this investment is approximately:

The impact of a capital budgeting decision upon the environment is an example of a nonfinancial consideration.

[The following information applies to the questions displayed below.] Helicopter Gear is planning to expand its product line,which requires investment of $475,200 in special-purpose machinery.The machinery has a useful life of six years and no salvage value.The estimated annual results of offering the new products are as follows: All revenue from the new products and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes. -The payback period for this proposed investment is:

The average carrying value (or average investment)of an asset with no salvage value is equal to:

The discount rate used in discounting cash flows from proposed investments is usually the rate of return required by the investor.

When the net present value is greater than zero,the investment's rate of return is less than the discount rate.