Question Details

ACC 162 Planning for capital investments PART 9

MULTIPLE CHOICE QUESTIONS

BRIEF EXERCISES
BE  148
Diamond Company is considering investing in new equipment that will cost $600,000 with a 10-year useful life. The new equipment is expected to produce annual net income of $40,000 over its useful life. Depreciation expense, using the straight-line rate, is $60,000 per year.
Instructions
Compute the cash payback period.



BE  149
Madeline Company is proposing to spend $160,000 to purchase a machine that will provide annual cash flows of $30,000. The appropriate present value factor for 10 periods is 5.65.
Instructions
Compute the proposed investment- net present value and indicate whether the investment should be made by Madeline Company.



BE  150
LakeFront Company is considering investing in a new dock that will cost $280,000. The company expects to use the dock for 5 years, after which it will be sold for $150,000. LakeFront anticipates annual cash flows of $55,000 resulting from the new dock. The company- borrowing rate is 8%, while its cost of capital is 10%.
Instructions
Calculate the net present value of the dock and indicate whether LakeFront should make the investment.




BE  151
Mobil Company has hired a consultant to propose a way to increase the company- revenues. The consultant has evaluated two mutually exclusive projects with the following information provided for each project:
	Project Turtle	Project Snake
Capital investment	$790,000	$440,000
Annual cash flows	130,000	75,000
Estimated useful life	10 years	10 years

Mobil Company uses a discount rate of 9% to evaluate both projects.

Instructions
(a)	Calculate the net present value of both projects.
(b)	Calculate the profitability for each project.
(c)	Which project should Mobil accept?
BE  152
Mint Company is contemplating an investment costing $90,000. The investment will have a life of 8 years with no salvage value and will produce annual cash flows of $18,150.

BE  152	(cont.)
Instructions
What is the approximate internal rate of return associated with this investment?



BE  153
Salt Company is considering investing in a new facility to extract and produce salt. The facility will increase revenues by $250,000, but it will also increase annual expenses by $160,000. The facility will cost $980,000 to build, and it will have a $20,000 salvage value at the end of its useful life.

Instructions
Calculate the annual rate of return on this facility.





EXERCISES
Ex. 154
Corn Doggy, Inc. produces and sells corn dogs. The corn dogs are dipped by hand. Austin Beagle, production manager, is considering purchasing a machine that will make the corn dogs. Austin has shopped for machines and found that the machine he wants will cost $262,000. In addition, Austin estimates that the new machine will increase the company- annual net cash inflows by $40,300. The machine will have a 12-year useful life and no salvage value.

Instructions
(a)	Calculate the cash payback period. 
(b)	Calculate the machine- internal rate of return.
(c)	Calculate the machine- net present value using a discount rate of 10%.
(d)	Assuming Corn Doggy, Inc.- cost of capital is 10%, is the investment acceptable? Why or why not?



Ex. 155
Top Growth Farms, a farming cooperative, is considering purchasing a tractor for $455,500. The machine has a 10-year life and an estimated salvage value of $32,000. Delivery costs and set-up charges will be $12,100 and $400, respectively. Top Growth uses straight-line depreciation.

Top Growth estimates that the tractor will be used five times a week with the average charge to the individual farmers of $350. Fuel is $50 for each use of the tractor. The present value of an annuity of 1 for 10 years at 9% is 6.418.

Instructions
For the new tractor, compute the:
(a)	cash payback period.
(b)	net present value.
(c)	annual rate of return.




Ex. 156
Tom Bat became a baseball enthusiast at a very early age. All of his baseball experience has provided him valuable knowledge of the sport, and he is thinking about going into the batting cage business. He estimates the construction of a state-of-the-art building and the purchase of necessary equipment will cost $630,000. Both the facility and the equipment will be depreciated over 12 years using the straight-line method and are expected to have zero salvage values. His required rate of return is 10% (present value factor of 6.8137). Estimated annual net income and cash flows are as follows:
	Revenue		$329,000
	Less:	
		Utility cost	40,000
		Supplies	8,000
		Labor	141,000
		Depreciation	52,500
		Other	  38,500	  280,000
	Net income		$  49,000

Instructions
For this investment, calculate:
(a)	The net present value.
(b)	The internal rate of return.
(c)	The cash payback period.


Ex. 157
Mimi Company is considering a capital investment of $250,000 in new equipment. The equipment is expected to have a 5-year useful life with no salvage value. Depreciation is computed by the straight-line method.  During the life of the investment, annual net income and cash inflows are expected to be $25,000 and $75,000, respectively. Mimi's minimum required rate of return is 10%. The present value of 1 for 5 periods at 10% is .621 and the present value of an annuity of 1 for 5 periods at 10% is 3.791.

Instructions
Compute each of the following:
(a)	cash payback period.
(b)	net present value.
(c)	annual rate of return.



Ex. 158
Savanna Company is considering two capital investment proposals. Relevant data on each project are as follows:
	Project Red	Project Blue
Capital investment	$400,000	$560,000
Annual net income	50,000	80,000
Estimated useful life	8 years	8 years

Depreciation is computed by the straight-line method with no salvage value. Savanna requires an 8% rate of return on all new investments. The present value of 1 for 8 periods at 8% is .540 and the present value of an annuity of 1 for 8 periods is 5.747.

Instructions
(a)	Compute the cash payback period for each project.
(b)	Compute the net present value for each project.
(c)	Compute the annual rate of return for each project.
(d)	Which project should Savanna select?



Ex. 159
Yappy Company is considering a capital investment of $320,000 in additional equipment. The new equipment is expected to have a useful life of 8 years with no salvage value.  Depreciation is computed by the straight-line method.  During the life of the investment, annual net income and cash inflows are expected to be $25,000 and $65,000, respectively. Yappy requires a 10% return on all new investments.
		Present Value of an Annuity of 1	
	Period	  8%		  9%		 10%		 11%		 12%		 15%	
	8	5.747	5.535	5.335	5.146	4.968	4.487

Instructions
(a)	Compute each of the following:
	1.	Cash payback period.
	2.	Net present value.
	3.	Profitability index.
	4	Internal rate of return.
	5.	Annual rate of return.
(b)	Indicate whether the investment should be accepted or rejected.




Ex. 160
Sophie- Pet Shop is considering the purchase of a new delivery van. Sophie Smith, owner of the shop, has compiled the following estimates in trying to determine whether the delivery van should be purchased:

	Cost of the van	$25,000
	Annual net cash flows	4,000
	Salvage value	3,000
	Estimated useful life	8 years
	Cost of capital	10%
	Present value of an annuity of 1	5.335
	Present value of 1	.467

Sophie's assistant manager is trying to convince Sophie that the van has other benefits that she hasn't considered in the initial estimates. These additional benefits, including the free advertising the store's name painted on the van's doors will provide, are expected to increase net cash flows by $500 each year.

Instructions
(a)	Calculate the net present value of the van, based on the initial estimates. Should the van be purchased?
(b)	Calculate the net present value, incorporating the additional benefits suggested by the assistant manager. Should the van be purchased?
(c)	Determine how much the additional benefits would have to be worth in order for the van to be purchased.


Ex. 161
Vista Company is considering two new projects, each requiring an equipment investment of $95,000. Each project will last for three years and produce the following cash inflows:

	Year	   Cool		     Hot	
	1	$  38,000	$  42,000
	2	42,000	42,000
	3	    48,000	    42,000
		$128,000	$126,000

The equipment will have no salvage value at the end of its three-year life. Vista Company uses straight-line depreciation and requires a minimum rate of return of 12%.

Present value data are as follows:

		Present Value of 1		Present Value of an Annuity of 1
	Period	12%		Period	 12%	
	1	.893	1	.893
	2	.797	2	1.690
	3	.712	3	2.402

Instructions
(a)	Compute the net present value of each project.
(b)	Compute the profitability index of each project.
(c)	Which project should be selected?  Why?




Ex. 162
Santana Company is considering investing in a project that will cost $110,000 and have no salvage value at the end of its 5-year life. It is estimated that the project will generate annual cash inflows of $30,000 each year. The company requires a 10% rate of return and uses the following compound interest table:

Present Value of an Annuity of 1
	Period	  6% 		  8% 		   9%		 10%		 11%		 12%		 15%	
	5	4.212	3.993	3.890	3.791	3.696	3.605	3.352

Instructions
(a)	Compute (1) the net present value and (2) the profitability index of the project.
(b)	Compute the internal rate of return on this project.
(c)	Should Santana invest in this project?



Ex. 163
Johnson Company is considering purchasing one of two new machines. The following estimates are available for each machine:
	Machine 1	Machine 2
	Initial cost	$148,000	$165,000
	Annual cash inflows	50,000	60,000
	Annual cash outflows	15,000	20,000
	Estimated useful life	6 years	6 years

The company's minimum required rate of return is 10%.

		Present Value of an Annuity of 1	
	Period	  8%		  9%		 10%		 11%		 12%		 15%	
	6	4.623	4.486	4.355	4.231	4.111	3.784

Instructions
(a)	Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each machine.
(b)	Which machine should be purchased?



Ex. 164
Platoon Company is performing a post-audit of a project that was estimated to cost $300,000, have a useful life of 6 years with a zero salvage value, and result in net cash inflows of $75,000 per year. After the investment was in operation for a year, revised figures indicate that it actually cost $345,000, will have a 9-year useful life, and will produce net cash inflows of $58,000. The present value of an annuity of 1 for 6 years at 10% is 4.355 and for 9 years is 5.759.
Ex. 164	(cont.)
Instructions
Determine whether the project should have been accepted based on (a) the original estimates and then on (b) the actual amounts.



Ex. 165
Shilling Corp. is thinking about opening a baseball camp in Florida. In order to start the camp, the company would need to purchase land, build five baseball fields, and a dormitory-type sleeping and dining facility to house 100 players. Each year the camp would be run for 10 sessions of 1 week each. The company would hire college baseball players as coaches. The camp attendees would be baseball players age 12-18. Property values in Florida have enjoyed a steady increase in value. It is expected that after using the facility for 20 years, Shilling can sell the property for more than it was originally purchased for. The following amounts have been estimated:
	Cost of land	$   600,000
	Cost to build dorm and dining facility	2,100,000
	Annual cash inflows assuming 100 players and 10 weeks	2,520,000
	Annual cash outflows	2,260,000
	Estimated useful life	20 years
	Salvage value	3,900,000
	Discount rate	10%
	Present value of an annuity of 1	8.514
	Present value of 1	.149

Instructions
(a)	Calculate the net present value of the project.
(b)	To gauge the sensitivity of the project to these estimates, assume that if only 80 campers attend each week, revenues will be $2,085,000 and expenses will be $1,865,000. What is the net present value using these alternative estimates?  Discuss your findings.
(c)	Assuming the original facts, what is the net present value if the project is actually riskier than first assumed, and a 12% discount rate is more appropriate?  The present value of 1 at 12% is .104 and the present value of an annuity of 1 is 7.469.



COMPLETION STATEMENTS
	166.	For purposes of capital budgeting, estimated ____________ and outflows are preferred for inputs into the capital budgeting decision tools.
	167.	The technique which identifies the time period required to recover the cost of the investment is called the ________________ method.
	168.	The two discounted cash flow techniques used in capital budgeting are (1) the _______________________ method and (2) the ______________________ method.
	169.	Under the net present value method, the interest rate to be used in discounting the future cash inflows is the ________________.
	170.	In using the net present value approach, a project is acceptable if the project's net present value is ____________ or_______________.
	171.	A project- ________________, such as increased quality or safety, are often incorrectly ignored in capital budgeting decisions.
	172.	The _______________ is a method of comparing alternative projects that takes into account both the size of the investment and its discounted future cash flows.
	173.	A well-run organization should perform an evaluation, called a _____________, of its investment projects after their completion.
	174.	The internal rate of return method differs from the net present value method in that it results in finding the ___________________ of the potential investment.
	175.	A major limitation of the annual rate of return approach is that it does not consider the _______________ of money.


MATCHING
176.	Match the items below by entering the appropriate code letter in the space provided.

	A.	Profitability index	E.	Annual rate of return method
	B.	Internal rate of return method	F.	Cash payback technique
	C.	Discounted cash flow techniques	G.	Cost of capital
	D.	Capital budgeting	H.	Net present value method
	

____	1.	A capital budgeting technique that identifies the time period required to recover the cost of a capital investment from the annual cash inflow produced by the investment.

____	2.	Capital budgeting techniques that consider both the estimated total cash inflows from the investment and the time value of money.

____	3.	A method used in capital budgeting in which cash inflows are discounted to their present value and then compared to the capital outlay required by the capital investment.

____	4.	A method of comparing alternative projects that take into account both the size of the investment and its discounted cash flows.

____	5.	A method used in capital budgeting that results in finding the interest yield of the potential investment.

____	6.	The average rate of return that the firm must pay to obtain borrowed and equity funds.

____	7.	The determination of the profitability of a capital expenditure by dividing expected annual net income by the average investment.

____	8.	The process of making capital expenditure decisions in business.