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Management Accounting (ISSM 541) Winter 2015

Assignment 5
Coverage: chapter 13; Weight: 8%
Due date: April 11, 2015
Multiple choice questions (5 marks each)

1. Why are the net present value and internal rate of return methods of capital budgeting superior
to the payback method?
A. Because they are easier to implement.
B. Because they consider the time value of money.
C. Because they require less input.
D. Because they reflect the effects of depreciation and income taxes.
2. The net present value method takes into account which of the following?

A. Option A
B. Option B
C. Option C
D. Option D
3. Which of the following is a weakness of the internal rate of return method for screening
investment projects?
A. It does NOT consider the time value of money.
B. It implicitly assumes that the company is able to reinvest cash flows from the project at the
company's discount rate.
C. It implicitly assumes that the company is able to reinvest cash flows from the project at the
internal rate of return.
D. It does NOT take into account all of the cash flows from a project.
4. Given the following data:

Based on the data given, what would be the profitability index? (Ignore income taxes in this
problem.)
A. 3.05%.
B. 35.8%.
C. 3.58%.
D. Cannot be determined from the information given.

Management Accounting (ISSM 541) Winter 2015


Assignment 5
Coverage: chapter 13; Weight: 8%
Due date: April 11, 2015
5. Jarvey Company is studying a project that would have a ten-year life and would require a
$450,000 investment in equipment that has no salvage value. The project would provide net
income each year as follows for the life of the project:

The company's required rate of return is 12%. What is the payback period for this project?
(Ignore income taxes in this problem.)
A. 2.00 years.
B. 3.00 years.
C. 4.28 years.
D. 9.00 years.
6. Denny Corporation is considering replacing a technologically obsolete machine with a new
state-of-the-art numerically controlled machine. The new machine would cost $450,000 and
would have a ten-year useful life. Unfortunately, the new machine would have no salvage
value. The new machine would cost $20,000 per year to operate and maintain, but would save
$100,000 per year in labour and other costs. The old machine can be sold now for scrap for
$50,000. The simple rate of return on the new machine is closest to which of the following?
(Ignore income taxes in this problem.)
A. 7.78%.
B. 8.75%.
C. 20.00%.
D. 22.22%.
7. The Jason Company is considering the purchase of a machine that will increase revenues by
$32,000 each year. Cash outflows for operating this machine will be $6,000 each year. The cost
of the machine is $65,000. It is expected to have a useful life of five years with no salvage
value. For this machine, what is the simple rate of return? (Ignore income taxes in this
problem.)
A. 9.2%.
B. 20.0%.
C. 40.0%.
D. 49.2%.

Management Accounting (ISSM 541) Winter 2015


Assignment 5
Coverage: chapter 13; Weight: 8%
Due date: April 11, 2015
8. Purvell Company has just acquired a new machine. Data on the machine follow:

The company uses straight-line depreciation and a $5,000 salvage value. (The company
considers salvage value in making depreciation deductions.) Assume cash flows occur
uniformly throughout a year. (Ignore income taxes in this problem.) The simple rate of return
would be closest to which of the following?
A. 12.50%.
B. 17.50%.
C. 18.75%.
D. 30.00%.
9.

A piece of equipment, acquired in Year 1, belongs to Class 7 with a maximum CCA rate of
15%. The income tax rate is 40%. The tax savings (before discounting) from the CCA tax
shield were $2,830.50 for Year 3. The after-tax cost of capital is 10%. What is the approximate
undepreciated capital cost (UCC) balance for the equipment at the beginning of Year 3?
A. $7,076.
B. $8,325.
C. $31,450.
D. $47,175.

10. The Morgan Company has been awarded a six-year contract to provide repair service to a
commercial bus line. Morgan Company has gathered the following data associated with the
items needed for this contract:

The special equipment is in Class 7 with a maximum 15% CCA rate. The income tax rate is
40%, and Morgan's after-tax cost of capital is 14%. At the end of six years, the working capital
will be released for use elsewhere.
Assume the special equipment will have a zero salvage value (instead of $20,000) at the end of
six years. The present value of the total tax savings for all years because of the CCA tax shield
is closest to which of the following? (Do not round your intermediate calculations.)
A. $56,373.
B. $58,258.
C. $60,143.
D. $62,069.

Management Accounting (ISSM 541) Winter 2015


Assignment 5
Coverage: chapter 13; Weight: 8%
Due date: April 11, 2015

Problems (10 marks each)

1. Ursus, Inc. is considering a project that would have a ten-year life and would require a $2,000,000
investment in equipment. At the end of ten years, the project would terminate and the equipment would
have no salvage value. The project would provide net income each year as follows:

All of the above items, except for depreciation of $200,000 a year, represent cash flows. The
depreciation is included in the fixed expenses. The company's required rate of return is 12%. (Ignore
income taxes in this problem.)
Required:
a) What is the project's net present value?
b) What is the project's internal rate of return?
c) What is the project's payback period?
d) What is the project's simple rate of return?
2. Mark Stevens is considering opening a hobby and craft store. He would need $100,000 to equip the
business and another $40,000 for inventories and other working capital needs. Rent for the building to
be used by the business will be $24,000 per year. Mark estimates that the annual cash inflow from the
business will amount to $90,000. In addition to building rent, annual cash outflow for operating costs
will amount to $30,000. Mark plans to operate the business for only six years. He estimates that the
equipment and furnishings could be sold at that time for 10% of their original cost. Mark uses a
discount rate of 16%. (Ignore income taxes in this problem.)
Required:
Would you advise Mark to make this investment? Use the net present value method.
3. AB Company is considering the purchase of a machine that promises to reduce operating costs by
the same amount for every year of its six-year useful life. The machine will cost $83,150 and has no
salvage value. The machine has a 20% internal rate of return. (Ignore income taxes in this problem.)
Required:
What is the annual cost savings promised by the machine?

Management Accounting (ISSM 541) Winter 2015


Assignment 5
Coverage: chapter 13; Weight: 8%
Due date: April 11, 2015

4. Vernal Company has been offered a seven-year contract to supply a part for the military. After

careful study, the company has developed the following estimated data relating to the contract:

The equipment above would be in Class 7 with a 15% CCA rate. The company would take the
maximum CCA allowable each year. It is not expected that the contract would be extended beyond the
initial contract period. The company's after-tax cost of capital is 10%, and the tax rate is 30%.
Required:
Use net present value analysis to determine whether or not the contract should be accepted. (Round all
calculations to the nearest dollar.)
5. Selah Company bought a new computer-assisted design (CAD) software for $10,000,000 at the

beginning of Year 1. The software has a useful life of 3 years and will save the company annual cash
operating expenses of $4,000,000 in each of those 3 years. The software will have a zero net salvage
value at the end of 3 years. It belongs to Class 12 with a capital cost allowance (CCA) rate of 100%.
With special permission from the Canada Revenue Agency, the half-year CCA rule has been waived
for the company to permit a maximum 100% CCA deduction for Year 1. The company's income tax
rate and after-tax cost of capital are 40% and 12%, respectively.
Required:
a) Calculate the maximum total CCA tax shied available to the company.
b) Calculate the present value of the annual cash savings in operating expenses.
c) Calculate the net present value (NPV) of the investment.
d) Was the internal rate of return (IROR) greater than or less than the company's after-tax cost of
capital of 12%? (Note: Do NOT try to calculate the implied actual internal rate or return.)
e) By how much must the annual savings in operating expenses be increased or decreased to make the
investment just worthwhile, that is, either zero NPV or 12% IROR?

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