Chapter 12

Chapter 12
Capital Budgeting Decisions

True/False
1.Boththenetpresentvaluemethodandtheinternalrateofreturnmethodcanbeusedasascreeningtool
incapitalbudgetingdecisions.
Level:EasyLO:1Ans:T
2.Whenconsideringanumberofinvestmentprojects,theprojectthathasthebestpaybackperiodwill
alsoalwayshavethehighestnetpresentvalue.
Level:MediumLO:1,3Ans:F
3.Whendiscountedcashflowmethodsofcapitalbudgetingareused,theworkingcapitalrequiredfora
projectisordinarilycountedasacashoutflowatthebeginningoftheprojectandasacashinflowatthe
endoftheproject.
Level:MediumLO:1Ans:T
4.Discountedcashflowtechniquesautomaticallyprovideforrecoveryofinitialinvestment.
5.Whencomputingtheprojectprofitabilityindexofaninvestmentproject,theinvestmentrequiredwill
includeanyinvestmentmadeinworkingcapitalatthebeginningoftheproject.
6.Ifinvestmentfundsarelimited,thenetpresentvalueofoneprojectshouldnotbecompareddirectlyto
thenetpresentvalueofanotherprojectunlesstheinitialinvestmentsintheseprojectsareequal.
7.Incalculatingpaybackwherenewequipmentisreplacingoldequipment,anysalvagevaluetobe
receivedondisposaloftheoldequipmentshouldbedeductedfromthecostofthenewequipment.
8.Inthepaybackmethod,depreciationisaddedbacktonetoperatingincomewhencomputingthenet
annualcashflow.
9.Thesimplerateofreturnmethodisdesirablebecauseofitssimplicityandthefactthatittakesthetime
valueofmoneyintoaccount.
Brewer,IntroductiontoManagerialAccounting,3/e
77
Level:MediumLO:4Ans:F
78
10.Thepresentvalueofacashflowwillneverbegreaterthanthefuturedollaramountofthecashflow.
Level:EasyLO:5Ans:T
MultipleChoice
11.Someinvestmentprojectsrequirethatacompanyincreaseitsworkingcapital.Underthenetpresent
valuemethod,theinvestmentandeventualrecoveryofworkingcapitalshouldbetreatedas:
A)aninitialcashoutflow.
B)afuturecashinflow.
C)bothaninitialcashoutflowandafuturecashinflow.
D)irrelevanttothenetpresentvalueanalysis.
Level:MediumLO:1Ans:C
12.Thenetpresentvalue(NPV)methodofinvestmentprojectanalysisassumesthattheprojectscash
flowsarereinvestedatthe:
A)internalrateofreturn.
B)discountrateusedintheNPVcalculation.
C)firmssimplerateofreturn.
D)firmsaverageROI.
Source:CMA,adapted
Level:MediumLO:1Ans:B
13.Iftaxesareignored,allofthefollowingitemsareincludedinadiscountedcashflowanalysisexcept:
A)futureoperatingcashsavings.
B)depreciationexpense.
C)futuresalvagevalue.
D)investmentinworkingcapital.
Source:CMA,adapted
14.Incapitalbudgetingcomputations,discountedcashflowmethods:
A)automaticallyprovideforrecoveryofinitialinvestment.
B)cantbeusedunlesscashflowsareuniformfromyeartoyear.
C)assumethatallcashflowsoccuratthebeginningofaperiod.
D)responsesa,b,andcareallcorrect.
Level:MediumLO:1Ans:A
15.Theinvestmentrequiredfortheprojectprofitabilityindexshould:
A)bereducedbytheamountofanysalvagerecoveredfromthesaleofoldequipment.
B)bereducedbytheamountofanysalvagerecoveredfromthesaleofthenewequipmentattheendof
itsusefullife.
C)bereducedbytheamountofanysalvagerecoveredfromthesaleofboththeoldandnewequipment.
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D)noneoftheaboveiscorrect.
80
16.Acompanywantstohave$40,000attheendofafiveyearperiodthroughinvestmentofasinglesum
now.Howmuchneedstobeinvestedinordertohavethedesiredsuminfiveyears,ifthemoneycanbe
investedat10%:
A)$10,551
B)$8,000
C)$24,840
D)$12,882
Level:EasyLO:1Ans:C
17.Thefollowingdataonaproposedinvestmentprojecthavebeenprovided:
Thenetpresentvalueoftheprojectwouldbe:
A)$3,730
B)$0
C)$32,450
D)$88,370
18.StratfordCompanypurchasedamachinewithanestimatedusefullifeofsevenyears.Themachine
willgeneratecashinflowsof$9,000eachyearoverthenextsevenyears.Ifthemachinehasnosalvage
valueattheendofsevenyears,andassumingthecompany'sdiscountrateis10%,whatisthepurchase
priceofthemachineifthenetpresentvalueoftheinvestmentis$17,000?
A)$43,812
B)$26,812
C)$17,000
D)$22,195
Level:HardLO:1Ans:B
19.Anthonyoperatesaparttimeautorepairservice.Heestimatesthatanewdiagnosticcomputersystem
willresultinincreasedcashinflowsof$1,500inYear1,$2,100inYear2,and$3,200inYear3.If
Anthony'srequiredrateofreturnis10%,thenthemosthewouldbewillingtopayforthenewcomputer
systemwouldbe:
A)$4,599
B)$5,501
C)$5,638
D)$5,107
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20.FossaRoadPavingCompanyisconsideringaninvestmentinacurbformingmachine.Themachine
willcost$240,000,willlast10years,andwillhavea$40,000salvagevalueattheendof10years.The
machineisexpectedtogeneratenetcashinflowsof$60,000peryearineachofthe10years.Fossa's
discountrateis18%.Whatisthenetpresentvalueofthismachine?
A)$5,840
B)$37,280
C)$(48,780)
D)$69,640
21.ApneaVideoRentalStoreisconsideringthepurchaseofanalmostnewminivantouseasavehicleto
deliverandpickupvideotapesforcustomers.Theminivanwillcost$18,000andisexpectedtolast8
yearsbutonlyiftheengineisoverhauledatacostof$3,000attheendofyear3.Theminivanisexpected
tohavea$1,000salvagevalueattheendof8years.Thisdeliveryserviceisexpectedtogeneratenetcash
inflowsof$6,000peryearineachofthe8years.Apnea'sdiscountrateis14%.Whatisthenetpresent
valueofthisinvestmentopportunity?
A)$(2,826)
B)$(3,801)
C)$7,185
D)$8,160
Level:MediumLO:1Ans:D
22.Inanefforttoreducecosts,PonticManufacturingCorporationisconsideringaninvestmentin
equipmentthatwillreducedefects.Thisequipmentwillcost$420,000,willhaveanestimatedusefullife
of10years,andwillhaveanestimatedsalvagevalueof$50,000attheendof10years.Pontic'sdiscount
rateis22%.Whatamountofcostsavingswillthisequipmenthavetogenerateperyearineachofthe10
yearsinorderforittobeanacceptableproject?
A)$50,690ormore
B)$41,315ormore
C)$105,315ormore
D)$94,316ormore
Level:HardLO:1Ans:C
23.NaomiCorporationhasacapitalbudgetingprojectthathasanegativenetpresentvalueof$36,000.
Thelifeofthisprojectis6years.Naomi'sdiscountrateis20%.Byhowmuchwouldtheannualcash
inflowsfromthisprojecthavetoincreaseinordertohaveapositivenetpresentvalue?
A)$1,200ormore
B)$2,412ormore
C)$6,000ormore
D)$10,824ormore
Level:HardLO:1Ans:D
83
24.Aprojectrequiresaninitialinvestmentof$70,000andhasaprojectprofitabilityindexof0.932.The
presentvalueofthefuturecashinflowsfromthisinvestmentis:
A)$70,000
B)$36,231
C)$135,240
D)Cannotbedeterminedfromthedataprovided.
25.BowenCompanyisconsideringseveralinvestmentproposals,asshownbelow:
Iftheprojectprofitabilityindexisused,therankingoftheprojectswouldbe:
A)Aabove
B)Babove
C)Cabove
D)Dabove
Level:EasyLO:2Ans:A
26.Informationonfourinvestmentproposalsisgivenbelow:
Ranktheproposalsintermsofpreferenceaccordingtotheprojectprofitabilityindex:
A)1,4,3,2
B)4,1,3,2
C)3,4,1,2
D)2,1,4,3
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27.Informationonfourinvestmentproposalsisgivenbelow:
Ranktheproposalsintermsofpreferenceusingtheprojectprofitabilityindex:
A)3,2,1,4
B)2,3,1,4
C)2,1,3,4
D)4,1,2,3
28.TheGomezCompanyisconsideringtwoprojects,TandV.Thefollowinginformationhasbeen
gatheredontheseprojects:
Basedonthisinformation,whichofthefollowingstatementsis(are)true?
I.ProjectThasthehighestrankingaccordingtotheprojectprofitabilityindexcriterion.
II.ProjectVhasthehighestrankingaccordingtothenetpresentvaluecriterion.
A)OnlyI
B)OnlyII
C)BothIandII
D)NeitherInorII
29.MajorCorporationisconsideringthepurchaseofanewmachinefor$5,000.Themachinehasan
estimatedusefullifeof5yearsandnosalvagevalue.ThemachinewillincreaseMajor'scashflowsby
$2,000annuallyfor5years.Majorusesstraightlinedepreciation.Thecompany'srequiredrateofreturn
is10%.Whatisthepaybackperiodforthemachine?
A)5.00years
B)2.50years
C)7.58years
D)8.34years
Source:CPA,adapted
Level:EasyLO:3Ans:B
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30.HarrisonCompanyisstudyingaprojectthatwouldhaveaneightyearlifeandwouldrequirea
$300,000investmentinequipmentwhichhasnosalvagevalue.Theprojectwouldprovidenetoperating
incomeeachyearasfollowsforthelifeoftheproject:
Thecompany'srequiredrateofreturnis10%.Whatisthepaybackperiodforthisproject?
A)3years
B)2years
C)2.5years
D)2.67years
31.Aninvestmentprojectrequiresaninitialinvestmentof$100,000.Theprojectisexpectedtogenerate
netcashinflowsof$28,000peryearforthenextfiveyears.Assuminga12%discountrate,theproject's
paybackperiodis:
A)0.28years
B)3.36years
C)3.57years
D)1.40years
Source:CMA,adapted
32.MercerCorporationisconsideringreplacingatechnologicallyobsoletemachinewithanewstateof
theartnumericallycontrolledmachine.Thenewmachinewouldcost$250,000andwouldhaveaten
yearusefullife.Unfortunately,thenewmachinewouldhavenosalvagevalue.Thenewmachinewould
cost$12,000peryeartooperateandmaintain,butwouldsave$55,000peryearinlaborandothercosts.
Theoldmachinecanbesoldnowforscrapfor$10,000.Thesimplerateofreturnonthenewmachineis
closestto:
A)17.9%
B)7.5%
C)22.0%
D)7.2%
Level:HardLO:4Ans:B
87
33.PearsonCo.isconsideringthepurchaseofa$200,000machinethatisexpectedtoreduceoperating
cashexpensesby$65,000peryear.Thismachine,whichhasnosalvagevalue,hasanestimateduseful
lifeof5yearsandwillbedepreciatedonastraightlinebasis.Forthismachine,thesimplerateofreturn
wouldbe:
A)10%
B)12.5%
C)20%
D)32.5%
Source:CPA,adapted
34.Assumeyoucaninvestmoneyata14%rateofreturn.Howmuchmoneymustbeinvestednowin
ordertobeabletowithdraw$5,000fromthisinvestmentattheendofeachyearfor8years,thefirst
withdrawaloccurringoneyearfromnow?
A)$24,840
B)$23,195
C)$21,440
D)$1,755
Level:EasyLO:5Ans:B
35.Howmuchwouldyouhavetoinvesttodayinthebankataninterestrateof5%tohaveanannuityof
$1,400peryearfor5years,withnothingleftinthebankattheendofthe5years?Selecttheamount
belowthatisclosesttoyouranswer.
A)$6,667
B)$6,061
C)$7,000
D)$1,098
Level:EasyLO:5Ans:B
36.Youhavedeposited$15,584inaspecialaccountthathasaguaranteedinterestrate.Ifyouwithdraw
$3,700attheendofeachyearfor5years,youwillcompletelyexhaustthebalanceintheaccount.The
guaranteedinterestrateisclosestto:
A)6%
B)19%
C)24%
D)4%
Level:HardLO:5Ans:A
37.Youhavedeposited$16,700inaspecialaccountthathasaguaranteedinterestrateof11%peryear.If
youarewillingtocompletelyexhausttheaccount,whatisthemaximumamountthatyoucouldwithdraw
attheendofeachofthenext6years?Selecttheamountbelowthatisclosesttoyouranswer.
A)$3,465
B)$3,089
C)$2,783
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D)$3,947
89
38.LattingCorporationhasenteredintoa7yearleaseforabuildingitwilluseasawarehouse.The
annualpaymentundertheleasewillbe$4,781.Thefirstpaymentwillbeattheendofthecurrentyear
andallsubsequentpaymentswillbemadeatyearends.Whatisthepresentvalueoftheleasepaymentsif
thediscountrateis6%?
A)$31,573
B)$22,257
C)$33,467
D)$26,688
Level:EasyLO:5Ans:D
39.SchaadCorporationhasenteredintoa8yearleaseforapieceofequipment.Theannualpayment
undertheleasewillbe$2,500,withpaymentsbeingmadeatthebeginningofeachyear.Ifthediscount
rateis14%,thepresentvalueoftheleasepaymentsisclosestto:
A)$20,000
B)$7,011
C)$17,544
D)$13,220
Level:HardLO:5Ans:D
40.TangenCorporationisconsideringthepurchaseofamachinethatwouldcost$380,000andwould
lastfor6years.Attheendof6years,themachinewouldhaveasalvagevalueof$80,000.Byreducing
laborandotheroperatingcosts,themachinewouldprovideannualcostsavingsof$104,000.The
companyrequiresaminimumpretaxreturnof14%onallinvestmentprojects.Thenetpresentvalueof
theproposedprojectisclosestto:
A)$104,456
B)$24,456
C)$133,753
D)$60,936
Level:EasyLO:1Ans:D
41.ThemanagementofUrbineCorporationisconsideringthepurchaseofamachinethatwouldcost
$350,000,wouldlastfor6years,andwouldhavenosalvagevalue.Themachinewouldreducelaborand
othercostsby$79,000peryear.Thecompanyrequiresaminimumpretaxreturnof14%onallinvestment
projects.Thenetpresentvalueoftheproposedprojectisclosestto:
A)$42,769
B)$124,000
C)$93,877
D)$56,493
Level:EasyLO:1Ans:A
90
42.Riveros,Inc.,isconsideringthepurchaseofamachinethatwouldcost$120,000andwouldlastfor8
years.Attheendof8years,themachinewouldhaveasalvagevalueof$29,000.Themachinewould
reducelaborandothercostsby$25,000peryear.Additionalworkingcapitalof$9,000wouldbeneeded
immediately.Allofthisworkingcapitalwouldberecoveredattheendofthelifeofthemachine.The
companyrequiresaminimumpretaxreturnof18%onallinvestmentprojects.Thenetpresentvalueof
theproposedprojectisclosestto:
A)$18,050
B)$63,683
C)$10,336
D)$16,942
Level:EasyLO:1Ans:D
43.ThemanagementofEdelmannCorporationisconsideringthefollowingthreeinvestmentprojects:
Ranktheprojectsaccordingtotheprofitabilityindex,frommostprofitabletoleastprofitable.
A)T,S,R
B)R,T,S
C)S,T,R
D)T,R,S
Level:EasyLO:2Ans:C
44.VillenaCorporationisconsideringaprojectthatwouldrequireaninvestmentof$48,000.Noother
cashoutflowswouldbeinvolved.Thepresentvalueofthecashinflowswouldbe$52,800.The
profitabilityindexoftheprojectisclosestto:
A)0.90
B)0.10
C)1.10
D)0.09
Level:EasyLO:2Ans:B
45.CrowleyCorporationisconsideringthreeinvestmentprojectsF,G,andH.ProjectFwouldrequirean
investmentof$21,000,ProjectGof$49,000,andProjectHof$82,000.Noothercashoutflowswouldbe
involved.Thepresentvalueofthecashinflowswouldbe$21,210forProjectF,$57,820forProjectG,
and$95,120forProjectH.Ranktheprojectsaccordingtotheprofitabilityindex,frommostprofitableto
leastprofitable.
A)F,H,G
B)G,H,F
C)H,F,G
D)H,G,F
Level:EasyLO:2Ans:B
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46.ThemanagementofCantellCorporationisconsideringaprojectthatwouldrequireaninitial
investmentof$47,000.Noothercashoutflowswouldberequired.Thepresentvalueofthecashinflows
wouldbe$55,930.Theprofitabilityindexoftheprojectisclosestto:
A)1.19
B)0.81
C)0.19
D)0.16
Level:EasyLO:2Ans:C
47.KautzerCorporationisconsideringaprojectthatwouldrequireaninvestmentof$418,000andwould
lastfor9years.Theincrementalannualrevenuesandexpensesgeneratedbytheprojectduringthose9
yearswouldbeasfollows:
Thescrapvalueoftheprojectsassetsattheendoftheprojectwouldbe$13,000.Thepaybackperiodof
theprojectisclosestto:
A)5.9years
B)6.1years
C)17.4years
D)16.9years
Level:EasyLO:3Ans:A
48.ThemanagementofHelbergCorporationisconsideringaprojectthatwouldrequireaninvestmentof
$203,000andwouldlastfor6years.Theannualnetoperatingincomefromtheprojectwouldbe
$103,000,whichincludesdepreciationof$30,000.Thescrapvalueoftheprojectsassetsattheendofthe
projectwouldbe$23,000.Thepaybackperiodoftheprojectisclosestto:
A)1.5years
B)2.0years
C)1.4years
D)1.7years
Level:EasyLO:3Ans:C
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49.WomblesCorporationiscontemplatingpurchasingequipmentthatwouldincreasesalesrevenuesby
$478,000peryearandcashoperatingexpensesby$249,000peryear.Theequipmentwouldcost
$738,000andhavea9yearlifewithnosalvagevalue.Theannualdepreciationwouldbe$82,000.The
simplerateofreturnontheinvestmentisclosestto:
A)19.9%
B)30.8%
C)31.0%
D)11.1%
Level:EasyLO:4Ans:A
50.ThemanagementofDukerCorporationisinvestigatingpurchasingequipmentthatwouldincrease
salesrevenuesby$130,000peryearandcashoperatingexpensesby$39,000peryear.Theequipment
wouldcost$328,000andhavean8yearlifewithnosalvagevalue.Thesimplerateofreturnonthe
investmentisclosestto:
A)12.5%
B)27.7%
C)38.5%
D)15.2%
Level:EasyLO:4Ans:D
51.AnexpansionatFidell,Inc.,wouldincreasesalesrevenuesby$75,000peryearandcashoperating
expensesby$38,000peryear.Theinitialinvestmentwouldbeforequipmentthatwouldcost$135,000
andhavea5yearlifewithnosalvagevalue.Theannualdepreciationontheequipmentwouldbe
$27,000.Thesimplerateofreturnontheinvestmentisclosestto:
A)20.0%
B)7.4%
C)27.4%
D)13.3%
Level:EasyLO:4Ans:B
52.MessersmithCorporationisinvestigatingautomatingaprocessbypurchasingamachinefor$688,000
thatwouldhavean8yearusefullifeandnosalvagevalue.Byautomatingtheprocess,thecompany
wouldsave$160,000peryearincashoperatingcosts.Thenewmachinewouldreplacesomeold
equipmentthatwouldbesoldforscrapnow,yielding$19,000.Theannualdepreciationonthenew
machinewouldbe$86,000.Thesimplerateofreturnontheinvestmentisclosestto:
A)23.3%
B)11.1%
C)10.8%
D)12.5%
Level:EasyLO:4Ans:B
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53.ThemanagementofStanforthCorporationisinvestigatingautomatingaprocess.Oldequipment,with
acurrentsalvagevalueof$24,000,wouldbereplacedbyanewmachine.Thenewmachinewouldbe
purchasedfor$516,000andwouldhavea6yearusefullifeandnosalvagevalue.Byautomatingthe
process,thecompanywouldsave$173,000peryearincashoperatingcosts.Thesimplerateofreturnon
theinvestmentisclosestto:
A)17.7%
B)16.9%
C)33.5%
D)16.7%
Level:EasyLO:4Ans:A
Usethefollowingtoanswer5456
OverlandCompanyhasgatheredthefollowingdataonaproposedinvestmentproject:
Thecompanyusesstraightlinedepreciationonallequipment.
54.Thepaybackperiodfortheinvestmentis:
A)0.27years
B)3.75years
C)10.00years
D)2.13years
Level:EasyLO:3Ans:B
55.Thesimplerateofreturnontheinvestmentis:
A)26.67%
B)16.67%
C)36.67%
D)10.00%
56.Thenetpresentvalueofthisinvestmentis:
A)$40,000
B)$3,625
C)$57,831
D)$95,800
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PerkyFoodCorporationproducesandsellscoffeejelly.Perkycurrentlyproducesthejellyusingamanual
operationbutisconsideringthepurchaseofmachinerytoautomateitsoperations.Informationrelatedto
thetwooperationsisasfollows:
Perkysdiscountrateis12%.Perkyusesthestraightlinemethodofdepreciation.
57.Whatisthenetpresentvalueofautomatingoperationsusingtheincrementalcostapproach?
A)$11,940
B)$56,940
C)$(104,106)
D)$112,684
Level:MediumLO:1
ReferTo:12_02Ans:C
58.Whatisthesimplerateofreturnforautomatingoperations?
A)3.8%
B)12.1%
C)14.5%
D)22.9%
59.Whatwillbetheeffectonthenetpresentvalueofthedecisiontoautomateoperationsif60,000jars
insteadof50,000jarsareexpectedtobesoldeachyear?(Assumenochangeincoststructureorselling
price.)
A)noeffect
B)$52,030decrease
C)$63,179increase
D)$115,208increase
Level:HardLO:1Ans:D
TamCompanyisnegotiatingforthepurchaseofequipmentthatwouldcost$100,000,withthe
expectationthat$20,000peryearcouldbesavedincashoperatingcosts.Theequipmentsestimated
usefullifeis10years,withnosalvagevalue,andwouldbedepreciatedbythestraightlinemethod.
Tamsrequiredrateofreturnis12%.
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96
60.Thenetpresentvalueofthisinvestmentis:
A)$5,760
B)$6,440
C)$12,200
D)$13,000
Source:CPA,adapted
Level:EasyLO:1Ans:D
61.Thepaybackperiodofthisinvestmentis:
A)4years
B)1year
C)10years
D)5years
Source:CPA,adapted
Level:EasyLO:3Ans:D
62.Thesimplerateofreturnofthisinvestmentis:
A)8%
B)20%
C)12%
D)10%
Source:CPA,adapted
Level:EasyLO:4Ans:D
EvansCompanyisconsideringrebuildingandsellingusedalternatorsforautomobiles.Thecompany
estimatesthatthenetcashflows(saleslesscashoperatingexpenses)arisingfromtherebuildingandsale
oftheusedalternatorswouldbeasfollows:
Inaddition,EvansCompanywouldneedtopurchaseequipmentcosting$275,000.Theequipmentwould
havea12yearlifeanda$25,000salvagevalue.Thecompanysrequiredrateofreturnis10%.
63.Thepaybackperiodonthisinvestmentis:
A)3.00years
B)2.75years
C)1.50years
D)4.00years
Level:EasyLO:3Ans:B
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64.Thenetpresentvalueoftheprojectisclosestto:
A)$364,090
B)$372,065
C)$339,090
D)$389,090
BaldockInc.isconsideringtheacquisitionofanewmachinethatcosts$420,000andhasausefullifeof5
yearswithnosalvagevalue.Theincrementalnetoperatingincomeandincrementalnetcashflowsthat
wouldbeproducedbythemachineare:
65.Ifthediscountrateis12%,thenetpresentvalueoftheinvestmentisclosestto:
A)$330,000
B)$539,365
C)$119,365
D)$420,000
Source:CMA,adapted
66.Thepaybackperiodofthisinvestmentisclosestto:
A)5.0years
B)3.2years
C)1.9years
D)2.8years
Source:CMA,adapted
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DelleyInc.isconsideringtheacquisitionofequipmentthatcosts$340,000andhasausefullifeof6years
withnosalvagevalue.Theincrementalnetcashflowsthatwouldbegeneratedbytheequipmentare:
67.Ifthediscountrateis17%,thenetpresentvalueoftheinvestmentisclosestto:
A)$45,811
B)$385,811
C)$301,000
D)$117,341
Source:CMA,adapted
Level:EasyLO:1Ans:A
68.Thepaybackperiodofthisinvestment,roundedofftothenearesttenthofayear,isclosestto:
A)3.9years
B)3.6years
C)3.1years
D)5.0years
Source:CMA,adapted
Level:EasyLO:3Ans:C
WestlandCollegehasatelephonesystemthatisinpoorcondition.Thesystemeithercanbeoverhauled
orreplacedwithanewsystem.Thefollowingdatahavebeengatheredconcerningthesetwoalternatives:
WestlandCollegeusesa10%discountrateandthetotalcostapproachtocapitalbudgetinganalysis.The
workingcapitalrequiredunderthenewsystemwouldbereleasedforuseelsewhereattheconclusionof
theproject.Bothalternativesareexpectedtohaveausefullifeofeightyears.
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100
69.Thenetpresentvalueofoverhaulingthepresentsystemis:
A)$(321,084)
B)$(532,516)
C)$(560,536)
D)$(592,516)
Level:HardLO:1Ans:B
70.Thenetpresentvalueofthenewsystemalternativeis:
A)$(483,095)
B)$(583,095)
C)$(596,395)
D)$(536,395)
Level:HardLO:1Ans:D
LambertManufacturinghas$100,000toinvestineitherProjectAorProjectB.Thefollowingdataare
availableontheseprojects:
Bothprojectswillhaveausefullifeof6years.Attheendof6years,theworkingcapitalinvestmentwill
bereleasedforuseelsewhere.Lambertsrequiredrateofreturnis14%.Thecompanyusesthetotalcost
approachtoevaluatingalternatives.
71.ThenetpresentvalueofProjectAis:
A)$51,000
B)$60,120
C)$55,560
D)$94,450
72.ThenetpresentvalueofProjectBis:
A)$90,355
B)$76,115
C)$36,115
D)$54,355
101
CarlsonManufacturinghassomeequipmentthatneedstoberebuiltorreplaced.Thefollowing
informationhasbeengatheredrelativetothisdecision:
Carlsonusesthetotalcostapproachandadiscountrateof12%.Regardlessofwhichoptionischosen,
rebuildorreplace,attheendoffiveyearsCarlsonManufacturingplanstocloseitsdomestic
manufacturingoperationsandtomovetheseoperationstoforeigncountries.
73.Ifthenewequipmentispurchased,thepresentvalueofallcashflowsthatoccurnowis:
A)$(48,000)
B)$(39,000)
C)$(41,000)
D)$(37,000)
Level:EasyLO:1Ans:B
74.Ifthenewequipmentispurchased,thepresentvalueoftheannualcashoperatingcostsassociated
withthisalternativeis:
A)$(28,840)
B)$(19,160)
C)$(14,420)
D)$(36,050)
75.Iftheequipmentisrebuilt,thepresentvalueofallcashflowsthatoccurnowis:
A)$(55,000)
B)$(25,000)
C)$(16,000)
D)$(23,000)
Level:EasyLO:1Ans:B
102
CedarHillHospitalneedstoexpanditsfacilitiesanddesirestoobtainanewbuildingonapieceof
propertyadjacenttoitspresentlocation.TwooptionsareavailabletoCedarHill,asfollows:
Option1:Buytheproperty,erectthebuilding,andinstallthefixturesatatotalcostof$600,000.Thiscost
wouldbepaidoffinfiveinstallments:animmediatepaymentof$200,000,andapaymentof$100,000at
theendofeachofthenextfouryears.Theannualcashoperatingcostsassociatedwiththenewfacilities
areestimatedtobe$12,000peryear.Thenewfacilitieswouldbeoccupiedforthirteenyears,andwould
haveatotalresalevalueof$300,000attheendofthe13yearperiod.
Option2:AleasingcompanywouldbuythepropertyandconstructthenewfacilitiesforCedarHill
whichwouldthenbeleasedbacktoCedarHillatanannualleasecostof$70,000.Theleaseperiodwould
runfor13years,witheachpaymentbeingdueattheBEGINNINGoftheyear.Additionally,the
companywouldrequireanimmediate$10,000securitydeposit,whichwouldbereturnedtoCedarHillat
theendofthe13yearperiod.Finally,CedarHillwouldhavetopaytheannualmaintenancecostofthe
facilities,whichisestimatedtobe$4,000peryear.Therewouldbenoresalevalueattheendofthe13
yearperiodunderthisoption.
Thehospitalusesadiscountrateof14%andthetotalcostapproachtonetpresentvalueanalysisin
evaluatingitsinvestmentdecisions.
76.Underoption1,thepresentvalueofallcashoutflowsassociatedwithbuyingtheproperty,erecting
thebuilding,andinstallingthefixturesisclosestto:
A)$(200,000)
B)$(491,400)
C)$(600,000)
D)$(387,200)
Level:HardLO:1Ans:B
77.Underoption1,thenetpresentvalueofallcashflowsisclosestto:
A)$(456,000)
B)$(600,000)
C)$(300,000)
D)$(507,000)
Level:HardLO:1Ans:D
78.Underoption2,thepresentvalueofalltheannualleasepaymentsof$70,000isclosestto:
A)$(466,200)
B)$(408,900)
C)$(483,700)
D)$(910,000)
Level:HardLO:1Ans:A
79.Underoption2,thepresentvalueofallcashflowsassociatedwithmaintenancecostsisclosestto:
A)$(23,400)
B)$(52,000)
C)$(70,100)
103
D)$(4,000)
Level:HardLO:1Ans:A
104
ClairmontCorporationisconsideringthepurchaseofamachinethatwouldcost$150,000andwouldlast
for5years.Attheendof5years,themachinewouldhaveasalvagevalueof$18,000.Byreducinglabor
andotheroperatingcosts,themachinewouldprovideannualcostsavingsof$37,000.Thecompany
requiresaminimumpretaxreturnof12%onallinvestmentprojects.
80.Thepresentvalueoftheannualcostsavingsof$37,000isclosestto:
A)$133,385
B)$235,070
C)$185,000
D)$20,979
Level:EasyLO:1Ans:A
81.Thenetpresentvalueoftheproposedprojectisclosestto:
A)$6,409
B)$11,295
C)$1,385
D)$16,615
Level:EasyLO:1Ans:A
Reference:12_12
ThemanagementofMashiahCorporationisconsideringthepurchaseofamachinethatwouldcost
othercostsby$102,000peryear.Thecompanyrequiresaminimumpretaxreturnof13%onall
investmentprojects.
82.Thepresentvalueoftheannualcostsavingsof$102,000isclosestto:
A)$849,012
B)$612,000
C)$195,872
D)$407,796
Level:EasyLO:1Ans:D
A)$154,663
B)$322,000
C)$117,796
D)$245,246
Level:EasyLO:1Ans:C
105
Lebert,Inc.,isconsideringthepurchaseofamachinethatwouldcost$380,000andwouldlastfor7
years.Attheendof7years,themachinewouldhaveasalvagevalueof$49,000.Themachinewould
immediately.Allofthisworkingcapitalwouldberecoveredattheendofthelifeofthemachine.The
companyrequiresaminimumpretaxreturnof18%onallinvestmentprojects.
84.Thecombinedpresentvalueoftheworkingcapitalneededatthebeginningoftheprojectandthe
workingcapitalreleasedattheendoftheprojectisclosestto:
A)$16,872
B)$0
C)$4,116
D)$13,111
Level:EasyLO:1Ans:C
A)$1,338
B)$8,849
C)$14,048
D)$2,778
Level:EasyLO:1Ans:D
DubeCorporationisconsideringthefollowingthreeinvestmentprojects:
86.TheprofitabilityindexofinvestmentprojectEisclosestto:
A)0.13
B)1.13
C)0.87
D)0.12
Level:EasyLO:2Ans:A
87.Ranktheprojectsaccordingtotheprofitabilityindex,frommostprofitabletoleastprofitable.
A)F,E,D
B)D,F,E
C)F,D,E
D)E,F,D
106
107
ThemanagementofKenoCorporationisconsideringthreeinvestmentprojectsB,C,andD.ProjectB
wouldrequireaninvestmentof$15,000,ProjectCof$50,000,andProjectDof$89,000.Thepresent
valueofthecashinflowswouldbe$16,350forProjectB,$56,500forProjectC,and$96,120forProject
D.
88.TheprofitabilityindexofinvestmentprojectCisclosestto:
A)0.13
B)0.87
C)0.12
D)1.13
Level:EasyLO:2Ans:A
89.Ranktheprojectsaccordingtotheprofitabilityindex,frommostprofitabletoleastprofitable.
A)B,D,C
B)C,B,D
C)D,C,B
D)D,B,C
Essay
90.Tranter,Inc.,isconsideringaprojectthatwouldhaveatenyearlifeandwouldrequirea$1,500,000
investmentinequipment.Attheendoftenyears,theprojectwouldterminateandtheequipmentwould
havenosalvagevalue.Theprojectwouldprovidenetoperatingincomeeachyearasfollows:
Alloftheaboveitems,exceptfordepreciation,representcashflows.Thecompanysrequiredrateof
returnis12%.
Required:
(a.)Computetheprojectsnetpresentvalue.
(b.)Computetheprojectspaybackperiod.
(c.)Computetheprojectssimplerateofreturn.
Level:MediumLO:1,3,4
108
Ans:
(a.)Sincedepreciationistheonlynoncashitemontheincomestatement,thenetannualcashflowcanbe
computedbyaddingbackdepreciationtonetoperatingincome.
(b.)Theformulaforthepaybackperiodis:
Paybackperiod=Investmentrequired Netannualcashinflow
=$1,500,000 $400,000=3.75years
(c.)Theformulaforthesimplerateofreturnis:
Simplerateofreturn=Netoperatingincome Initialinvestment
=$250,000$1,500,000=16.7%
91.Fiveyearsago,theCityofParanoyaspent$30,000topurchaseacomputerizedradarsystemcalled
W.A.S.T.E.(WatchingAliensSentToEarth).Recently,asalesrepfromW.A.S.T.E.RadarCompany
toldthecitymanageraboutanewandimprovedradarsystemthatcanbepurchasedfor$50,000.Therep
alsotoldthemanagerthatthecompanywouldgivethecity$10,000intradeontheoldsystem.Thenew
systemwilllast10years.Theoldsystemwillalsolastthatlongbutonlyifa$4,000upgradeisdonein5
years.Themanagerassembledthefollowinginformationtouseinthedecisionastowhichsystemis
moredesirable:
Required:
(a.)WhatistheCityofParanoyasnetpresentvalueforthedecisiondescribedabove?Usethetotalcost
approach.
(b.)ShouldtheCityofParanoyapurchasethenewsystemorkeeptheoldsystem?
Level:MediumLO:1
109
Ans:
(a.)
(b.)Keeptheoldsystem;thenetpresentvalueofthecostsundertheoldsystemislowerthanforthenew
system.
92.Thefollowingdataconcernaninvestmentproject:
Theworkingcapitalwillbereleasedforuseelsewhereattheconclusionoftheproject.
Required:
Computetheprojectsnetpresentvalue.
Level:MediumLO:1
Ans:
93.Fiveyearsago,JoeSarverpurchased600sharesof9%,$100parvaluepreferredstockfor$75per
share.Sarverreceiveddividendsonthestockeachyearforfiveyears,andfinallysoldthestockfor$90
110
pershare.Insteadofpurchasingthepreferredstock,Sarvercouldhaveinvestedthefundsinamoney
marketcertificateyieldinga16%rateofreturn.
111
Required:
Determinewhetherornotthepreferredstockprovidedatleastthe16%rateofreturnthatcouldhavebeen
receivedonthemoneymarketcertificate.
Level:HardLO:1
Ans:
No,thestockdidnotprovidea16percentrateofreturn.
94.BigBlueCo.isconsideringthreeinvestmentopportunitieshavingcashflowsasdescribedbelow:
ProjectIwouldrequireanimmediatecashoutlayof$10,000andwouldresultincashsavingsof$3,000
eachyearfor8years.
ProjectIIwouldrequirecashoutlaysof$3,000peryearandwouldprovideacashinflowof$30,000at
theendof8years.
ProjectIIIwouldrequireacashoutlayof$10,000nowandwouldprovideacashinflowof$30,000eight
yearsfromnow.
Required:
IfBigBluehasarequiredrateofreturnof14%,determinewhich,ifany,ofthethreeprojectsis
acceptable.UsetheNPVmethod.
Level:MediumLO:1
Ans:
112
Conclusion:ProjectsIandIIIhavepositivenetpresentvaluesandarethusacceptable.ProjectIIwould
notbeadvisablesinceitsnetpresentvalueisnegative.
113
95.AxillarBeautyProductsCorporationisconsideringtheproductionofanewconditioningshampoo
whichwillrequirethepurchaseofnewmixingmachinery.Themachinerywillcost$375,000,isexpected
tohaveausefullifeof10years,andisexpectedtohaveasalvagevalueof$50,000attheendof10years.
Themachinerywillalsoneeda$35,000overhaulattheendofyear6.A$40,000increaseinworking
capitalwillbeneededforthisinvestmentproject.Theworkingcapitalwillbereleasedattheendofthe
10years.Thenewshampooisexpectedtogeneratenetcashinflowsof$85,000peryearforeachofthe
10years.Axillarsdiscountrateis16%.
Required:
(a.)Whatisthenetpresentvalueofthisinvestmentopportunity?
(b.)Basedonyouranswerto(a)above,shouldAxillargoaheadwiththenewconditioningshampoo?
Level:MediumLO:1
Ans:
(a.)
(b.)Yes,acceptproject.Thenetpresentvalueispositive.
96.LajaraInc.hasprovidedthefollowingdataconcerningaproposedinvestmentproject:
Thecompanyusesadiscountrateof13%.
Required:
Computethenetpresentvalueoftheproject.
Level:EasyLO:1
Ans:
114
115
97.BurbaInc.isconsideringinvestinginaprojectthatwouldrequireaninitialinvestmentof$200,000.
Thelifeoftheprojectwouldbe8years.Theannualnetcashinflowsfromtheprojectwouldbe$60,000.
Thesalvagevalueoftheassetsattheendoftheprojectwouldbe$30,000.Thecompanyusesadiscount
rateof17%.
Required:
Level:EasyLO:1
Ans:
98.GrossettCorporationhasprovidedthefollowingdataconcerningaproposedinvestmentproject:
Thecompanyusesadiscountrateof10%.Theworkingcapitalwouldbereleasedattheendofthe
project.
Required:
Level:EasyLO:1
Ans:
99.WoolfolkCorporationisconsideringinvesting$210,000inaproject.Thelifeoftheprojectwouldbe
9years.Theprojectwouldrequireadditionalworkingcapitalof$46,000,whichwouldbereleasedforuse
elsewhereattheendoftheproject.Theannualnetcashinflowswouldbe$42,000.Thesalvagevalueof
theassetsusedintheprojectwouldbe$32,000.Thecompanyusesadiscountrateof17%.
Required:
Level:EasyLO:1Ans:
116
100.SwaggertyCompanyisconsideringpurchasingamachinethatwouldcost$462,000andhavea
usefullifeof7years.Themachinewouldreducecashoperatingcostsby$115,500peryear.Themachine
wouldhavenosalvagevalue.
Required:
(a.)Computethepaybackperiodforthemachine.
(b.)Computethesimplerateofreturnforthemachine.
Level:EasyLO:3,4
Ans:
(a.)Thepaybackperiodiscomputedasfollows:
Paybackperiod=InvestmentrequiredNetannualcashflow
=$462,000$115,500=4.00years
(b.)Thesimplerateofreturniscomputedasfollows:
Simplerateofreturn=(AnnualcostsavingsAnnualdepreciation)
Initialinvestment
=$(115,500$66,000)$462,000=10.71%
101.AlesiCompanyisconsideringpurchasingamachinethatwouldcost$243,600andhaveausefullife
of8years.Themachinewouldreducecashoperatingcostsby$76,125peryear.Themachinewouldhave
asalvagevalueof$60,900attheendoftheproject.
Required:
(a.)Computethepaybackperiodforthemachine.
(b.)Computethesimplerateofreturnforthemachine.
Level:MediumLO:3,4
Ans:
(a.)Thepaybackperiodiscomputedasfollows:
Paybackperiod=InvestmentrequiredNetannualcashflow
=$243,600$76,125=3.20years
Inthiscasethesalvagevalueplaysnopartinthepaybackperiodsincealloftheinvestmentisrecovered
beforetheendoftheproject.
117
(b.)Thesimplerateofreturniscomputedasfollows:
Simplerateofreturn=(AnnualcostsavingsAnnualdepreciation)
Initialinvestment
=$(76,125$22,838)$243,600=21.88%
102.YeungCorporationisconsideringthepurchaseofamachinethatwouldcost$330,000andwould
lastfor6years.Attheendof6years,themachinewouldhaveasalvagevalueof$33,000.Themachine
wouldreducelaborandothercostsby$86,000peryear.Thecompanyrequiresaminimumpretaxreturn
of12%onallinvestmentprojects.
Required:
Determinethenetpresentvalueoftheproject.Showyourwork!
Level:EasyLO:1
Ans:
103.ThemanagementofGlascoCorporationisconsideringthepurchaseofamachinethatwouldcost
othercostsby$63,000peryear.Thecompanyrequiresaminimumpretaxreturnof18%onallinvestment
projects.
Required:
Level:EasyLO:1
Ans:
118
104.Lovan,Inc.,isconsideringthepurchaseofamachinethatwouldcost$450,000andwouldlastfor8
years,attheendofwhich,themachinewouldhaveasalvagevalueof$63,000.Themachinewould
immediately,allofwhichwouldberecoveredattheendof8years.Thecompanyrequiresaminimum
pretaxreturnof8%onallinvestmentprojects.
Required:
Level:EasyLO:1
Ans:
105.DimpsonCorporationisconsideringthefollowingthreeinvestmentprojects:
Required:
Ranktheinvestmentprojectsusingtheprofitabilityindex.Showyourwork!
Level:EasyLO:2
Ans:
106.ThemanagementofGrayerCorporationisconsideringthefollowingthreeinvestmentprojects:
Theonlycashoutflowsaretheinitialinvestmentsintheprojects.
119
Required:
Ranktheinvestmentprojectsusingtheprofitabilityindex.Showyourwork!
Level:EasyLO:2
Ans:
107.FlamioCorporationisconsideringaprojectthatwouldrequireaninitialinvestmentof$210,000and
wouldlastfor6years.Theincrementalannualrevenuesandexpensesforeachofthe6yearswouldbeas
follows:
Attheendoftheproject,thescrapvalueoftheprojectsassetswouldbe$24,000.
Required:
Determinethepaybackperiodoftheproject.Showyourwork!
Level:EasyLO:3
Ans:
=$186,000 $97,000=1.92years
120
108.ThemanagementofSobusCorporationisconsideringaprojectthatwouldrequireaninitial
investmentof$458,000andwouldlastfor9years.Theannualnetoperatingincomefromtheproject
wouldbe$58,000,includingdepreciationof$48,000.Attheendoftheproject,thescrapvalueofthe
projectsassetswouldbe$26,000.
Required:
Determinethepaybackperiodoftheproject.Showyourwork!
Level:EasyLO:3
Ans:
=$432,000 $106,000=4.08years
109.ShifflerCorporationiscontemplatingpurchasingequipmentthatwouldincreasesalesrevenuesby
$246,000peryearandcashoperatingexpensesby$133,000peryear.Theequipmentwouldcost
$275,000andhavea5yearlifewithnosalvagevalue.Theannualdepreciationwouldbe$55,000.
Required:
Determinethesimplerateofreturnontheinvestmenttothenearesttenthofapercent.Showyourwork!
Level:EasyLO:4
Ans:
Simplerateofreturn=[Incrementalrevenues(Cashoperatingexpenses+Depreciation)]Initial
investment
=[$246,000($133,000+$55,000)] $275,000
=[$58,000] $275,000=21.1%
110.ThemanagementofMoyaCorporationisinvestigatingpurchasingequipmentthatwouldcost
$336,000andhavean8yearlifewithnosalvagevalue.Theequipmentwouldallowanexpansionof
capacitythatwouldincreasesalesrevenuesby$288,000peryearandcashoperatingexpensesby
$164,000peryear.
Required:
Level:EasyLO:4
Ans:
Simplerateofreturn=[Incrementalrevenues(Cashoperatingexpenses+Depreciation)]Initial
investment
=[$288,000($164,000+$42,000)] $336,000
=[$82,000] $336,000=24.4%
121
111.HinckCorporationisinvestigatingautomatingaprocessbypurchasinganewmachinefor$520,000
thatwouldhavean8yearusefullifeandnosalvagevalue.Byautomatingtheprocess,thecompany
wouldsave$134,000peryearincashoperatingcosts.Thecompanyscurrentequipmentwouldbesold
forscrapnow,yielding$22,000.Theannualdepreciationonthenewmachinewouldbe$65,000.
Required:
Level:EasyLO:4
Ans:
Simplerateofreturn=(CostsavingsDepreciation) Initialinvestment
=($134,000$65,000) ($520,000$22,000)
=$69,000 $498,000=13.9%
112.ThemanagementofKleppeCorporationisinvestigatingautomatingaprocessbyreplacingold
equipmentbyanewmachine.Theoldequipmentwouldbesoldforscrapnowfor$19,000.Thenew
machinewouldcost$180,000,wouldhavea9yearusefullife,andwouldhavenosalvagevalue.By
automatingtheprocess,thecompanywouldsave$30,000peryearincashoperatingcosts.
Required:
Level:EasyLO:4
Ans:
Depreciationonthenewmachine=$180,000 9=$20,000
Simplerateofreturn=(CostsavingsDepreciation) Initialinvestment
=($30,000$20,000) ($180,000$19,000)
=$10,000 $161,000=6.2%
122

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Chapter 12

Capital Budgeting Decisions

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