Chapter 15

Income Taxes in Capital Budgeting Decisions

True/False

1. The present value of the tax savings under the optional

F straight-line method will ordinarily be greater than the
Medium present value of the tax savings under the MACRS table method.

2. Depreciation expenses taken on financial reports is relevant

F for capital budgeting decisions since it affects the company's
Medium net income.

3. The reduction in taxes made possible by a depreciation tax

T shield equals the depreciation deduction multiplied by the tax
Medium rate.

4. If a company is operating at a profit, all cash inflows

F associated with an investment project should be multiplied by
Hard one minus the tax rate to be placed on an after-tax basis.

5. Depreciation deductions shield revenues from taxation and

T thereby lower the amount of taxes that a company must pay.
Easy

6. The release of working capital at the end of an investment

F project is a taxable cash inflow.
Medium

7. Not all cash inflows are taxable.

T
Medium

8. If a company operates at a profit, the after-tax cost of a tax-

T deductible cash expense is determined by multiplying the cash
Easy expense by one minus the tax rate.

9. The working capital required at the start of an investment is a

F taxable cash outflow.
Medium

10. To determine the effect of income taxes on a project, multiply

F the net present value of the project by one minus the tax rate.
Hard

ManagerialAccounting,9/e 40
11. Due to the half-year convention, assets in the 3-year property
T class are depreciated over four years.
Medium

12. When a company invests in equipment, it gets to immediately

F expense the cost of the equipment on the company's tax reports.
Easy

13. If an asset is in the MACRS 3-year property class, but has an

F estimated useful life of six years, it should be depreciated
Medium over six years on tax reports.

14. An asset that is in the MACRS 5-year property class would be

T depreciated over six years.
Medium

15. Under the MACRS system, any salvage value realized when an
T asset is sold is taxed if the asset has exceeded the useful
Hard life assumed in its property class.

Multiple Choice

16. Depreciation expense reduces income taxes by an amount equal

B to:
Easy a. one minus the tax rate times the amount of deprecation.
CMA b. the tax rate times the amount of depreciation.
adapted c. the amount of the depreciation.
d. one minus the amount of depreciation.

17. The calculation of the net present value of an investment

C project requires that the depreciation tax shield be included
Medium at:
a. the amount of the depreciation with no adjustment for taxes.
b. the amount of the depreciation times one minus the tax rate.
c. the amount of the depreciation times the tax rate.
d. zero, since depreciation is not relevant to the calculation
of net present value.

18. In a capital budgeting decision, the use of MACRS tables as

A compared to the optional straight-line method will result in:
Medium a. equal total depreciation for both methods.
CMA b. more total depreciation for the MACRS tables method.
adapted c. more total depreciation for the optional straight-line
method.
d. less depreciation for the MACRS tables method in the early
years of asset life.

41 ManagerialAccounting,9/e
19. The use of the MACRS tables instead of the optional straight-
C line method of depreciation has the effect of:
Medium a. raising the hurdle rate necessary to justify the project.
CMA b. decreasing the net present value of the project.
adapted c. increasing the present value of the depreciation tax shield.
d. increasing the cash outflows at the beginning of the
project.

20. Which of the following is correct?

B a. Use of the MACRS tables requires that salvage value be
Medium deducted in computing depreciation deductions.
b. Use of the optional straight-line method requires that
salvage value not be considered in computing depreciation
deductions.
c. The use of both MACRS tables and the optional straight-line
method requires that salvage value be deducted in computing
depreciation deductions.
d. None of the above are true.

21. When computing depreciation deductions under the MACRS system,

C taxpayers must:
Medium a. use the half-year convention under which taxpayers are
allowed to take only a half year's depreciation in the first
year of an asset's life.
b. use the half-year convention under which taxpayers are
allowed to take only a half year's depreciation in the last
year of an asset's life.
c. use the half-year convention under which taxpayers are
allowed to take only a half year's depreciation in the first
and last years of an asset's life.
d. calculate depreciation for partial periods using the exact
number of days if the asset is acquired at some time other
than the beginning or end of the fiscal year.

22. Which of the following would decrease the net present value of
D a project?
Hard a. A decrease in the income tax rate.
CMA b. A decrease in the initial investment.
adapted c. An increase in the useful life of the project.
d. An increase in the discount rate.

23. A piece of equipment is in the MACRS 5-year property class and

D is being depreciated using the MACRS tables. The tax rate is
Hard 35%. If the
tax savings from the depreciation tax shield in Year 3 is
$4,500, then the original cost of the equipment was:
a. $36,058.
b. $6,923.
c. $12,857.
d. $66,964.

ManagerialAccounting,9/e 42
24. A company anticipates a taxable cash receipt of $50,000 in year
A 4 of a project. The company's tax rate is 30% and its discount
Medium rate is 12%. The present value of this future cash flow is
closest to:
a. $22,243.
b. $35,000.
c. $9,533.
d. $15,000.

25. A company anticipates a taxable cash receipt of $20,000 in year

D 3 of a project. The company's tax rate is 30% and its discount
Medium rate is 8%. The present value of this future cash flow is
closest to:
a. $6,000.
b. $4,763.
c. $14,000.
d. $11,114.

26. A company anticipates a taxable cash receipt of $50,000 in year

C 3 of a project. The company's tax rate is 30% and its discount
Medium rate is 14%. The present value of this future cash flow is
closest to:
a. $10,125.
b. $35,000.
c. $23,624.
d. $15,000.

27. A company anticipates a taxable cash expense of $10,000 in year

D 2 of a project. The company's tax rate is 30% and its discount
Medium rate is 8%. The present value of this future cash flow is
closest to:
a. ($3,000).
b. ($2,572).
c. ($7,000).
d. ($6,001).

28. A company anticipates a taxable cash expense of $40,000 in year

A 2 of a project. The company's tax rate is 30% and its discount
Medium rate is 10%. The present value of this future cash flow is
closest to:
a. ($23,140).
b. ($9,917).
c. ($12,000).
d. ($28,000).

43 ManagerialAccounting,9/e
29. A company anticipates a taxable cash expense of $60,000 in year
C 2 of a project. The company's tax rate is 30% and its discount
Medium rate is 14%. The present value of this future cash flow is
closest to:
a. ($13,850).
b. ($42,000).
c. ($32,318).
d. ($18,000).

30. A company anticipates a depreciation deduction of $20,000 in

D year 2 of a project. The company's tax rate is 30% and its
Medium discount rate is 12%. The present value of the depreciation tax
shield resulting from this deduction is closest to:
a. $11,161.
b. $14,000.
c. $6,000.
d. $4,783.

31. A company anticipates a depreciation deduction of $30,000 in

C year 3 of a project. The company's tax rate is 30% and its
Medium discount rate is 12%. The present value of the depreciation tax
shield resulting from this deduction is closest to:
a. $21,000.
b. $14,947.
c. $6,406.
d. $9,000.

32. A company anticipates a depreciation deduction of $70,000 in

A year 2 of a project. The company's tax rate is 30% and its
Medium discount rate is 14%. The present value of the depreciation tax
shield resulting from this deduction is closest to:
a. $16,159.
b. $49,000.
c. $21,000.
d. $37,704.

33. A company needs an increase in working capital of $20,000 in

B project that will last 4 years. The company's tax rate is 30%
Medium and its discount rate is 10%. The present value of the release
of the working capital at the end of the project is closest to:
a. $6,000.
b. $13,660.
c. $9,562.
d. $14,000.

ManagerialAccounting,9/e 44
34. A company needs an increase in working capital of $50,000 in
A project that will last 4 years. The company's tax rate is 30%
Medium and its discount rate is 8%. The present value of the release
of the working capital at the end of the project is closest to:
a. $36,751.
b. $15,000.
c. $25,726.
d. $35,000.

35. A company needs an increase in working capital of $70,000 in

D project that will last 3 years. The company's tax rate is 30%
Medium and its discount rate is 8%. The present value of the release
of the working capital at the end of the project is closest to:
a. $49,000.
b. $21,000.
c. $38,898.
d. $55,568.

36. Eyring Industries has a truck purchased seven years ago at a

B cost of $6,000. At the time of purchase, the ultimate salvage
Hard value was estimated at $500, but salvage value was ignored in
depreciation deductions. The truck is now fully depreciated.
Assuming a tax rate of 40%, if the truck is sold for $500, the
after-tax cash inflow for capital budgeting purposes will be:
a. $500.
b. $300.
c. $200.
d. $100.

37. Suppose a machine costs $20,000 now, has an expected life of

B eight years, and will require a $7,000 overhaul at the end of
Easy the third year. If the tax rate is 40%, then the after-tax cost
of this overhaul would be:
a. $12,000.
b. $4,200.
c. $8,000.
d. $2,800.

38. Suppose a machine that costs $80,000 has a useful life of 10

B years. Also suppose that depreciation on the machine is $8,000
Easy for tax purposes in year 4. The tax rate is 40%. The tax
savings from the depreciation tax shield in year 4 would be:
a. $4,800 inflow.
b. $3,200 inflow.
c. $4,800 outflow.
d. $3,200 outflow.

45 ManagerialAccounting,9/e
39. Consider a machine which costs $115,000 now and which has a
A useful life of seven years. This machine will require a major
Hard overhaul at the end of the fourth year which will cost "X"
dollars. If the tax rate is 40%, and if the after-tax cash
outflow for this overhaul is $3,600, then the amount of "X" in
dollars is:
a. $6,000.
b. $9,000.
c. $2,160.
d. $1,440.

40. Last year the sales at Jersey Company were $200,000 and were
D all cash sales. The expenses at Jersey were $125,000 and were
Easy all cash expenses. The tax rate was 30%. The after-tax net cash
inflow at Jersey last year from these operations was:
a. $37,500.
b. $60,000.
c. $22,500.
d. $52,500.

41. Last year a firm had taxable cash receipts of $800,000 and the
C tax rate was 30%. The after-tax net cash inflow from these
Easy receipts was
a. $800,000.
b. $640,000.
c. $560,000.
d. $240,000.

42. A company had tax-deductible cash expenses of $650,000 last

B year and the tax rate was 30%. The after-tax net cash outflow
Easy for these expenses was:
a. $195,000.
b. $455,000.
c. $650,000.
d. $390,000.

43. At the Bartholomew Company last year all sales were for cash
D and all expenses were paid in cash. The tax rate was 30%. If
Medium the after-tax net cash inflow from these operations last year
was $10,500, and if the total before tax cash expenses were
$35,000, then the total before-tax cash sales must have been:
a. $65,000.
b. $60,000.
c. $45,000.
d. $50,000.

ManagerialAccounting,9/e 46
44. Superstrut is considering replacing an old press that cost
B $80,000 six years ago with a new one that would cost $245,000.
Medium The old press has a net book value of $15,000 and could be sold
CMA for $5,000. The increased production of the new press would
adapted require an investment in additional working capital of $6,000.
The company's tax rate is 40%. Superstrut's net investment now
in the project would be:
a. $256,000.
b. $242,000.
c. $250,000.
d. $245,000.

45. Kane Company is in the process of purchasing a new machine for

A its production line. It is near the end of the year, and the
Medium machine is being offered at a special discount if purchased
before the end of the year. Kane has determined that the
depreciation deduction for tax purposes on the new machine for
the year of purchase would be $13,000. The tax rate is 30%. If
Kane purchases the machine and reports a positive net income
for the year, then the tax savings from the deprecation tax
shield related to this machine for the year of purchase would
be:
a. $3,900.
b. $9,100.
c. $13,000.
d. $0.

46. Last year the sales at Seidelman Company were $700,000 and were
C all cash sales. The company's expenses were $450,000 and were
Easy all cash expenses. The tax rate was 35%. The after-tax net cash
inflow at Seidelman last year was:
a. $700,000.
b. $250,000.
c. $162,500.
d. $87,500.

47 ManagerialAccounting,9/e
Reference: 15-1
The Lorenz Company is deciding whether or not it should replace an old piece
of equipment with new equipment that is more efficient. The following data
relate to this investment decision:

Cost of the new equipment now .............. $120,000

Annual cash operating costs of
the new equipment ........................ $ 50,000
Useful life of the new equipment............ 7 years
Salvage value of the new equipment
in seven years ........................... $ 8,000
Book value of the old equipment now ........ $ 40,000
Salvage value of the old equipment now ..... $ 30,000
Salvage value of the old equipment in
seven years .............................. $ 4,000
Original cost of the old equipment three
years ago ................................ $ 80,000
Annual cash operating costs of the
old equipment ............................ $ 70,000
Overhaul of the old equipment needed at
the end of four years .................... $15,000

The old equipment is in the MACRS 5-year property class and is being
depreciated by the optional straight-line method, but this equipment will
last for seven more years. The new equipment is also in the MACRS 5-year
property class and will be depreciated using MACRS tables. The tax rate is
30% and the company's after-tax cost of capital is 12%. The following
questions are based on the incremental-cost approach to the net present
value method. All questions should be answered from point of view of
replacing the old equipment with the new equipment.

47. The present value of the net annual savings in cash operating
A costs (for all years) in favor or the new equipment is closest
Medium to:
Refer To: a. $63,896.
15-1 b. $91,280.
c. $159,740.
d. $223,636.

48. The present value of the overhaul of the old equipment that is
B avoided is closest to:
Easy a. $15,000.
Refer To: b. $6,678.
15-1 c. $10,500.
d. $9,540.

49. The present value of the tax savings at the end of one year
D from the loss on the sale of the old equipment is closest to:
Medium a. $10,000.
Refer To: b. $3,000.
15-1 c. $7,000.
d. $2,679.

ManagerialAccounting,9/e 48
50. The present value of the difference in tax savings between the
C two pieces of equipment (for all years) arising from the
Hard depreciation tax shield in favor of the new equipment is
Refer To: closest to:
15-1 a. $24,000.
b. $26,571.
c. $16,751.
d. $12,912.

Reference: 15-2
The Moon Company is contemplating the purchase of a new machine to replace
an old machine. The following data are available concerning this investment
possibility:

New machine:
Purchase price now ............................. $50,000
Annual cash operating costs .................... $20,000
Useful life .................................... 7 years
Salvage value at the end of seven years ........ $ 3,000
Old machine:
Original purchase price three years ago ........ $40,000
Book value now ................................. $20,000
Annual cash operating costs .................... $30,000
Salvage value at the end of seven years ........ $ 2,000
Overhaul needed four years from now ............ $ 7,000
Salvage value of the machine now ............... $20,000

The machine is in the MACRS 5-year property class and would be depreciated
using the MACRS tables. The old machine is also in the 5-year property class
and is being depreciated by the optional straight-line method. However, this
old machine could last seven more years if overhauled in four years. The
company requires a 12% after-tax return on all equipment purchases, and the
tax rate is 30%. The following questions are based on the total-cost
approach to the net present value method:

51. From the point of view of buying the new machine, the present
A value of the salvage to be received in seven years is closest
Medium to:
Refer To: a. $949.
15-2 b. $2,100.
c. $1,356.
d. $3,000.

52. From the point of view of buying the new machine, the present
D value of the annual cash operating costs (for all years) is
Easy closest to:
Refer To: a. $72,435.
15-2 b. $(72,435).
c. $(95,844).
d. $(63,896).

49 ManagerialAccounting,9/e
53. From the point of view of buying the new machine, the present
C value of the tax savings (for all years) arising from the
Hard depreciation tax shield) is closest to:
Refer To: a. $15,183.
15-2 b. $12,400.
c. $11,071.
d. $10,630.

54. From the point of view of keeping the old machine, the present
D value of the overhaul needed at the end of Year 4 is closest
Easy to:
Refer To: a. $(4,900).
15-2 b. $(5,675).
c. $(7,000).
d. $(3,116).

55. From the point of view of keeping the old machine, the present
B value of the tax savings (for all years) arising from the
Hard depreciation tax shield is closest to:
Refer To: a. $6,000.
15-2 b. $4,910.
c. $15,000.
d. $16,368.

Reference: 15-3
Maxwell Company purchased a new machine January 1 of Year 1. Data relating
to the machine are as follows:

Cost of machine ..... $180,000

Salvage value ....... 30,000
Useful life ......... 8 years

This machine is in the MACRS 5-year property class. Maxwell uses a 10%
discount rate in capital budgeting analysis. The companys tax rate is 30%.

56. If Maxwell uses the MACRS tables, what will be the present
D value of the depreciation tax shield recorded in Year 2 (to the
Medium nearest dollar)?
Refer To: a. $27,754.
15-3 b. $11,894.
c. $33,304.
d. $14,273.

57. If Maxwell uses the optional straight-line method, what will be

A the present value of the depreciation tax shield recorded in
Medium Year 4?
Refer To: a. $7,376.
15-3 b. $6,147.
c. $14,343.
d. $17,212.

ManagerialAccounting,9/e 50
Reference: 15-4
Shields Company is considering the purchase of a new computer to replace an
old computer. The new computer will have a useful life of six years with a
salvage value of $4,000. The computer will be depreciated using the MACRS
tables, and it belongs in the MACRS 5-year property class. The tax rate is
35%, and the company's after-tax cost of capital is 10%. The new computer
will provide annual savings in cash operating costs (before taxes) of
$15,000. The new computer would cost $45,000. The old fully depreciated
computer it would replace could be sold now for a salvage value of $4,000.
The new computer requires a $3,000 cash investment in working capital which
will be released at the end of six years for use elsewhere.

58. The present value of the after-tax cash flow from the salvage
C received on the sale of the old computer would be:
Medium a. $4,000.
Refer To: b. $1,400.
15-4 c. $2,600.
d. $0.

59. The present value of the tax savings (for all years) resulting
A from the depreciation tax shield is (rounded to the nearest
Hard dollar):
Refer To: a. $12,174.
15-4 b. $22,610.
c. $34,785.
d. $45,000.

60. The present value of the after-tax annual savings in cash

A operating costs (for all years) is:
Medium a. $42,461.
Refer To: b. $22,864.
15-4 c. $65,325.
d. $36,962.

61. The present value of the after-tax net cash flows occurring
D during Year 2 (to the nearest dollar) is:
Hard a. $19,948.
Refer To: b. $16,231.
15-4 c. $8,500.
d. $12,217.

62. The present value of the after-tax net cash flows (all cash
B inflows less all cash outflows) occurring during Year 6 (to the
Hard nearest dollar) is:
Refer To: a. $7,480.
15-4 b. $9,172.
c. $7,706.
d. $8,657.

51 ManagerialAccounting,9/e
63. A piece of equipment is in the MACRS 5-year property class and
A is being depreciated by the optional straight-line method. The
Hard tax rate is 35%. If the tax savings from the depreciation tax
Refer To: shield on this equipment is $3,500 in Year 3, then the original
15-4 cost of this equipment was:
a. $50,000.
b. $17,500.
c. $21,000.
d. $52,083.

Reference: 15-5
The Fargo Company is considering a new machine to replace an old machine.
The following data are available:

Annual cash operating cost savings from the

new machine ................................ $ 60,000
Cost of the new machine ....................... 150,000
Salvage value of the new machine in 9 years ... 20,000
Salvage value of the old machine now .......... 15,000
Useful life of the new machine ................ 9 years
Income tax rate ............................... 40%
After-tax cost of capital ..................... 16%

The new machine is in the MACRS 5-year property class. The company computes
depreciation for tax purposes using MACRS tables. The old machine has been
fully depreciated for tax purposes. Each of the following questions is
independent:

64. The present value of the tax savings (for all years) arising
D from the depreciation tax shield provided by the new machine is
Hard closest to:
Refer To: a. $60,000.
15-5 b. $96,488.
c. $101,295.
d. $40,518.

65. The present value of the after-tax cash inflows (for all years)
A due to the annual cost savings from the new machine is closest
Medium to:
Refer To: a. $165,852.
15-5 b. $276,420.
c. $117,864.
d. $540,000.

66. The present value of the cash flow arising from the salvage
C value of the new machine is closest to:
Medium a. $5,712.
Refer To: b. $2,104.
15-5 c. $3,156.
d. $5,260.

ManagerialAccounting,9/e 52
67. Consider only the cash flows which will occur now. The present
D value of these cash flows is:
Medium a. -$150,000.
Refer To: b. -$135,000.
15-5 c. -$201,000.
d. -$141,000.

Reference: 15-6
The Smith Lumber Company is considering cutting trees on a plot of land to
which it has cutting rights. The following data are available:

Investment required now in new equipment ........ $300,000

Working capital investment required ............. 40,000
Overhaul of equipment needed in 2 years ......... 70,000
Net annual cash inflow from sale of logs ........ 90,000
Cash cost to reseed the land in 4 years ......... 50,000
Salvage value of the equipment in 4 years ....... 20,000
Income tax rate ................................. 40%
After-tax cost of capital ....................... 16%

The equipment would be in the MACRS 3-year property class, and its cost
would be depreciated using the MACRS tables. This investment project would
end with the reseeding of the land in four years.

68. The present value of the annual cash inflows (in total) from
B the sale of logs is closest to:
Medium a. $251,820.
Refer To: b. $151,092.
15-6 c. $243,198.
d. $100,728.

69. The present value of the tax savings (in total) arising from
A the depreciation tax shield provided by the equipment is
Hard closest to:
Refer To: a. $90,420.
15-6 b. $26,050.
c. $131,917.
d. $220,503.

70. Consider only the cash flows which occur during the fourth
C year. The net present value of the cash flows that occur during
Hard the fourth year (ignoring the depreciation tax shield) is
Refer To: closest to:
15-6 a. $76,000.
b. $22,080.
c. $41,952.
d. $13,248.

53 ManagerialAccounting,9/e
Reference: 15-7
The Elwood Express Company needs a new piece of equipment in order to fill a
contract that it has just signed with the US Army. This equipment will have
a useful life of seven years. It will be depreciated using the MACRS tables,
and it belongs in the MACRS 5-year property class. The new equipment has a
cash purchase cost of $400,000; however, an old, fully depreciated piece of
equipment would be sold now for a salvage value of $25,000. At the end of
seven years, the new equipment will have a salvage value of $30,000. The net
annual cash operating inflows from the contract will be $100,000. The tax
rate is 30%, and the company's after-tax cost of capital is 14%.

71. The present value of the net annual after-tax cash operating
B inflows (for all years) is closest to:
Medium a. $428,800.
Refer To: b. $300,160.
15-7 c. $128,640.
d. $259,780.

72. The present value of the tax savings (for all years) resulting
A from the depreciation tax shield is closest to:
Hard a. $84,635.
Refer To: b. $282,117.
15-7 c. $450,000.
d. $420,000.

73. The present value of the net cash flows (all cash inflows less
D all cash outflows) occurring during year 7 is closest to:
Medium a. $21,000.
Refer To: b. $8,400.
15-7 c. $91,000.
d. $36,400.

74. The present value of the net cash flows (all cash inflows less
C all cash outflows including the depreciation tax shield)
Medium occurring during year 3 is closest to:
Refer To: a. $93,040.
15-7 b. $23,040.
c. $62,802.
d. $15,552.

ManagerialAccounting,9/e 54
Reference: 15-8
Simmons Company is considering two investment projects, A and B. The
following data are available:

Project A Project B
Investment in delivery
trucks now .............. $120,000 --
Investment in working
capital now ............. -- $100,000
Net annual operating cash
inflows .................. 18,000 16,000
Life of the project ........ 7 years 7 years

The delivery trucks will have a total salvage value of $10,000 at the end of
seven years; these trucks are in the 5-year MACRS property class and will be
depreciated by the optional straight-line method. At the end of seven years
the working capital will be released for use elsewhere. The income tax rate
is 30% and Simmons' after-tax cost of capital is 12%.

75. The present value of the after-tax net annual operating cash
C inflows of Project A is closest to:
Medium a. $51,117.
Refer To: b. $82,152.
15-8 c. $57,506.
d. $73,024.

76. The present value of the tax savings (for all years) due to the
D depreciation tax shield for Project A is closest to:
Hard a. $85,237.
Refer To: b. $25,776.
15-8 c. $81,888.
d. $24,566.

Reference: 15-9
Lee Company is considering replacing an old delivery van with a new van. The
following data relate to this investment decision:

Cost of the new van now ................................ $20,000

Annual cash operating costs of the new van ............. $ 7,000
Useful life of the new van ............................. 6 years
Salvage value of the new van in six years .............. $ 3,500
Original cost of the old van two years ago ............. $17,000
Book value of the old van now .......................... $ 5,000
Salvage value of the old van now ....................... $ 3,200
Salvage value of the old van in six years .............. $ 500
Annual cash operating costs of the old van ............. $ 9,000
Overhaul of the old van needed three years from now .... $ 6,500

The old van is in the MACRS 5-year property class and is being depreciated
by the optional straight-line method, but this van will last for six more
years. The new van also is in the MACRS 5-year property class and will be
depreciated using the MACRS tables. The tax rate is 40% and the company's
after-tax cost of capital is 12%. The following questions are based on the
incremental cost approach to the net present value method. All questions
should be answered from the point of view of replacing the old van with the
new van.

55 ManagerialAccounting,9/e
77. The net incremental outlay for the purchase of the new van is:
D a. $20,000.
Medium b. $13,300.
Refer To: c. $23,200.
15-9 d. $16,800.

78. The present value of the overhaul of the old van that is
C avoided is:
Medium a. $4,628.
Refer To: b. $6,500.
15-9 c. $2,777.
d. $1,851.

79. The present value of the after-tax net savings in cash

A operating costs (for all years) is:
Medium a. $4,933.
Refer To: b. $3,289.
15-9 c. $17,266.
d. $8,222.

Essay

80. Vernal Company has been offered a 7-year contract to supply a

Hard part for the military. After careful study, the company has
developed the following estimated data relating to the
contract:

Cost of equipment needed ........................ $300,000

Working capital needed to carry inventories ..... 50,000
Annual net cash inflow .......................... 90,000
Salvage value of equipment ...................... 10,000

The equipment above would be in the MACRS 5-year property

class. 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.

ManagerialAccounting,9/e 56
 Answer:
10% Present
Years Amount Factor Value
Cost of equipment needed .... Now $(300,000) 1.000 $(300,000)
Working capital needed ...... Now ( 50,000) 1.000 ( 50,000)
Net annual cash inflows
$90,000 x (1-0.30) ........ 1-7 63,000 4.868 306,684
Depreciation: Income tax savings
$300,000 x 0.200 x .3 ..... 1 18,000 0.902 16,362
$300,000 x 0.320 x .3 ..... 2 28,800 0.826 23,789
$300,000 x 0.192 x .3 ..... 3 17,200 0.751 12,977
$300,000 x 0.115 x .3 ..... 4 10,350 0.683 7,069
$300,000 x 0.115 x .3 ..... 5 10,350 0.621 6,427
$300,000 x 0.058 x .3 ..... 6 5,220 0.564 2,944
Salvage value
$10,000 x (1-0.30) ........ 7 7,000 0.513 3,591
Working capital released .... 7 50,000 0.513 25,650
Net present value ........... $ 55,493

The contract should be accepted, since the project has a positive

net present value.

81. FM Company has been offered a 7-year contract to supply a part

Hard to a major aircraft manufacturer. After careful study, the
company has developed the following data relating to the
contract:

Cost of equipment needed.............................. $400,000

Working capital needed to carry inventories........... 60,000
Annual before-tax cash receipts from delivery of parts,
less related cash operating costs................... 97,000
Salvage value of equipment at termination of the
contract............................................ 12,000

The equipment would be in the MACRS 5-year property class. The

contract is not expected to be extended beyond the initial
contract period. The company's cost of capital is 10% and the
tax rate is 35%.

Required:

Use net present value analysis to determine if the contract should

be accepted. Round all computations to the nearest dollar.

57 ManagerialAccounting,9/e
 Answer:

Tax After-tax 10% Present

Year Cash Flow Effect Cash Flow Factor _Value
Cost of
equipment .. 0 $(400,000) - $(400,000) 1.000
$(400,000)
Working capital
needed ..... 0 (60,000) - (60,000) 1.000
(60,000)
Annual savings 1-7 97,000 1-0.35 63,050 4.868
306,927
Depreciation:
400,000 x 0.200 1 80,000 0.35 28,000 0.909
25,452
400,000 x 0.320 2 128,000 0.35 44,800 0.826
37,005
400,000 x 0.192 3 76,800 0.35 26,880 0.751
20,187
400,000 x 0.115 4 46,000 0.35 16,100 0.683
10,996
400,000 x 0.115 5 46,000 0.35 16,100 0.621
9,998
400,000 x 0.058 6 23,200 0.35 8,120 0.564
4,580
Salvage ....... 7 12,000 1-0.35 7,800 0.513
4,001
Working capital
released .... 7 60,000 - 60,000 0.513
30,780
Net present value
$(10,074)

The contract should not be accepted as the project has a negative

net present value.

82. Anaconda Mining Company owns the mining rights to several

Hard tracts of land in which copper ore has been found. The amount
of ore on some of the tracts is low-grade, and the company is
unsure whether it would be profitable to extract and sell the
ore these tracts contain. One such tract is the Elton tract, on
which the following information has been gathered:

Investment in equipment ............................ $600,000

Working capital investment ......................... 85,000
Annual cash receipts from sale of ore, net of
related cash operating expenses (before taxes) ... 110,000
Cost of restoring land at the completion of
mining activities ................................ 70,000

The ore body in the Elton tract will be exhausted after 10

years of mining. The equipment can be sold for 15% of its
original cost when extraction is completed. The company uses
the MACRS tables in computing depreciation deductions. The
equipment related to this project is in the MACRS 7-year
property class. The tax rate is 35%, and the company's after-
tax cost of capital is 10%.

ManagerialAccounting,9/e 58
 Required:

Compute the net present value of the Elton tract (round all dollar
amounts to the nearest whole dollar) and make a recommendation
regarding the viability of this investment.

Answer:

Tax After-tax 10% Present

Year Cash Flow Effect Cash Flow Factor _Value

Cost of
equipment ... 0 $(600,000) - $(600,000) 1.000
$(600,000)
Working capital
needed ...... 0 (85,000) - (85,000) 1.000
(85,000)
Net annual cash
receipts .... 1-10 110,000 1-0.35 71,500 6.145
439,368
Depreciation:
600,000 x 0.143 1 85,800 0.35 30,030 0.909
27,297
600,000 x 0.245 2 147,000 0.35 51,450 0.826
42,497
600,000 x 0.175 3 105,000 0.35 36,750 0.751
27,599
600,000 x 0.125 4 75,000 0.35 26,250 0.683
17,929
600,000 x 0.089 5 53,400 0.35 18,690 0.621
11,607
600,000 x 0.089 6 53,400 0.35 18,690 0.564
10,541
600,000 x 0.089 7 53,400 0.35 18,690 0.513
9,588
600,000 x 0.045 8 27,000 0.35 9,450 0.467
4,413
Cost of restoring
land ........ 10 (70,000) 1-0.35 45,500 0.386
(17,563)
Salvage (15% of
$600,000) ... 10 90,000 1-0.35 58,500 0.386
22,581
Working capital
released .... 10 85,000 - 85,000 0.386
32,810
Net present value $
(56,333)

The project should not be undertaken as the net present value is

59 ManagerialAccounting,9/e
 negative.

83. Roy Company is trying to decide whether to invest in one of two

Hard projects, X or Z. Associated data for each investment project
follow:

Project
X Z
Cost of equipment ..... $90,000 $140,000
Useful life ........... 6 years 9 years
Annual net cash inflow $25,000 $ 30,000
Salvage value ......... $ 8,000 $ 12,000

The equipment for each project is in the MACRS 5-year property

class. Roy uses the optional straight-line method for
calculating depreciation for tax purposes. The tax rate is 30%.
Roy's after-tax cost of capital is 12%.

Required:

a. Compute the net present value of each project and indicate

which appears preferable in terms of net present value.

b. Compute the profitability index for each project, and

indicate which project would be preferable using this
investment criterion.

Answer:
a. The net present values of the projects are computed below:

Cash Tax After-tax 12% Present

Year Flow Effect Cash Flow Factor Value
Project X:
Cost of
equipment .. 0 $(90,000) -- $(90,000) 1.000 $(90,000)
Annual Savings 1-6 25,000 1-.30 17,500 4.111 71,943
Depreciation:
$90,000 x 0.1 1 9,000 .30 2,700 0.893 2,411
$90,000 x 0.2 2 18,000 .30 5,400 0.797 4,304
$90,000 x 0.2 3 18,000 .30 5,400 0.712 3,845
$90,000 x 0.2 4 18,000 .30 5,400 0.636 3,434
$90,000 x 0.2 5 18,000 .30 5,400 0.567 3,062
$90,000 x 0.1 6 9,000 .30 2,700 0.507 1,369
Salvage ...... 6 8,000 1-.30 5,600 0.507 2,839
Net present value $3,207

Project Z:
Cost of
equipment .. 0 $(140,000) -- $(140,000) 1.000 $(140,000)
Annual savings 1-9 30,000 1-.30 21,000 5.328 111,888
Depreciation:
$140,000 x 0.1 1 14,000 .30 4,200 0.893 3,751
$140,000 x 0.2 2 28,000 .30 8,400 0.797 6,695
$140,000 x 0.2 3 28,000 .30 8,400 0.712 5,981

ManagerialAccounting,9/e 60
 $140,000 x 0.2 4 28,000 .30 8,400 0.636 5,342
$140,000 x 0.2 5 28,000 .30 8,400 0.567 4,763
$140,000 x 0.1 6 14,000 .30 4,200 0.507 2,129
Salvage ...... 9 12,000 1-.30 8,400 0.361 3,032
Net present value $3,581

Project Z would be preferable to Project X using the net present

value measure.

b.
Profitability index = Present value of cash inflows Investment

For Project X : Profitability index = $93,207 $90,000

= 1.0356

For Project Z : Profitability index = $143,581 $140,000

= 1.0256

Thus, Project X is preferred using the profitability index.

61 ManagerialAccounting,9/e
84. Snyder Company is trying to decide whether to invest in one of
Hard two projects, A or B. Data for each investment project follow:

Project
A B
Cost of equipment........................ $100,000 $150,000
Useful life.............................. 6 years 6 years
Estimated net annual cash inflow......... $ 30,000 $ 44,000
Salvage value at the end of useful life.. $ 9,000 $ 14,000

The equipment for each project is in the MACRS 5-year property

class. Snyder Company uses the optional straight-line method
for calculating depreciation. The tax rate is 35%. Snyder's
cost of capital is 12%.

Required:

a. Compute the net present value of each project and indicate

which project appears preferable in terms of net present
value. Round all computations to the nearest dollar.
b. Compute the profitability index for each project, and
indicate which project would be preferable using this
investment criterion.

Answer:

a.
Project A:
Tax After-tax 12% Present
Year Cash Flow Effect Cash Flow Factor _Value
Cost of
equipment 0 $(100,000) - $(100,000) 1.000
$(100,000)
Annual
savings ... 1-6 30,000 1-0.35 19,500 4.111
80,165
Depreciation:
100,000 x 0.1 1 10,000 0.35 3,500 0.893
3,126
100,000 x 0.2 2 20,000 0.35 7,000 0.797
5,579
100,000 x 0.2 3 20,000 0.35 7,000 0.712
4,984
100,000 x 0.2 4 20,000 0.35 7,000 0.636
4,452
100,000 x 0.2 5 20,000 0.35 7,000 0.567
3,969
100,000 x 0.1 6 10,000 0.35 3,500 0.507
1,775
Salvage ..... 6 9,000 1-0.35 5,850 0.507
2,966
Net present value $
7,016

ManagerialAccounting,9/e 62
 Project B:

Tax After-tax 12% Present

Year Cash Flow Effect Cash Flow Factor _Value
Cost of
equipment 0 $(150,000) - $(150,000) 1.000
$(150,000)
Annual
savings ... 1-6 44,000 1-0.35 28,600 4.111
117,575
Depreciation:
150,000 x 0.1 1 15,000 0.35 5,250 0.893
4,688
150,000 x 0.2 2 30,000 0.35 10,500 0.797
8,369
150,000 x 0.2 3 30,000 0.35 10,500 0.712
7,476
150,000 x 0.2 4 30,000 0.35 10,500 0.636
6,678
150,000 x 0.2 5 30,000 0.35 10,500 0.567
5,594
150,000 x 0.1 6 15,000 0.35 5,250 0.507
2,262
Salvage ..... 6 14,000 1-0.35 9,100 0.507
4,614
Net present value $
7,256

Project B would be preferable to Project A using the net present

value method.

b.
Profitability index = present value of cash inflows/investment

For Project A: profitability index = 107,016/100,000 = 1.070.

For Project B: profitability index = 157,256/150,000 = 1.048.

Project A is preferred using the profitability index.

85. Roy Company is trying to decide whether to invest in one of two

Hard projects, X and Z. Data for each investment project follow:

Project
X Z
Cost of equipment ..................... $ 90,000 $140,000
Useful life ........................... 6 years 6 years
Estimated net annual cash inflow ...... $ 25,000 $ 30,000
Salvage value at the end of useful life $ 8,000 $ 12,000

The equipment for each project is in the MACRS 5-year property

class. Roy uses the optional straight-line method for
calculating depreciation. The tax rate is 35%. Roy's cost of
capital is 12%.

Required:

63 ManagerialAccounting,9/e
 a. Compute the net present value of each project and indicate
which appears preferable in terms of net present value.
Round all computations to the nearest dollar.
b. Compute the profitability index for each project, and
indicate which project would be preferable using this
investment criterion.

ManagerialAccounting,9/e 64
 Answer:

a.
Project X:
Tax After-tax 12% Present
Year Cash Flow Effect Cash Flow Factor _Value
Cost of
equipment 0 $(90,000) - $(90,000) 1.000 $(90,000)
Annual
savings ... 1-6 25,000 1-0.35 16,250 4.111 66,804
Depreciation:
90,000 x 0.1 1 9,000 0.35 3,150 0.893 2,813
90,000 x 0.2 2 18,000 0.35 6,300 0.797 5,021
90,000 x 0.2 3 18,000 0.35 6,300 0.712 4,486
90,000 x 0.2 4 18,000 0.35 6,300 0.636 4,006
90,000 x 0.2 5 18,000 0.35 6,300 0.567 3,572
90,000 x 0.1 6 9,000 0.35 3,150 0.507 1,597
Salvage ..... 6 8,000 1-0.35 5,200 0.507 2,636
Net present value $ 935

Project Z:

Tax After-tax 12% Present

Year Cash Flow Effect Cash Flow Factor _Value
Cost of
equipment 0 $(140,000) - $(140,000) 1.000 $(140,000)
Annual
savings ... 1-6 30,000 1-0.35 19,500 4.111 80,165
Depreciation:
140,000 x 0.1 1 14,000 0.35 4,900 0.893 4,376
140,000 x 0.2 2 28,000 0.35 9,800 0.797 7,811
140,000 x 0.2 3 28,000 0.35 9,800 0.712 6,978
140,000 x 0.2 4 28,000 0.35 9,800 0.636 6,233
140,000 x 0.2 5 28,000 0.35 9,800 0.567 5,557
140,000 x 0.1 6 14,000 0.35 4,900 0.507 2,484
Salvage ..... 6 12,000 1-0.35 7,800 0.507 3,955
Net present value $(22,441)

Project X would be preferable to Project Z using the net present

value method.

b.
Profitability index = present value of cash inflows/investment

For Project X: profitability index = 90,935/90,000 = 1.010.

For Project Z: profitability index = 117,559/140,000 = 0.840.

Project X is preferred using the profitability index.

65 ManagerialAccounting,9/e
86. Vasquez Company has been offered a 7-year contract to supply a
Hard part to a major aircraft manufacturer. After careful study, the
company has developed the following data relating to the
contract:

Cost of equipment needed ........................... $300,000

Working capital needed to carry inventories ........ 50,000
Annual before-tax cash receipts from delivery
of parts, less related cash operating costs ..... 90,000
Salvage value of equipment at
termination of the contract ............. ....... 10,000

The equipment above would be in the MACRS 5-year property

class. The contract is not expected to be extended beyond the
initial contract period. The company's cost of capital is 10%
and the tax rate is 35%.

Required:

Use net present value analysis to determine if the contract

should be accepted. Round all computations to the nearest
dollar.

Answer:

Tax After-tax 10% Present

Year Cash Flow Effect Cash Flow Factor Value
Cost of
equipment ... 0 $(300,000) - $(300,000) 1.000
$(300,000)
Working capital
needed .... 0 (50,000) - (50,000) 1.000
(50,000)
Annual
savings ..... 1-7 90,000 1-0.35 58,500 4.868 284,778
Depreciation:
300,000 x 0.200 1 60,000 0.35 21,000 0.909 19,089
300,000 x 0.320 2 96,000 0.35 33,600 0.826 27,754
300,000 x 0.192 3 57,600 0.35 20,160 0.751 15,140
300,000 x 0.115 4 34,500 0.35 12,075 0.683 8,247
300,000 x 0.115 5 34,500 0.35 12,075 0.621 7,499
300,000 x 0.058 6 17,400 0.35 6,090 0.564 3,435
Salvage ....... 7 10,000 1-0.35 6,500 0.513 3,334
Working capital
released .... 7 50,000 - 50,000 0.513 25,650
Net present value $ 44,926

The contract should be accepted, since the project has a

positive net present value.

ManagerialAccounting,9/e 66
87. A company is considering purchasing an asset for $50,000 which
Medium would have a useful life of 4 years. The asset belongs to the
MACRS 3 year property class and would be depreciated for tax
purposes using the MACRS optional straight-line method. The
asset would generate annual net cash inflows of $20,000
throughout its useful life. There would be a need for an
increase in working capital of $2,000 which would be released
at the end of the project. The asset's salvage value would be
$5,000. The company's tax rate is 40% and its discount rate is
10%.

Required:

What is the net present value of the project?

Answer:
10% Present
Years Amount Factor Value
Cost of asset ............. Now $(50,000) 1.000 $(50,000)
Working capital needed .... Now $ (2,000) 1.000 $ (2,000)
Net annual cash inflows ... 1-4 $ 12,000 3.170 $ 38,040
Depreciation tax shield:
1 $ 3,333 0.909 $ 3,030
2 $ 6,667 0.826 $ 5,507
3 $ 6,667 0.751 $ 5,007
4 $ 3,333 0.683 $ 2,277
$ 15,821

Salvage value ............. 4 $ 3,000 0.683 $ 2,049

Working capital released .. 4 $ 2,000 0.683 $ 1,366
Net present value ......... $ 5,276

88. A company is considering purchasing an asset for $60,000 which

Medium would have a useful life of 5 years. The asset belongs to the
MACRS 3 year property class and would be depreciated for tax
purposes using the MACRS tables. The asset would generate
annual net cash inflows of $26,000 throughout its useful life.
There would be a need for an increase in working capital of
$6,000 which would be released at the end of the project. The
asset's salvage value would be $8,000. The company's tax rate
is 40% and its discount rate is 12%.

Required:

What is the net present value of the project?

Answer:

67 ManagerialAccounting,9/e
 12% Present
Years Amount Factor Value
Cost of asset ........... Now $(60,000) 1.000 $(60,000)
Working capital needed .. Now $ (6,000) 1.000 $ (6,000)
Net annual cash inflows 1-5 $ 15,600 3.605 $ 56,238
Depreciation tax shield:
1 $ 7,992 0.893 $ 7,137
2 $ 10,680 0.797 $ 8,512
3 $ 3,552 0.712 $ 2,529
4 $ 1,776 0.636 $ 1,130
$ 19,308

Salvage value ........... 5 $ 4,800 0.567 $ 2,722

Working capital released 5 $ 6,000 0.567 $ 3,402
Net present value ....... $ 15,670

ManagerialAccounting,9/e 68