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Exam 7: Capital Budgeting Decisions

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Question 21

Multiple Choice

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The assumption that the cash flows from an investment project are reinvested at the company's discount rate applies to:

A) both the internal rate of return and the net present value methods.
B) only the internal rate of return method.
C) only the net present value method.
D) neither the internal rate of return nor net present value methods.

E) A) and B)
F) All of the above

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Question 22

Multiple Choice

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The project profitability index and the internal rate of return:

A) will always result in the same preference ranking for investment projects.
B) will sometimes result in different preference rankings for investment projects.
C) are less dependable than the payback method in ranking investment projects.
D) are less dependable than net present value in ranking investment projects.

E) A) and D)
F) A) and C)

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Question 23

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Basta Corporation has provided the following data concerning an investment project that it is considering: Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided. The working capital would be released for use elsewhere at the end of the project in 4 years. The company's discount rate is 8%. The net present value of the project is closest to:

(Ignore income taxes in this problem.) Maxcy Limos, Inc., is considering the purchase of a limousine that would cost $187,335, would have a useful life of 9 years, and would have no salvage value. The limousine would bring in cash inflows of $45,000 per year in excess of its cash operating costs. Required: Determine the internal rate of return on the investment in the new limousine. Show your work!

Joetz Corporation has gathered the following data on a proposed investment project (Ignore income taxes.) : The company uses straight-line depreciation on all equipment. Assume cash flows occur uniformly throughout a year except for the initial investment. The payback period for the investment is:

(Ignore income taxes in this problem.) Jim Bingham is considering starting a small catering business. He would invest $125,000 to purchase a delivery van and various equipment and another $60,000 for inventories and other working capital needs. Rent for the building used by the business will be $35,000 per year. In addition to the building rent, annual cash outflow for operating costs will amount to $40,000. The annual cash inflow from the business will amount to $120,000. Jim wants to operate the catering business for only six years. He estimates that the equipment could be sold at that time for 4% of its original cost. Jim uses a 16% discount rate. All cash flows, except for the initial investment, would occur at the ends of the years. The investment in working capital would be returned at the end of the six years. Required: Compute the net present value of this investment.

Some investment projects require that a company increase its working capital. Under the net present value method, the investment and eventual recovery of working capital should be treated as:

A company is pondering an investment project that has an internal rate of return which is equal to the company's discount rate. The project profitability index of this investment project is:

(Ignore income taxes in this problem.) Boxton Corporation's required rate of return is 12%. The company is considering the purchase of a new machine that will save $20,000 per year in cash operating costs. The machine will cost $128,360 and will have a 10-year useful life with zero salvage value. Straight-line depreciation will be used. Required: Compute the machine's internal rate of return. Would you recommend purchase of the machine? Explain.

Lambert Manufacturing has $100,000 to invest in either Project A or Project B. The following data are available on these projects (Ignore income taxes.) : Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided. Both projects will have a useful life of 6 years and the total cost approach to net present value analysis. At the end of 6 years, the working capital investment will be released for use elsewhere. Lambert's required rate of return is 14%. The net present value of Project B is:

Nevland Corporation is considering the purchase of a machine that would cost $130,000 and would last for 6 years. At the end of 6 years, the machine would have a salvage value of $18,000. By reducing labor and other operating costs, the machine would provide annual cost savings of $44,000. The company requires a minimum pretax return of 19% on all investment projects. The net present value of the proposed project is closest to (Ignore income taxes.) : Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided.

Purvell Corporation has just acquired a new machine with the following characteristics (Ignore income taxes.) : The company uses straight-line depreciation and a $5,000 salvage value. Assume cash flows occur uniformly throughout a year except for the initial investment and the salvage at the end of the project. The payback period is closest to:

(Ignore income taxes in this problem.) Bradley Corporation's required rate of return is 14%. The company has an opportunity to be the exclusive distributor of a very popular consumer item. No new equipment would be needed, but the company would have to use one-fourth of the space in a warehouse it owns. The warehouse cost $200,000 new. The warehouse is currently half-empty and there are no other plans to use the empty space. In addition, the company would have to invest $100,000 in working capital to carry inventories and accounts receivable for the new product line. The company would have the distributorship for only 5 years. The distributorship would generate a $17,000 annual net cash inflow. Required: What is the net present value of the project?

Crockin Corporation is considering a machine that will save $9,000 a year in cash operating costs each year for the next six years. At the end of six years it would have no salvage value. If this machine costs $33,165 now, the machine's internal rate of return is closest to (Ignore income taxes.) : Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided.

(Ignore income taxes in this problem.) The management of Crosson Corporation is investigating the purchase of a new satellite routing system with a useful life of 9 years. The company uses a discount rate of 17% in its capital budgeting. The net present value of the investment, excluding its intangible benefits, is -$173,055. Required: How large would the additional cash flow per year from the intangible benefits have to be to make the investment in the automated equipment financially attractive?

Becker Billing Systems, Inc., has an antiquated high-capacity printer that needs to be upgraded. The system either can be overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives (Ignore income taxes.) : Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided. The company uses a 10% discount rate and the total-cost approach to capital budgeting analysis. The working capital required under the new system would be released for use elsewhere at the conclusion of the project. Both alternatives are expected to have a useful life of ten years. The net present value of the overhaul alternative is closest to:

The required rate of return is the maximum rate of return that an investment project must yield to the acceptable.

(Ignore income taxes in this problem.) The following data concern an investment project: The working capital will be released for use elsewhere at the conclusion of the project. Required: Compute the project's net present value.

The net present value method assumes that cash flows from a project are immediately reinvested at a rate of return equal to the internal rate of return.

Welch Corporation is planning an investment with the following characteristics (Ignore income taxes.) : Use Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor(s) using the tables provided. The initial cost of the equipment is closest to: