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Exam 25: Capital Budgeting and Managerial Decisions

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Question 31

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A company has the choice of either selling 1,000 defective units as scrap or rebuilding them.The company could sell the defective units as they are for $4.00 per unit.Alternatively,it could rebuild them with incremental costs of $1.00 per unit for materials,$2.00 per unit for labor,and $1.50 per unit for overhead,and then sell the rebuilt units for $8.00 each.What should the company do?

A) Sell the units as scrap.
B) Rebuild the units.
C) It does not matter because both alternatives have the same result.
D) Neither sell nor rebuild because both alternatives produce a loss.Instead,the company should store the units permanently.
E) Throw the units away.

F) All of the above
G) None of the above

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Question 32

Multiple Choice

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A cost that requires a future outlay of cash,and is relevant for current and future decision making,is a(n) :

A) Out-of-pocket cost.
B) Sunk cost.
C) Opportunity cost.
D) Operating cost.
E) Uncontrollable cost.

F) B) and C)
G) A) and E)

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Question 33

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The internal rate of return equals the rate that yields a net present value of zero for an investment.

Elliot Company can sell all of its products A and Z that it can produce,but it has limited production capacity.It can produce 8 units of A per hour or 10 units of Z per hour,and it has 20,000 production hours available.Contribution margin per unit is $12 for A and $10 for Z.What is the most profitable sales mix for Elliot Company?

When computing payback period,the year in which a capital investment is made is year 1.

Capital budgeting is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

An out-of-pocket cost requires a future outlay of cash and is relevant for current and future decision making.

Butler Corporation is considering the purchase of new equipment costing $30,000.The projected annual after-tax net income from the equipment is $1,200,after deducting $10,000 for depreciation.The revenue is to be received at the end of each year.The machine has a useful life of 3 years and no salvage value.Butler requires a 12% return on its investments.The present value of an annuity of 1 for different periods follows: What is the net present value of the machine?

Two investments with exactly the same payback periods are not equally valuable to an investor because the timing of net cash flows may be different.

A company is trying to decide which of two new product lines to introduce in the coming year.The company requires a 12% return on investment.The predicted revenue and cost data for each product line follows: The company has a 30% tax rate and it uses the straight-line depreciation method.The present value of an annuity of 1 for 5 years at 12% is 3.6048.Compute the net present value for each piece of equipment under each of the two product lines.Which,if either of these two investments is acceptable?

A sunk cost will change with a future course of action.

The hurdle rate is often set at:

A company puts four products through a common production process.This process costs $100,000 each year.The four products can be sold when they emerge from this process at the "split-off point," or processed further and then sold.Data about the four products for the coming period are: Determine which products should be sold at the split-off point and which should be processed further.

The __________________________ is the rate that yields a net present value of zero for an investment.

The accounting rate of return is calculated as:

The process of analyzing alternative long-term investments and deciding which assets to acquire or sell is known as:

Gordon Corporation inadvertently produced 10,000 defective digital watches.The watches cost $8 each to produce.A salvage company will purchase the defective units as they are for $3 each.Gordon's production manager reports that the defects can be corrected for $5 per unit,enabling them to be sold at their regular market price of $12.50.Gordon should:

The internal rate of return method of evaluating capital investments cannot be used with uneven cash flows.

Frederick Co.is thinking about having one of its products manufactured by a subcontractor. Currently,the cost of manufacturing 5,000 units follows: If Frederick can buy 5,000 units from a subcontractor for $130,000,it should:

The accounting rate of return is based on cash flows rather than net income in its calculation.