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Exam 25: Capital Budgeting and Managerial Decisions

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Question 31

Multiple Choice

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A limitation of the internal rate of return method is:

A) Failure to measure time value of money.
B) Failure to measure results as a percent.
C) Failure to consider the payback period.
D) Failure to reflect changes in risk levels over project life.
E) Failure to compare dissimilar projects.

F) All of the above
G) A) and C)

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Question 32

Multiple Choice

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The potential benefits of one alternative that are lost by choosing another is known as a(n) :

A) Alternative cost.
B) Sunk cost.
C) Out-of-pocket cost.
D) Differential cost.
E) Opportunity cost.

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

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Question 33

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A machine costs $180,000 and is expected to yield an after-tax net income of $10,800 each year.Management estimates the machine will have a ten-year life,a $20,000 salvage value,and straight-line depreciation is used.Compute the accounting rate of return for the investment.

For each of the capital budgeting methods listed below,place an X in the correct column,indicating the measurement basis of each,the ability to make comparison among projects,and whether each method reflects or ignores the time value of money.

Briefly describe both the payback period method and the net present value method of comparing investment alternatives.

The time value of money is considered when calculating the payback period of an investment.

Parker Plumbing has received a special one-time order for 1,500 faucets (units) at $5 per unit.Parker currently produces and sells 7,500 units at $6.00 each.This level represents 75% of its capacity.Production costs for these units are $4.50 per unit,which includes $3.00 variable cost and $1.50 fixed cost.To produce the special order,a new machine needs to be purchased at a cost of $1,000 with a zero salvage value.Management expects no other changes in costs as a result of the additional production.Should the company accept the special order?

Relevant benefits refer to the additional or incremental revenue generated by selecting a particular course or action over another.

Two investments with exactly the same payback periods are always equally valuable to an investor.

A _____________________ arises from a past decision and cannot be avoided or changed; it is irrelevant to future decisions.

If a company has the capacity to produce either 10,000 units of Product X or 10,000 units of Product Y; assuming fixed costs remain constant,production restrictions are the same for both products,and the markets for both products are unlimited; the company should commit 100% of its capacity to the product that has the higher contribution margin.

The net present value decision rule is: When an asset's expected cash flows are discounted at the required rate and yield a positive net present value,the asset should be acquired.

Sherman Company can sell all of product A that it produces but only 160,000 units of Z and it has limited production capacity.It can produce 6 units of A per hour or 10 units of Z per hour,and it has 30,000 production hours available.Contribution margin per unit is $12 for A and $10 for Z.What is the most profitable sales mix for this company?

A company produces three different products that all require processing on the same machines.There are only 27,000 machine hours available in each year.Production information for each product is: Required: (1)Determine the preferred sales mix if there are no market constraints on any of the products. (2)Determine the preferred sales mix if the demand is limited to 5,000 units for each product. (3)Determine the preferred sales mix if the demand is limited to 3,000 units for each product.

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

What is one advantage and one disadvantage of using the accounting rate of return to evaluate investment alternatives?

If net present values are used to evaluate two investments that have equal costs and equal total cash flows,the one with more cash flows in the early years has the higher net present value.

Presented below are terms preceded by letters a through g and followed by a list of definitions 1 through 7.Match the letter of the term with the definition.Use the space provided preceding each definition.

The process of restating future cash flows in today's dollars is known as:

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?