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Exam 25: Capital Budgeting and Managerial Decisions

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Question 21

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Paxton Company can produce a component of its product that incurs the following costs per unit: direct materials, $10; direct labor, $14, variable overhead, $3 and fixed overhead, $8. An outside supplier has offered to sell the product to Axle for $32. Compute the net incremental cost or savings of buying the component.

A) $5.00 savings per unit.
B) $0 cost or savings per unit.
C) $3.00 cost per unit.
D) $5.00 cost per unit.
E) $3.00 savings per unit.

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

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Question 22

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Frederick Co. is thinking about having one of its products manufactured by an outside supplier. Currently, the cost of manufacturing 5,000 units follows: $\begin{array} { l r } \text { Direct material } & \$ 62,000 \\\text { Direct labor } & 47,000 \\\text { Variable factory overhead } & 38,000 \\\text { Fired factory overhead } & 52,000\end{array}$ If Frederick can buy 5,000 units from an outside supplier for $130,000, it should:

A) Buy the product because the total incremental costs of manufacturing are greater than $130,000.
B) Make the product because factory overhead is a sunk cost.
C) Make the product because the cost of direct material plus direct labor of manufacturing is less than $130,000.
D) Make the product because current factory overhead is less than $130,000.
E) Buy the product because total fixed and variable manufacturing costs are greater than $130,000.

F) A) and B)
G) C) and D)

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Question 23

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A company buys a machine for $60,000 that has an expected life of 9 years and no salvage value. The company anticipates a yearly net income of $2,850 after taxes of 30%, with the cash flows to be received evenly throughout each year. What is the accounting rate of return?

A company is considering the purchase of a new machine for $48,000. Management predicts that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $12,000 per year including depreciation of $3,000 per year. The company's tax rate is 40%. - What is the annual cash flow for the new machine?

A company inadvertently produced 3,000 defective products. The product cost $15 each to be manufactured and normally sells for $35 each. A salvage company will purchase the defective units as they are for $13 each. The production manager reports that the defects can be corrected for $5 per unit, enabling the company to sell them at a discounted price of $22.00. The repair operations would not affect other production operations. Prepare an analysis that shows which action should be taken.

What is capital budgeting? Why are capital budgeting decisions often difficult and risky?

Additional business in the form of a special order of goods or services should be accepted when the incremental revenue equals the incremental costs.

Chang Industries has 2,000 defective units of product that have already cost $14 each to produce. A salvage company will purchase the defective units as they are for $5 each. Chang's production manager reports that the defects can be corrected for $6 per unit, enabling them to be sold at their regular market price of $21. -Chang should:

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?

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

Vextra Corporation is considering the purchase of new equipment costing $35,000. The projected annual cash inflow is $11,000, to be received at the end of each year. The machine has a useful life of 4 years and no salvage value. Vextra requires a 12% return on its investments. The present value of an annuity of $1 for different periods follows: $\begin{array} { c c } \text { Periods } & 12 \% \\1 & 0.8929 \\2 & 1.6901 \\3 & 2.4018 \\4 & 3.0373\end{array}$ What is the machine's net present value?

A limitation of the internal rate of return method is that it:

A(n) ________ requires a future outlay of cash and is relevant for current and future decision making.

The calculation of the payback period for an investment when net cash flow is even (equal) is:

Walters manufactures a specialty food product that can currently be sold for $22 per unit and has 20,000 units on hand. Alternatively, it can be further processed at a cost of $12,000 and converted into 12,000 units of Deluxe and 6,000 units of Super. The selling price of Deluxe and Super are $30 and $20, respectively. The incremental net income of processing further would be:

Spilker Linens Store has three departments: Bath, Kitchen, and Bedding. The most recent income statement, showing the total operating profit and departmental results is shown below: $\begin{array}{l|l|l|l|l|l}&\text { Total } &\text {Bath } &\text { Kitchen } & \text { Bedding }\\\hline \text { Sales } & \$ 2,100,000 & \$ 1,000,000 & \$ 600,000 & \$ 500,000 \\\hline \text { Cost of goods sold } & (1,260,000) & (500,000) & (400,000) & (360,000) \\\hline \text { Gross profit } & 840,000 & 500,000 & 200,000 & 140,000 \\\hline \text { Direct expenses } & (420,000) & (200,000) & (100,000) & (120,000) \\\hline \text { Allocated expenses } & \underline{(350,000)} & \underline{(100,000)} & (75,000) & (175,000) \\\hline \text { Net income (loss) } & \$ 70,000 & \$ 200,000 & \$ 25,000 & \$(155,000) \\\hline\end{array}$ Based on this income statement, management is planning on eliminating the Bedding department, as it is generating a net loss. If the Bedding department is eliminated, the Kitchen department will expand to fill the space, but sales will not change in total, nor will direct expenses. None of Bedding's allocated expenses will be avoided, but they will be reallocated to Bath and Kitchen. Bath will be allocated $100,000 additional expenses, and Kitchen will be allocated $75,000 additional expenses. Prepare a new income statement for Spilker Linens Store, showing the results if the Bedding Department is eliminated and indicate whether eliminating the department is advisable.

A company has the choice of either selling 600 defective units as scrap or rebuilding them. The company could sell the defective units as they are for $2.00 per unit. Alternatively, it could rebuild them with incremental costs of $0.60 per unit for materials, $1.00 per unit for labor, and $0.80 per unit for overhead, and then sell the rebuilt units for $5.00 each. - What is the amount of incremental cost from rebuilding?

Benjamin Company had the following results of operations for the past year: $\begin{array}{llr} \text { Sales }(16,000 \text { units at } \$ 10) &&\$160,000\\ \text { Direct materials and direct labor } &\$96,000\\ \text { Overhead ( 20 \% variable) } &16,000\\ \text { Selling and administrative expenses (all fixed) } &32,000&(144,000) \\ \text {Operating income } &&\$16,000\\\end{array}$ A foreign company (whose sales will not affect Benjamin's market) offers to buy 4,000 units at $7.50 per unit. In addition to variable manufacturing costs, selling these units would increase fixed overhead by $600 and selling and administrative costs by $300. - Assuming Benjamin's productive capacity is 16,000 units per year and accepts the offer, its profits will:

Capital budgeting decisions are generally based on:

A company is considering a new project that will cost $19,000. This project would result in additional annual revenues of $6,000 for the next 5 years. The $19,000 cost is an example of a(n) :