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Exam 25: Capital Budgeting and Managerial Decisions

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Question 81

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An opportunity cost is the potential benefit lost by taking a specific action when two or more alternative choices are available.

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B) False

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Question 82

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A company has a decision to make between two investment alternatives. The company requires a 10% return on investment. Predicted data is provided below: $\begin{array}{llr}&\text { Investment A }&\text { Investment Z }\\\text { Projected after-tax net income } & \$ 40,000 & \$ 42,000 \\\text { Investment costs } & \$ 600,000 & \$ 675,000 \\\text { Estimated life } & 6 \text { years } & 6 \text { years }\end{array}$ The present value of an annuity for 6 years at 10% is 4.3553. This company uses straight-line depreciation. Required: (a) Calculate the net present value for each investment. (b) Which investment should this company select? Explain.

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Question 83

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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 has excess capacity and accepts the offer, its profits will:

A company is considering the purchase of a new piece of equipment for $90,000. Predicted annual cash inflows from this investment are $36,000 (year 1) , $30,000 (year 2) , $18,000 (year 3) , $12,000 (year 4) and $6,000 (year 5) . The payback period is:

A cost that cannot be avoided or changed because it arises from a past decision, and is irrelevant to future decisions, is called a(n) :

The decision to accept an additional volume of business should be based on a comparison of the revenue from the additional business with the sunk costs of producing that revenue.

Relevant costs are also known as ________.

Bluebird Mfg. has received a special one-time order for 15,000 bird feeders at $3 per unit. Bluebird currently produces and sells 75,000 units at $7.00 each. This level represents 80% of its capacity. These bird feeders would be marketed under the wholesaler's name and would not affect Bluebird's sales through its normal channels. Production costs for these units are $3.50 per unit, which includes $2.25 variable cost and $1.25 fixed cost. -If Bluebird accepts this additional business, the incremental cost will be:

A company is considering a 5-year project. The company plans to invest $60,000 now and it forecasts cash flows for each year of $16,200. The company requires a hurdle rate of 12%. Calculate the internal rate of return to determine whether it should accept this project. Selected factors for a present value of an annuity of 1 for five years are shown below: Interest rate Present value of an annuity of $1 factor for year 5 10 % 3.7908 12 % 3.6048 14 % 3.4331

Trevoline Company is deciding between two projects. Each project requires an initial investment of $350,000. The projected net cash flows for the two projects are listed below. The revenue is to be received at the end of each year. Trevoline requires a 10% return on its investments. The present value of an annuity of $1 and present value of an annuity factors for 10% are presented below. Use net present value to determine which project should be pursued and explain why. $\begin{array} { l | l | l | l | l } & \text { Project A } & \text { Project B } & \text { Present Value } & \text { Present Value of an } \\\hline \text { Periods } & \text { Cash Flows } & \text { Cash Flows } & \text { of \$1 at } 10 \% & \text { Annuity of \$1 at } 10 \% \\\hline 1 & \$ 50,000 & \$ 160,000 & 0.9091 & 0.9091 \\\hline 2 & \$ 200,000 & \$ 175,000 & 0.8264 & 1.7355 \\\hline 3 & \$ 250,000 & \$ 175,000 & 0.7513 & 2.4869\end{array}$

Variations Company had the following results of operations for the past year: $\begin{array} { l | l } \text { Sales (8,000 units at \$7.00) } & \$ 56,000 \\\hline \text { Variable manufacturing costs } & ( 30,000 ) \\\hline \text { Fixed manufacturing costs } & ( 6,000 ) \\\hline \text { Fixed selling and adrinistrative expenses } & ( 4,500 ) \\\hline \text { Operating income } & \$ 15,500 \\\hline\end{array}$ A foreign company (whose sales will not affect Variations' regular sales) offers to buy 700 units at $4.00 per unit. In addition to variable manufacturing costs, there would be an export cost of $0.30 per unit. Prepare an analysis of this additional business to show whether Variations should take this order.

An estimate of an asset's value to the company, calculated by discounting the future cash flows from the investment at the project's required rate of return and then subtracting the initial amount of the investment, is known as:

A new manufacturing machine is expected to cost $278,000, have an eight-year life, and a $30,000 salvage value. The machine will yield an annual incremental after-tax income of $35,000 after deducting the straight-line depreciation. Compute the accounting rate of return for the investment.

Porter Co. is analyzing two projects for the future. Assume that only one project can be selected. $\begin{array} { l r r } & \text { Project X } & \text { Project } Y \\\text { Cost of machine } & \$ 68,000 & \$ 60,000 \\\text { Net cash flow: } & & \\\text { Year 1 } & 24,000 & 4,000 \\\text { Year 2 } & 24,000 & 26,000 \\\text { Year 3 } & 24,000 & 26,000 \\\text { Year 4 } & 0 & 20,000\end{array}$ - The payback period in years for Project Y is:

A company is considering the purchase of new equipment for $45,000. The projected annual net cash flows are $19,000. The machine has a useful life of 3 years and no salvage value. Management of the company requires a 12% return on investment. The present value of an annuity of $1 for various periods follows: $\begin{array} { l c } \text { Period } & \text { Present value of an annuity of } 1 \text { at } 12 \% \\\hline 1 & 0.8929 \\3 & 1.6901 \\3 & 2.4018\end{array}$ What is the net present value of this machine assuming all cash flows occur at year-end?

Good management accounting indicates that projects be evaluated using relevant data. In choosing among alternatives, what factors (considerations) are relevant?

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

Product A requires 5 machine hours per unit to be produced, Product B requires only 3 machine hours per unit, and the company's productive capacity is limited to 240,000 machine hours. Product A sells for $16 per unit and has variable costs of $6 per unit. Product B sells for $12 per unit and has variable costs of $5 per unit. Assuming the company can sell as many units of either product as it produces, the company should:

A company is considering a 5-year project. It plans to invest $62,000 now and it forecasts cash flows for each year of $16,200. The company requires a hurdle rate of 12%. Calculate the internal rate of return to determine whether it should accept this project. Selected factors for a present value of an annuity of $1 for five years are shown below: $\begin{array} { l l } \text { Interest rate } & \text { Present value of an annuity of } \$ 1 \\ & \text { factor } \\ 10 \%& 3.7908 \\12 \%& 3.6048 \\14 \% & 3.4331 \end{array}$

Nestor Company is considering the purchase of an asset for $100,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year. Annual Net Cash Flows $\begin{array} { l l } \text { Year 1 } & \$ 40,000 \\\text { Year 2 } & \$ 40,000 \\\text {Year 3 } & \$ 35,000 \\ \text {Year 4 } & \$ 35,000 \\ \text {Year 5 } & \$ 30,000\end{array}$ Compute the payback period for this investment.