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Exam 10: Planning for Capital Investments

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Question 81

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Newton Company is considering the purchase of an asset that will provide a depreciation tax shield of $10,000 per year for 10 years. Assuming the company is subject to a 40% tax rate during the period, and a zero salvage value, what is the depreciable cost of the new asset?

A) $100,000
B) $250,000
C) $400,000
D) Can't be determined from the information provided

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

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Question 82

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The unadjusted rate of return is found by dividing the average incremental increase in annual operating income by the cost of the investment.

A) True
B) False

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Question 83

Multiple Choice

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Benson Corporation is considering an investment in equipment that would cost $50,000 and provide annual cash inflows of $14,000. The company's required rate of return is 12%; the internal rate of return for the investment is 10.5%. Should the company make this investment?

Chico Company is considering the purchase of a new high-speed machine for its factory. The machine will cost $160,000 and will save the company $45,000 per year in cash operating costs. The machine has an estimated useful life of five years and no expected salvage value. The company's cost of capital is 12%.Required: 1) Compute the net present value of this investment.2) What is the maximum amount that Chico should be willing to pay for the machine? 3) What are the minimum annual cash savings that will make the machine acceptable on a net present value basis if the purchase price is $160,000?

Morrisey Company has two investment opportunities. Both investments cost $5,500 and will provide the same total future cash inflows. The cash receipt schedule for each investment is given below: What is the net present value of Investment II assuming an 8% minimum rate of return? (Do not round your intermediate calculations. Round your answer to nearest whole dollar.) $\begin{array} { | l | c | c | } \hline & \text { Investment I } & \text { Investment II } \\\hline \text { Period 1 } & \$ 1,000 & \$ 1,000 \\\hline \text { Period 2 } & 1,000 & 2,000 \\\hline \text { Period 3 } & 2,000 & 3,000 \\\hline \text { Period 4 } & \underline { 4,000 } & \underline { 2,000 } \\\hline \text { Total } & \underline { \$ 8,000 } & \underline { \$ 8,000 } \\\hline & & \\\hline\end{array}$

Fenwick Company is considering purchase of equipment that costs $60,000 and is expected to offer annual cash inflows of $16,645 for 5 years. Fenwick Company's required rate of return is 10%. The internal rate of return of this investment project is closest to:

A project's net present value can be found by subtracting the cost of the project from the total present value of the future cash flows generated by the project.

Indicate whether each of the following statements is true or false.The net present value method provides a direct measure of the rate of return to be expected from a capital investment project.Managers who want to know the rate of return to expect from a capital investment project should calculate the net present value.The internal rate of return for a capital investment is the rate that would produce a net present value of zero.For a capital investment project to be acceptable, the internal rate of return should be higher than the hurdle rate.A capital investment project that has a positive net present value may have an internal rate of return that is lower than the hurdle or required rate of return.

Indicate whether each of the following statements is true or false.An ordinary annuity assumes that cash flows occur at the beginning of each period.To say that an investment earns the desired rate of return assumes that all cash flows generated by the investment are reinvested at the desired rate of return.Managers should not use two different methods in evaluating capital investment decisions because different methods generally give different results.Copley Corporation uses a required rate of return of 10% for its capital investment decisions. A particular project had a negative net present value. For this project, the actual rate of return was expected to be more than 10%.The net present value of a capital investment project is calculated by subtracting the present value of expected cash inflows from the cost of the investment.

Neighbors Company is considering the purchase of new equipment that will cost $130,000. The equipment will save the company $38,000 per year in cash operating costs. The equipment has an estimated useful life of five years and a zero expected salvage value. The company's cost of capital is 10%.Required: 1) Ignoring income taxes, compute the net present value and internal rate of return. Round net present value to the nearest dollar and round internal rate of return to the nearest whole percent.2) Should the equipment be purchased? Why or why not?

Because of the expense of applying multiple techniques, managers should use a single capital budgeting technique to analyze potential capital investments.

In performing capital budgeting analysis that takes time value of money into account, cash flows generated by a capital project are assumed to be reinvested at the project's rate of return.

Montana Company is evaluating two different capital investments, Project X and Y. Either X or Y would cost $210,000, and the company cannot afford to do both. The company expects that Project X would provide net cash inflows of $62,000 per year for 5 years. For Project Y, the net cash inflows are expected to be as follows: Montana's cost of capital is 12%.Required: 1) Calculate the present value index for Project X and for Project Y. Round your answer to three decimal places.2) Indicate whether each of the projects is an acceptable investment.3) Based on present value index, which of the two projects should Montana implement?