Chapter 16: Capital Expenditure Decisions

Instructions: The following tables are provided for use with all questions that require future- and present-value calculations. Periods " $ 4 # 6 & 8 % ! Periods " $ 4 # 6 & 8 % ! Periods " $ 4 # 6 & 8 % ! 4% .!4! .!8" . "# . &! ." & ."6# .$ 6 .$6% .4"$ .48! 4% .!!! ".!4! $. "" 4."4& #.4 6 6.6$$ &.8%8 %." 4 !.#8$ ".!!6 4% .%6" .%"# .88% .8## .8"" .&%! .&6! .&$ .&!$ .6&6 6% .!6! . "4 . % ."6$ .$$8 .4 % .#!4 .#%4 .6%! .&% 6% .!!! ".!6! $. 84 4.$&# #.6$& 6.%&# 8.$%4 %.8%8 .4% $. 8 6% .%4$ .8%! .84! .&%" .&4& .&!# .66# .6"& .#%" .##8 8% .!8! . 66 ."6! .$6 .46% .#8& .& 4 .8# .%%% ". #% Future Value of $1 !% "% . !! . "! ." ! ."#4 .$$ .4!# .464 .#&4 .6 .&6" .&&" .%&4 .%4% "." ". 44 ".4&6 ".$#% ".&&$ ".#%4 $. !6 4% . 4! .$!! .48" .68% .%"# ". %# ".#!" ".8#$ $."#" $.&!& 6% . 6! .$46 .#6 .8 ". ! ".4$& ".8"& $."&% $.8!$ 4.4 " 8% . 8! .$%$ .64$ .%$% "."88 ".&!! $. 86 $.&#% 4.4$6 #."$4 8% .!!! ". 8! $.#&" #." # &. #4 %.44" ". 4" #.$"& %.!86 "$.#" 8% .84& .& 8 .6!% .# 6 .4$& .$&! .$ 4 ."66 .""# . % "!% ."!! .44! .&"8 ".!&4 ".488 ".%86 $.#8$ 4.$!! #. 6! 6. %" "!% .!!! ".""! $.64! #.$68 &.44" %.%$! ".% 6 6.4%% "!.&%% "#.%#% "!% .8$$ .6%4 .#&% .48" .4!" .$$# ."&% ."$$ . %4 . 6"

Future Value of a Series of $1 Cash Flows 8% !% "% 4% 6% .!!! .!!! .!!! .!!! .!!! ".!8! ". !! ". "! ". 4! ". 6! $."46 $.$ ! $.$&4 $.44! $.#!6 4.#!6 4.64 4.&&% 4.%" #.!6& #.86& 6. !# 6.$#$ 6.6 ! 6.8&& &.$$6 &.& 6 8. # 8.#$6 8.%&& 8.%"$ %.48& !.!8% !.&$! .4 4 !.6$& .4$6 ".$!! $."$$ 4."4! ".488 $.#8! 4.&&6 6.!8# &.# % 4.48& #.%$8 &.#4% %.$$& " .$" 8% .%"6 .8#& .&%4 .&$# .68 .6$! .#8$ .#4! .#!! .46$ Present Value of $1 !% "% .%!% .8%$ .8"6 .&%& .&# .& " .68$ .6$6 .6" .#6& .#64 .#!& .# $ .4#" .46& .4!4 .4"4 .$6 .$86 .$"" 4% .8&& .&6% .6&# .#%" .# % .4#6 .4!! .$# .$!8 ."&! 6% .86" .&4$ .64 .##" .4&6 .4 ! .$#4 .$!# ."6$ .""&

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Periods " $ 4 # 6 & 8 % !

4% !.%6" .886 ".&&# $.6$! 4.4#" #."4" 6.!!" 6.&$$ &.4$# 8.

6% !.%4$ .8$$ ".6&$ $.46# 4." " 4.% & #.#8" 6." ! 6.8!" &.$6!

Present Value of a Series of $1 Cash Flows 8% !% "% 4% 6% !.%"6 !.%!% !.8%$ !.8&& !.86" .&8$ .&$6 .6%! .64& .6!# ".#&& ".48& ".4!" ".$"" "."46 $.$ " $. &! $.!$& ".% 4 ".&%8 $.%%$ $.&% $.6!# $.4$$ $."&4 4.6"$ 4.$## 4. $.88% $.68# #."!6 4.868 4.#64 4."88 4.!$% #.&4& #.$$# 4.%68 4.6$% 4.$44 6."4& #.&#% #.$"8 4.%46 4.6!& 6.& ! 6. 4# #.6#! #." 6 4.8$$

8% !.84& .#66 ". &4 ".6%! $. "& $.4%8 $.8 " 4.!&8 4.$!$ 4.4%4

"!% !.8$$ .#"8 ". !6 ".#8% ".%% $.$"6 $.6!# $.8$& 4.!$ 4. %"

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MU !"P E C#$"CE %UES!"$&S . 'apital-budgeting decisions pri(aril) involve: *. e(ergenc) situations. +. long-ter( decisions. '. short-ter( planning situations. ,. cash inflows and outflows in the current )ear. -. planning for the acquisition of capital. *nswer: + ./: T)pe: 0'

". 1hich of the following would not involve a capital-budgeting anal)sis2 *. The acquisition of new equip(ent. +. The addition of a new product line. '. The adoption of a new cost driver for overhead application. ,. The construction of a new distribution facilit). -. 1hether a pro football tea( should trade for and sign a star quarterbac3 to a long-ter( contract. *nswer: ' ./: T)pe: 4

$. The decision process that has (anagers select fro( a(ong several acceptable invest(ent proposals to (a3e the best use of li(ited funds is 3nown as: *. capital rationing. +. capital budgeting. '. acceptance or re5ection anal)sis 6*0*7. ,. cost anal)sis. -. pro5ect planning. *nswer: * ./: T)pe: 0'

4. 'apital budgeting tends to focus pri(aril) on: *. revenues. +. costs. '. cost centers. ,. progra(s and pro5ects. -. allocation tools. *nswer: , ./: T)pe: 0'

#. ,iscounted-cash-flow anal)sis focuses pri(aril) on: *. the stabilit) of cash flows. +. the ti(ing of cash flows. '. the probabilit) of cash flows. ,. the sensitivit) of cash flows. -. whether cash flows are increasing or decreasing. *nswer: + ./: T)pe: 0'

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6. In a net-present-value anal)sis8 the discount rate is often called the: *. pa)bac3 rate. +. hurdle rate. '. (ini(al value. ,. net unit rate. -. ob5ective rate of return. *nswer: + ./: T)pe: 0'

&. The hurdle rate that is used in a net-present-value anal)sis is the sa(e as the fir(9s: *. discount rate. +. internal rate of return. '. (ini(u( desired rate of return. ,. ob5ective rate of return. -. discount rate and (ini(u( desired rate of return. *nswer: - ./: T)pe: 0'

8. 1hich of the following is ta3en into account b) the net-present-value (ethod2 * Pro5ect9s 'ash :lows I((ediate ,uring a Ti(e ;alue 'ash :lows Pro5ect9s .ife of <one) *. =es 4o 4o +. =es =es 4o '. =es =es =es ,. 4o =es =es -. 4o =es 4o *nswer: ' ./: T)pe: 4

%. 'onsider the following factors related to an invest(ent: I. II. III. The net inco(e fro( the invest(ent. The cash flows fro( the invest(ent. The ti(ing of the cash flows fro( the invest(ent.

1hich of the preceding factors would be i(portant considerations in a net-present-value anal)sis2 *. I onl). +. II onl). '. I and II. ,. II and III. -. I8 II8 and III. *nswer: , ./: T)pe: 4

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!. The true econo(ic )ield produced b) an asset is su((ari>ed b) the asset9s: *. non-discounted cash flows. +. net present value. '. future value. ,. annuit) discount factor. -. internal rate of return. *nswer: - ./: T)pe: 0'

. The internal rate of return on an asset can be calculated: *. if the return is greater than the hurdle rate. +. if the asset9s cash flows are identical to the future value of a series of cash flows. '. if the future value of a series of cash flows can be arrived at b) the annuit) accu(ulation factor. ,. b) finding a discount rate that )ields a >ero net present value. -. b) finding a discount rate that )ields a positive net present value. *nswer: , ./: T)pe: 0'

". The internal rate of return: *. ignores the ti(e value of (one). +. equates a pro5ect9s cash inflows with its cash outflows. '. equates a pro5ect9s cash outflows with its e?penses. ,. equates the present value of a pro5ect9s cash inflows with the present value of the cash outflows. -. equates the present value of a pro5ect9s cash flows with the future value of the pro5ect9s cash flows. *nswer: , ./: T)pe: 0'

$. Page 'o(pan) is conte(plating the acquisition of a (achine that costs @#!8!!! and pro(ises to reduce annual cash operating costs b) @ 8!!! over each of the ne?t si? )ears. 1hich of the following is a proper wa) to evaluate this invest(ent if the co(pan) desires a "% return on all invest(ents2 *. @#!8!!! vs. @ 8!!! ? 6. +. @#!8!!! vs. @668!!! ? !.#!&. '. @#!8!!! vs. @668!!! ? 4. . ,. @#!8!!! vs. @ 8!!! ? 4. . -. @#!8!!! ? !.8%$ vs. @ 8!!! ? 4. . *nswer: , ./: T)pe: *

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4. *da(s 'o(pan) can acquire a @&#!8!!! (achine now that will benefit the fir( over the ne?t 8 )ears. *nnual savings in cash operating costs are e?pected to total @ 4!8!!!. If the hurdle rate is !%8 the invest(ent9s net present value is: *. @6""68%6!7. +. @6$8 !!7. '. @6#8 #!. ,. @$&!8!!!. -. so(e other a(ount. *nswer: + ./: T)pe: *

#. 0eeder 'o(pan)8 which uses net present value to anal)>e invest(ents8 requires a !% (ini(u( rate of return. * staff assistant recentl) calculated a @#!!8!!! (achine9s net present value to be @8684!!8 e?cluding the i(pact of straight-line depreciation. If 0eeder ignores inco(e ta?es and the (achine is e?pected to have a five-)ear service life8 the correct net present value of the (achine would be: *. @6 $86!!7. +. @8684!!. '. @ 8684!!. ,. @"%"8&!!. -. @46#8#!!. *nswer: + ./: T)pe: *

6. * new asset is e?pected to provide service over the ne?t four )ears. It will cost @#!!8!!!8 generates annual cash inflows of @ #!8!!!8 and requires cash operating e?penses of @$!8!!! each )ear. In addition8 a @ !8!!! overhaul will be needed in )ear $. If the co(pan) requires a !% rate of return8 the net present value of this (achine would be: *. @6 "&8 !78 and the (achine (eets the co(pan)9s rate-of-return require(ent. +. @6 "&8 !78 and the (achine does not (eet the co(pan)9s rate-of-return require(ent. '. @6 "%86!!78 and the (achine does not (eet the co(pan)9s rate-of-return require(ent. ,. @6 # 8&!!78 and the (achine (eets the co(pan)9s rate-of-return require(ent. -. so(e other a(ount. *nswer: + ./: T)pe: *

&. * new (achine that costs @ &"8 !! is e?pected to save annual cash operating costs of @4!8!!! over each of the ne?t nine )ears. The (achine9s internal rate of return is: *. appro?i(atel) 4%. +. appro?i(atel) 6%. '. appro?i(atel) 8%. ,. appro?i(atel) "!%. -. so(e other figure not noted above. *nswer: ' ./: T)pe: *

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8. Paulsen is considering the acquisition of a @" &8&#! (achine that is e?pected to produce annual savings in cash operating costs of @#!8!!! over the ne?t si? )ears. If Paulsen uses the internal rate of return 6I007 to evaluate new invest(ents and the fir( has a hurdle rate of "%8 which of the following state(ents is correct2 *. The (achine9s I00 is less than 4%8 and the (achine should not be acquired. +. The (achine9s I00 is appro?i(atel) !%8 and the (achine should not be acquired. '. The (achine9s I00 is appro?i(atel) !%8 and the (achine should be acquired. ,. The (achine9s I00 is appro?i(atel) "%8 and the (achine should be acquired. -. *ll of the preceding state(ents are false. *nswer: + ./: T)pe: *8 4

Ase the following to answer questions %-"!: * (achine costs @"#8!!!B it is e?pected to generate annual cash revenues of @88!!! and annual cash e?penses of @"8!!! for five )ears. The required rate of return is "%. %. The net present value of the (achine is: *. @6$884!7. +. @6$8$&!7. '. @!. ,. @" 86$!. -. @"8884!. *nswer: + ./: T)pe: *

"!. 1hich of the following state(ents about the (achine9s internal rate of return is true2 *. The internal rate of return is greater than "%. +. The internal rate of return is between !% and "%. '. The internal rate of return is less than !%. ,. The internal rate of return (ust be greater than #%. -. There is insufficient infor(ation to (a3e an) 5udg(ent about the internal rate of return. *nswer: ' ./: T)pe: *

Ase the following to answer questions " -"$: The (a)or of C(alltown is considering the purchase of a new co(puter s)ste( for the cit)9s ta? depart(ent. The s)ste( costs @&#8!!! and has an e?pected life of five )ears. The (a)or esti(ates the following savings will result if the s)ste( is purchased: =ear " $ 4 # Cavings @"!8!!! "#8!!! $!8!!! #8!!! "8!!!

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" . If C(alltown uses a !% discount rate for capital-budgeting decisions8 the net present value of the co(puter s)ste( would be: *. @48%. +. @48!#&. '. @ 86#8. ,. @6$8$4". -. @&%8!#&. *nswer: + ./: T)pe: *

"". 1hat can be said about the co(puter s)ste(9s internal rate of return if the net present value at "% is positive2 *. The internal rate of return is greater than "%. +. The internal rate of return is between !% and "%. '. The internal rate of return is less than !%. ,. The internal rate of return (ust be less than #%. -. There is insufficient infor(ation to (a3e an) 5udg(ent about the internal rate of return. *nswer: * ./: T)pe: 4

"$. * salesperson fro( a different co(puter co(pan) clai(s that his (achine8 which costs @8#8!!! and has an esti(ated service life of four )ears8 will generate annual savings for the cit) of @$"8!!!. If the discount rate is !%8 the net present value of this s)ste( would be: *. @ 6844!. +. @"$8 &#. '. @6$8# ". ,. @ ! 844!. -. so(e other a(ount. *nswer: * ./: T)pe: *

"4. * co(pan) that is using the internal rate of return 6I007 to evaluate pro5ects should accept a pro5ect if the I00: *. is greater than the pro5ect9s net present value. +. equates the present value of the pro5ect9s cash inflows with the present value of the pro5ect9s cash outflows. '. is greater than >ero. ,. is greater than the hurdle rate. -. is less than the fir(9s cost of invest(ent capital. *nswer: , ./: " T)pe: 0'

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"#. 1hich of the following choices correctl) states the rules for pro5ect acceptance under the netpresent-value (ethod and the internal-rate-of-return (ethod2 4et Present ;alue Internal 0ate of 0eturn *. Positive total Dreater than hurdle rate +. Positive total .ess than hurdle rate '. 4egative total Dreater than hurdle rate ,. 4egative total .ess than hurdle rate -. Dreater than hurdle rate Positive nu(ber *nswer: * ./: " T)pe: 0' "6. The net-present-value (ethod assu(es that pro5ect funds are reinvested at the: *. hurdle rate. +. rate of return earned on the pro5ect. '. cost of debt capital. ,. cost of equit) capital. -. internal rate of return. *nswer: * ./: " T)pe: 0' "&. The internal-rate-of-return (ethod assu(es that pro5ect funds are reinvested at the: *. hurdle rate. +. rate of return earned on the pro5ect. '. cost of debt capital. ,. cost of equit) capital. -. rate of earnings growth 60-D7. *nswer: + ./: " T)pe: 0' "8. 1hich of the following choices correctl) states how funds are assu(ed to be reinvested under the net-present-value (ethod and the internal-rate-of-return (ethod2 4et Present ;alue Internal 0ate of 0eturn *. *t the hurdle rate *t the hurdle rate +. *t the hurdle rate *t the return earned on the pro5ect '. *t the cost of debt capital *t the cost of debt capital ,. *t the cost of debt capital *t the cost of equit) capital -. *t the cost of equit) capital *t the cost of equit) capital *nswer: + ./: " T)pe: 0' "%. * co(pan)9s hurdle rate is generall) influenced b): *. the cost of capital. +. the fir(9s depreciable assets. '. whether (anage(ent uses the net-present-value (ethod or the internal-rate-of-return (ethod. ,. pro5ect ris3. -. ite(s E*E and E,E above. *nswer: - ./: " T)pe: 0'

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$!. If inco(e ta?es are ignored8 which of the following choices correctl) notes how a pro5ect9s depreciation is treated under the net-present-value (ethod and the internal-rate-of-return (ethod2 4et Present ;alue Internal 0ate of 0eturn *. 'onsidered 'onsidered +. 'onsidered Ignored '. Ignored 'onsidered ,. Ignored Ignored -. The correct answer depends on the depreciation (ethod 6straight line or accelerated7 that is used. *nswer: , ./: " T)pe: 0' $ . 'onsider the following state(ents about the total-cost and the incre(ental-cost approaches of invest(ent evaluation: I.+oth approaches will )ield the sa(e conclusions. II.'hoosing between these approaches is a (atter of personal preference. III.The incre(ental approach focuses on cost differences between alternatives. 1hich of the above state(ents is 6are7 true2 *. I onl). +. II onl). '. III onl). ,. II and III. -. I8 II8 and III. *nswer: - ./: $ T)pe: 0' $". The s)ste(atic follow-up on a capital pro5ect to see how the pro5ect actuall) turns out is co((onl) 3nown as: *. capital budgeting assess(ent 6'+*7. +. a postaudit. '. control of capital e?penditures 6''-7. ,. overall cost perfor(ance. -. the cost evaluation phase. *nswer: + ./: $ T)pe: 0'

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$$. 'onsider the following state(ents about capital budgeting postaudits: I.Postaudits can be used to detect desirable pro5ects that were re5ected. II.Postaudits can be used to detect undesirable pro5ects that were accepted. III.Postaudits (a) reveal shortco(ings in cash-flow pro5ections8 providing insights that allow a fir( to i(prove future predictions. 1hich of the above state(ents is 6are7 correct2 *. I onl). +. II onl). '. III onl). ,. II and III. -. I8 II8 and III. *nswer: , ./: $ T)pe: 0' $4. Denerall) spea3ing8 which of the following would not directl) affect a co(pan)9s inco(e ta? pa)(ents2 *. *dvertising e?pense. +. Dain on sale of (achiner). '. Cales revenue. ,. .and owned b) the fir(. -. .oss on sale of building. *nswer: , ./: 4 T)pe: 0' $#. * co(pan)9s cash flows fro( inco(e ta?es are nor(all) affected b): *. revenues. +. operating e?penses. '. gains on the sale of assets. ,. losses on the sale of assets. -. all of the above. *nswer: - ./: 4 T)pe: 0' $6. 'onsider the following state(ents about ta?es and after-ta? cash flows: I.'apital budgeting anal)ses should incorporate after-ta? cash flows rather than before-ta? cash flows. II.*dded co(pan) revenues will result in lower ta?es for a fir(. III./perating e?penses (a) actuall) provide a ta? benefit for an organi>ation. 1hich of the above state(ents is 6are7 correct2 *. I onl). +. II onl). '. III onl). ,. I and II. -. I and III.

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*nswer: - ./: 4 T)pe: 0'8 4 $&. 1hen inco(e ta?es are considered in capital budgeting8 the cash flows related to a co(pan)9s advertising e?pense would be correctl) figured b) ta3ing the cash paid for advertising and: *. adding the result of (ultipl)ing 6advertising e?pense ? ta? rate7. +. adding the ta? rate. '. adding the result of (ultipl)ing Fadvertising e?pense ? 6 - ta? rate7G. ,. subtracting the result of (ultipl)ing 6advertising e?pense ? ta? rate7. -. subtracting the result of (ultipl)ing Fadvertising e?pense ? 6 - ta? rate7G. *nswer: , ./: 4 T)pe: 4 $8. /f the five e?penses that follow8 which one is (ost li3el) treated differentl) than the others when inco(e ta?es are considered in a discounted-cash-flow anal)sis2 *. Calaries e?pense. +. *dvertising e?pense. '. ,epreciation e?pense. ,. Atilities e?pense. -. /ffice e?pense. *nswer: ' ./: 4 T)pe: 4 $%. *ssu(e that a capital pro5ect is being anal)>ed b) a discounted-cash-flow approach8 and an e(plo)ee first assu(es no inco(e ta?es and then later assu(es a $!% inco(e ta? rate. How would depreciation e?pense be incorporated in the anal)sis2 $!% Inco(e 4o Inco(e Ta?es Ta? 0ate *. 'onsidered 'onsidered +. 'onsidered Ignored '. Ignored 'onsidered ,. Ignored Ignored -. The correct answer depends on the depreciation (ethod that is used. *nswer: ' ./: 4 T)pe: 4 4!. 1hen a co(pan) is anal)>ing a capital pro5ect b) a discounted-cash-flow approach and inco(e ta?es are being considered8 depreciation: *. should be ignored. +. should be considered because it results in a ta? savings. '. should be considered because it is a fi?ed cost. ,. should be considered because it is a cash inflow. -. should be considered because8 li3e other e?penses8 it is a cash outla) related to operations. *nswer: + ./: 4 T)pe: 0'

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4 . 1hen inco(e ta?es are considered in capital budgeting8 the cash flows related to a co(pan)9s depreciation e?pense would be correctl) figured b) ta3ing the cash paid for depreciation and: *. adding the result of (ultipl)ing 6depreciation e?pense ? ta? rate7. +. adding the result of (ultipl)ing Fdepreciation e?pense ? 6 - ta? rate7G. '. subtracting the result of (ultipl)ing 6depreciation e?pense ? ta? rate7. ,. subtracting the result of (ultipl)ing Fdepreciation e?pense ? 6 - ta? rate7G. -. doing none of the above because there is no cash paid for depreciation. *nswer: - ./: 4 T)pe: 4 4". Iester plans to generate @6#!8!!! of sales revenue if a capital pro5ect is i(ple(ented. *ssu(ing a $!% ta? rate8 the sales revenue should be reflected in the anal)sis b) a: *. @ %#8!!! inflow. +. @ %#8!!! outflow. '. @4##8!!! inflow. ,. @4##8!!! outflow. -. @6#!8!!! inflow. *nswer: ' ./: 4 T)pe: * 4$. Highlander 'o(pan) plans to incur @$#!8!!! of salaries e?pense if a capital pro5ect is i(ple(ented. *ssu(ing a $!% ta? rate8 the salaries should be reflected in the anal)sis b) a: *. @ !#8!!! inflow. +. @ !#8!!! outflow. '. @"4#8!!! inflow. ,. @"4#8!!! outflow. -. @$#!8!!! outflow. *nswer: , ./: 4 T)pe: * 44. Penn 'o(pan) plans to incur @ 8!8!!! of salaries e?pense and produce @$!!8!!! of additional sales revenue if a capital pro5ect is i(ple(ented. *ssu(ing a $!% ta? rate8 these two ite(s collectivel) should appear in a capital budgeting anal)sis as: *. a @$68!!! inflow. +. a @$68!!! outflow. '. an @848!!! inflow. ,. an @848!!! outflow. -. so(e other a(ount. *nswer: ' ./: 4 T)pe: * 4#. +roo3side 'o(pan) has @&!8!!! of depreciation e?pense and is sub5ect to a $!% inco(e ta? rate. /n an after-ta? basis8 depreciation results in a: *. @" 8!!! inflow. +. @" 8!!! outflow. '. @4%8!!! inflow. ,. @4%8!!! outflow. -. neither an inflow nor an outflow because depreciation is a noncash e?pense.

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*nswer: * ./: 4 T)pe: *

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46. 'rossland 'o(pan) is stud)ing a capital pro5ect that will produce @6!!8!!! of added sales revenue8 @4!!8!!! of additional cash operating e?penses8 and @#!8!!! of depreciation. *ssu(ing a $!% inco(e ta? rate8 the co(pan)9s after-ta? cash inflow 6outflow7 is: *. @ !#8!!!. +. @ "#8!!!. '. @ ##8!!!. ,. @ &#8!!!. -. so(e other a(ount. *nswer: ' ./: 4 T)pe: * 4&. 1hich of the following is the proper calculation of a co(pan)9s depreciation ta? shield2 *. ,epreciation J ta? rate. +. ,epreciation J 6 - ta? rate7. '. ,epreciation ? ta? rate. ,. ,epreciation ? 6 - ta? rate7. -. ,epreciation deduction K inco(e ta?es. *nswer: ' ./: 4 T)pe: 0' 48. * depreciation ta? shield is a6n7: *. after-ta? cash outflow. +. increase in inco(e ta?. '. noncash factor. ,. reduction in inco(e ta?. -. sporadic fluctuation in inco(e ta?. *nswer: , ./: 4 T)pe: 0' 4%. 'onsider the following state(ents about depreciation ta? shields: I. II. III. * depreciation ta? shield provides distinct benefits to a business. * depreciation ta? shield should be ignored when doing a net-present-value anal)sis. * depreciation ta? shield can occur in (ore than one )ear.

1hich of the above state(ents is 6are7 correct2 *. I onl). +. II onl). '. III onl). ,. I and II. -. I and III. *nswer: - ./: 4 T)pe: 0'

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#!. * co(pan) that uses accelerated depreciation: *. would write off a larger portion of an asset9s cost sooner than under the straight-line (ethod. +. would find that depreciation speeds up8 with a s(all portion ta3en in earl) )ears and larger a(ounts ta3en in later )ears. '. would find that (ore ta? benefits occur earlier than under the straight-line (ethod. ,. would find itself out of co(pliance with generall) accepted accounting principles 6D**P7. -. would find that choices E*E and E'E are true. *nswer: - ./: 4 T)pe: 0' # . ,avid 'o(pan) is considering the use of accelerated depreciation rather than straight-line depreciation for a new asset acquisition. 1hich of the following choices correctl) shows when the (a5orit) of depreciation would be ta3en 6earl) or late in the asset9s life78 when (ost of the ta? savings occur 6earl) or late in the asset9s life78 and which depreciation (ethod would have the higher present value2 Depreciation 1hen <a5orit) 1hen <a5orit) of ,epreciation of Ta? Cavings Method is Ta3en /ccur With Higher Present Value *. -arl) in life -arl) in life *ccelerated +. -arl) in life -arl) in life Ctraight-line '. -arl) in life .ate in life Ctraight-line ,. .ate in life .ate in life Ctraight-line -. .ate in life -arl) in life *ccelerated *nswer: * ./: 4 T)pe: 0'8 4 #". Iulie 'o(pan) purchased a @"!!8!!! (achine that has a four-)ear life and no salvage value. The co(pan) uses straight-line depreciation on all asset acquisitions and is sub5ect to a $!% ta? rate. The proper cash flow to show in a discounted-cash-flow anal)sis as occurring at ti(e ! would be: *. @6"!!8!!!7. +. @6 4!8!!!7. '. @6$#8!!!7. ,. @ #8!!!. -. @#!8!!!. *nswer: * ./: 4 T)pe: * #$. If a co(pan) desires to be in co(pliance with current inco(e ta? law and write off the cost of its assets rapidl)8 the fir( would use: *. straight-line depreciation. +. su(-of-the-)ears9-digits depreciation. '. accelerated depreciation. ,. the <odified *ccelerated 'ost 0ecover) C)ste( 6<*'0C7. -. annuit) depreciation.
243 Hilton, Managerial Accounting, Seventh Edition

*nswer: , ./: # T)pe: 0'

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#4. The <odified *ccelerated 'ost 0ecover) C)ste( 6<*'0C7 assu(es that8 on average8 assets will be placed in service: *. at the beginning of the ta? )ear. +. three (onths into the ta? )ear. '. halfwa) through the ta? )ear. ,. at the end of the ta? )ear. -. in the ne?t ta? )ear. *nswer: ' ./: # T)pe: 0' ##. * co(pan) used the net-present-value (ethod to anal)>e an invest(ent and found the invest(ent to be ver) attractive. If the fir( used straight-line depreciation and changes to the <odified *ccelerated 'ost 0ecover) C)ste( 6<*'0C78 the invest(ent9s net present value will: *. increase. +. re(ain the sa(e. '. decrease. ,. change8 but the direction cannot be deter(ined based on the data presented. -. fluctuate in an erratic (anner. *nswer: * ./: # T)pe: 4 #6. Pic3 'o(pan) received @ 88!!! cash fro( the sale of a (achine that had a @ $8!!! boo3 value. If the co(pan) is sub5ect to a $!% inco(e ta? rate8 the net cash flow to use in a discounted-cash-flow anal)sis would be: *. @$8#!!. +. @68#!!. '. @ "86!!. ,. @ 68#!!. -. @ %8#!!. *nswer: , ./: 6 T)pe: * #&. 0alston 'o(pan) received @&8!!! cash fro( the sale of a (achine that had an @ 8!!! boo3 value. If the co(pan) is sub5ect to a $!% inco(e ta? rate8 the net cash flow to use in a discounted-cash-flow anal)sis would be: *. @"8 !!. +. @48%!!. '. @#88!!. ,. @&8!!!. -. @88"!!. *nswer: - ./: 6 T)pe: *

24

Hilton, Managerial Accounting, Seventh Edition

#8. * (achine was sold in ,ece(ber "!?$ for @%8!!!. It was purchased in Ianuar) "!? for @ #8!!!8 and depreciation of @ "8!!! was recorded fro( the date of purchase through the date of disposal. *ssu(ing a 4!% inco(e ta? rate8 the after-ta? cash inflow at the ti(e of sale is: *. @$86!!. +. @686!!. '. @884!!. ,. @%8!!!. -. @ 84!!. *nswer: + ./: 6 T)pe: * #%. 0ogers 'o(pan) purchased equip(ent for @$!8!!! in ,ece(ber "!? . The equip(ent is e?pected to generate @ !8!!! per )ear of additional revenue and incur @"8!!! per )ear of additional cash e?penses8 beginning in "!?". Ander <*'0C8 depreciation in "!?" will be @$8!!!. If the fir(9s inco(e ta? rate is 4!%8 the after-ta? cash flow in "!?" would be: *. @$8"!!. +. @$86!!. '. @488!!. ,. @68!!!. -. so(e other a(ount. *nswer: , ./: 6 T)pe: * Ase the following to answer questions 6!-6 : Ia(es 'o(pan) has an asset that cost @#8!!! and currentl) has accu(ulated depreciation of @"8!!!. Cuppose the fir( sold the asset for @"8#!! and is sub5ect to a $!% inco(e ta? rate. 6!. The loss on disposal would be: *. @$#!. +. @#!!. '. @6#!. ,. @"8#!!. -. none8 because the transaction produced a gain. *nswer: + ./: 6 T)pe: * 6 . The net after-ta? cash flow of the disposal is: *. @"8 !!. +. @"8$#!. '. @"8#!!. ,. @"86#!. -. so(e other a(ount. *nswer: , ./: 6 T)pe: *

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6". 1right 'o(pan) is considering a five-)ear pro5ect that requires a t)pical invest(ent in wor3ing capital8 in this case8 @ !!8!!!. 'onsider the following state(ents about this situation: I.1right should include a @ !!8!!! outflow that occurs at ti(e ! in a discounted-cash-flow anal)sis. II.1right should include separate @ !!8!!! outflows in each )ear of the pro5ect9s five-)ear life. III.1right should include a @ !!8!!! recover) of its wor3ing-capital invest(ent in )ear # of a discounted-cash-flow anal)sis. 1hich of the above state(ents is 6are7 correct2 *. I onl). +. II onl). '. III onl). ,. I and II. -. I and III. *nswer: - ./: 6 T)pe: 0' 6$. * (achine is e?pected to produce annual savings in cash operating costs of @4!!8!!! for the ne?t si? )ears. If the fir( has a !% after-ta? hurdle rate and is sub5ect to a $!% inco(e ta? rate8 the correct discounted net cash flow would be: *. @#""86!!. +. @%4&8#"!. '. @ 8" %84!!. ,. @ 8&4"8!!!. -. so(e other a(ount. *nswer: ' ./: 6 T)pe: * 64. * (achine is e?pected to produce increases in cash operating costs of @"!!8!!! for the ne?t si? )ears. If the fir( has a 4% after-ta? hurdle rate and is sub5ect to a $!% inco(e ta? rate8 the correct discounted net cash flow would be: *. @6"$$8$4!7. +. @6#44846!7. '. @6&&&88!!7. ,. @6 8! 8 4!7. -. so(e other a(ount. *nswer: + ./: 6 T)pe: *

24!

Hilton, Managerial Accounting, Seventh Edition

6#. * new (achine is e?pected to produce a <*'0C deduction in three )ears of @#!8!!!. If the fir( has a "% after-ta? hurdle rate and is sub5ect to a $!% inco(e ta? rate8 the correct discounted net cash flow to include in an acquisition anal)sis would be: *. @!. +. @ !868!. '. @"48%"!. ,. @468"8!. -. so(e other a(ount. *nswer: + ./: 6 T)pe: * 66. In ! )ears8 Hop3ins 'o(pan) plans to receive @%8!!! cash fro( the sale of a (achine that has a @#8!!! boo3 value. If the co(pan) is sub5ect to a $!% inco(e ta? rate and has an 8% after-ta? hurdle rate8 the correct discounted net cash flow would be: *. @"8% 6.%!. +. @$86 .4!. '. @48 6&.!!. ,. @48&"".6!. -. so(e other a(ount. *nswer: + ./: 6 T)pe: * 6&. In eight )ears8 .arson 'o(pan) plans to receive @ 8!!! cash fro( the sale of a (achine that has a @ 68!!! boo3 value. If the co(pan) is sub5ect to a $!% inco(e ta? rate and has a "% after-ta? hurdle rate8 the correct discounted net cash flow would be: *. @6!6. +. @ 84 4. '. @$88$8. ,. @#8!#!. -. so(e other a(ount. *nswer: , ./: 6 T)pe: * 68. 1hich of the following tools is so(eti(es used to ran3 invest(ent proposals2 *. Profitabilit) inde?. +. *nnuit) inde?. '. Pro5ect assess(ent guide 6P*D7. ,. Invest(ent opportunit) inde?. -. 'apital ran3ing inde?. *nswer: * ./: & T)pe: 0'

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6%. If a proposal9s profitabilit) inde? is greater than one: *. the net present value is negative. +. the net present value is positive. '. the net present value is >ero. ,. none of the above8 because the net present value cannot be gauged b) the profitabilit) inde?. -. the proposal should be re5ected. *nswer: + ./: & T)pe: 4 &!. Ct. *ndrews ran3s invest(ents b) using the profitabilit) inde? 6PI7. The following data relate to Pro5ect L and Pro5ect =: Initial invest(ent Present value of inflows Pro5ect L @4!!8!!! 6!!8!!! Pro5ect = @ 8$!!8!!! 88!!8!!!

1hich pro5ect would be (ore attractive as 5udged b) its ran3ing8 and wh)2 *. Pro5ect L because the PI is .#!. +. Pro5ect = because the PI is .$8. '. Pro5ect L because the PI is !.6&. ,. Pro5ect = because the PI is !.&". -. +oth pro5ects would be equall) attractive in ter(s of ran3ing8 as indicated b) a positive PI. *nswer: * ./: & T)pe: * & . 1a3efield evaluates future pro5ects b) using the profitabilit) inde?. The co(pan) is currentl) reviewing five si(ilar pro5ects and (ust choose one of the following: Projec t 1 $ ' ( % Initial Investme nt $1 % ! #%! ) ! 1% ! ! Present Value of Cash Inflows $ "#! & 11 1 $ ! ! ! !

1hich pro5ect should 1a3efield select if the decision is based entirel) on the profitabilit) inde?2 *. Pro5ect . +. Pro5ect ". '. Pro5ect $. ,. Pro5ect 4. -. Pro5ect #.

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*nswer: , ./: & T)pe: *

Chapter 16

2 0

&". The pa)bac3 period is best defined as: *. initial invest(ent J annual after-ta? cash inflow. +. annual after-ta? cash inflow J initial invest(ent. '. initial invest(ent J useful life of invest(ent. ,. present value of the cash flows8 e?clusive of the initial invest(ent8 J initial invest(ent. -. initial invest(ent J present value of the cash flows8 e?clusive of the initial invest(ent. *nswer: * ./: 8 T)pe: 0' &$. 'onsider the following state(ents about the pa)bac3 period: I.*s shown in )our te?t8 the pa)bac3 period considers the ti(e value of (one). II.The pa)bac3 period can onl) be used if net cash inflows are unifor( throughout a pro5ect9s life. III.The pa)bac3 period ignores cash inflows that occur after the pa)bac3 period is reached. 1hich of the above state(ents is 6are7 correct2 *. I onl). +. II onl). '. III onl). ,. I and II. -. I8 II8 and III. *nswer: ' ./: 8 T)pe: 0' &4. * piece of equip(ent costs @$!8!!!8 and is e?pected to generate @88#!! of annual cash revenues and @ 8#!! of annual cash e?penses. The disposal value at the end of the esti(ated !-)ear life is @$8!!!. Ignoring inco(e ta?es8 the pa)bac3 period is: *. $.#$ )ears. +. $.86 )ears. '. 4."% )ears. ,. 6.%8 )ears. -. so(e other period of ti(e not noted above. *nswer: ' ./: 8 T)pe: *

2 1

Hilton, Managerial Accounting, Seventh Edition

&#.

Portland is considering the acquisition of new (achiner) that will produce unifor( benefits over the ne?t eight )ears. The following infor(ation is available: *nnual savings in cash operating costs: @$#!8!!! *nnual depreciation e?pense: @"#!8!!! If the co(pan) is sub5ect to a $!% ta? rate8 what deno(inator should be used to co(pute the (achiner)9s pa)bac3 period2 *. @&!8!!!. +. @ &!8!!!. '. @"4#8!!!. ,. @$"!8!!!. -. Co(e other a(ount. *nswer: , ./: 8 T)pe: *8 4

&6. Pinecrest is considering a @6!!8!!! invest(ent in new equip(ent that is anticipated to produce the following net cash inflows: =ear " $ 4 # 4et 'ash Inflows @ "!8!!! "#!8!!! !8!!! 8!8!!! 6!8!!!

If cash flows occur evenl) throughout a )ear8 the equip(ent9s pa)bac3 period is: *. 4 )ears8 " (onths. +. 4 )ears8 $ (onths. '. 4 )ears8 4 (onths. ,. # )ears. -. so(e other period of ti(e not noted above. *nswer: + ./: 8 T)pe: *8 4 &&. 1hich of the following pro5ect evaluation (ethods focuses on accounting inco(e rather than cash flows2 *. 4et present value. +. *ccounting rate of return. '. Internal rate of return. ,. Pa)bac3 period. -. 4one of the above. *nswer: + ./: 8 T)pe: 0'

Chapter 16

2 2

&8. The accounting rate of return focuses on the: *. total accounting inco(e over a pro5ect9s life. +. average accounting inco(e over a pro5ect9s life. '. average cash flows over a pro5ect9s life. ,. cash inflows fro( a pro5ect. -. ta? savings fro( a pro5ect. *nswer: + ./: 8 T)pe: 0' &%. 1hich of the following choices correctl) depicts whether discounted cash flows are used b) the (ethod noted when evaluating long-ter( invest(ents2 4et Internal 0ate *ccounting Present ;alue of 0eturn 0ate of 0eturn *. 4o 4o =es +. =es 4o =es '. =es 4o 4o ,. =es =es 4o -. =es =es =es *nswer: , ./: 8 T)pe: 0' 8!. 'onsider the following state(ents about the accounting rate of return: I.The accounting rate of return focuses on a pro5ect9s inco(e rather than its cash flows. II.'o(panies can figure the accounting rate of return on either the initial invest(ent figure or an average invest(ent figure. III.The accounting rate of return considers the ti(e value of (one). 1hich of the above state(ents is 6are7 correct2 *. I onl). +. II onl). '. III onl). ,. I and II. -. II and III. *nswer: , ./: 8 T)pe: 0'

2 3

Hilton, Managerial Accounting, Seventh Edition

8 . <ulligan 'orporation8 which is sub5ect to a $!% inco(e ta? rate8 is considering a @ #!8!!! asset that will result in the following over its seven-)ear life: Total revenue: @ 8 %!8!!! Total operating e?penses 6e?cluding depreciation7: @&&!8!!! Total depreciation: @ #!8!!! The accounting rate of return on the initial invest(ent is: *. 6%. +. 8%. '. "6%. ,. "8%. -. so(e other figure. *nswer: + ./: 8 T)pe: * 8". Can 0e(o has a @48!!!8!!! asset invest(ent and is sub5ect to a $!% inco(e ta? rate. 'ash inflows are e?pected to average @6!!8!!! before ta? over the ne?t few )earsB in contrast8 average inco(e before ta? is anticipated to be @#!!8!!!. The co(pan)9s accounting rate of return is: *. 8.&#%. +. !.#!%. '. ".#!%. ,. #.!!% -. so(e other figure. *nswer: * ./: 8 T)pe: * 8$. 1hen (a3ing invest(ent decisions that involve advanced (anufacturing s)ste(s8 the use of net present value: *. presents no special proble(s for the anal)st. +. often gives rise to net-present-value figures that are negative despite a (anager9s belief that the invest(ent is beneficial for the fir(. '. is not reco((ended. ,. often o(its a nu(ber of factors that are difficult to quantif) 6e.g.8 greater (anufacturing fle?ibilit)8 i(proved product qualit)8 and so forth7. -. is characteri>ed b) choices E+E and E,E above. *nswer: - ./: % T)pe: 0'

Chapter 16

2 4

84. Hunter 'orporation will evaluate a potential invest(ent in an advanced (anufacturing s)ste( b) use of the net-present-value 64P;7 (ethod. 1hich of the following s)ste( benefits is least li3el) to be o(itted fro( the 4P; anal)sis2 *. Cavings in operating costs. +. Dreater fle?ibilit) in the production process. '. I(proved product qualit). ,. Chorter (anufacturing c)cle ti(e. -. *bilit) to fill custo(er orders (ore quic3l). *nswer: * ./: % T)pe: 0'8 4 8#. * cash flow (easured in no(inal dollars is: *. the actual cash flow that we e?perience. +. the ad5ust(ent for a change in the dollar9s purchasing power. '. the discounted cash flow. ,. the realistic cash flow after ta?es. -. none of the above. *nswer: * ./: ! T)pe: 0' 86. * cash flow (easured in real dollars: *. is the actual cash flow that we e?perience. +. is the actual cash flow ad5usted for a change in the dollar9s purchasing power. '. is discounted to reflect the ti(e value of (one). ,. equals the cash flow (easured in no(inal dollars. -. coincides with the a(ount of conte(plated new invest(ent. *nswer: + ./: ! T)pe: 0' 8&. 'onsider the following state(ents about the accounting for inflation in a capital budgeting anal)sis: I.*n anal)st can use no(inal dollars in con5unction with a no(inal interest rate. II.*n anal)st can use real dollars in con5unction with a real interest rate. III.*n anal)st can use no(inal dollars in con5unction with a real interest rate. 1hich of the above state(ents is 6are7 correct2 *. I onl). +. II onl). '. III onl). ,. I and II. -. II and III. *nswer: , ./: ! T)pe: 0'

Hilton, Managerial Accounting, Seventh Edition

E'E(C"SES &et Present Value 88. Dreen is considering the replace(ent of so(e (achiner) that has >ero boo3 value and a current (ar3et value of @"88!!. /ne possible alternative is to invest in new (achiner) that costs @$!8!!!. The new equip(ent has a four-)ear service life and an esti(ated salvage value of @$8#!!8 will produce annual cash operating savings of @%84!!8 and will require a @"8"!! overhaul in )ear $. The co(pan) uses straight-line depreciation. 0equired: Prepare a net-present-value anal)sis of Dreen9s replace(ent decision8 assu(ing an 8% hurdle rate and no inco(e ta?es. Chould the (achiner) be acquired2 4ote: 0ound calculations to the nearest dollar. ./: T)pe: * @6$!8!!!7 ? .! @"88!! ? .! @%84!! ? $.$ " @6"8"!!7 ? !.&%4 @$8#!! ? !.&$# @6$!8!!!7 "88!! $ 8 $$ 6 8&4&7 "8#&$ @ 48&#%

*nswer: Purchase of new (achine Cale of old (achine 'ash operating savings /verhaul Calvage value Total

The (achiner) should be acquired because the invest(ent has a positive net present value.

Chapter 16

2 6

Deter)ination of Cash Flows* &et Present Value 8%. /n Ianuar) "8 "!? 8 0ebecca +rown purchased 8!! shares of +a>oo3a Teleco((unications co((on stoc3 at @$# per share. The co(pan) paid a @ .#! dividend per share on ,ece(ber "8 of that )ear8 and raised the a(ount b) @!.#! per share for a distribution on ,ece(ber "88 "!?". 0ebecca sold her entire invest(ent on ,ece(ber $!8 "!?"8 generating a @#8!!! gain on the sale of stoc3. 0equired: *. Prepare a dated listing of the cash inflows and outflows related to 0ebecca9s stoc3 invest(ent. Ignore inco(e ta?es. +. *ssu(e that 0ebecca has a !% hurdle rate for all invest(ents. 0ounding to the nearest dollar8 co(pute the net present value of her invest(ent in +a>oo3a and deter(ine whether she achieved her !% goal. ./: T)pe: *8 4 Purchase 68!! shares ? @$#7 ,ividend 68!! shares ? @ .#!7 ,ividend 68!! shares ? @".!!7 Cale 6@"88!!! K @#8!!!7 @6"88!!!7 8"!! 86!! $$8!!!

*nswer: *. Ianuar) "8 "!? ,ece(ber "88 "!? ,ece(ber "88 "!?" ,ece(ber $!8 "!?" +.

0ebecca achieved her goal8 as indicated b) the positive net present value. Purchase of shares ,ividend8 "!? ,ividend8 "!?" Cale of shares Total @6"88!!!7 ? .! @ 8"!! ? !.%!% @ 86!! ? !.8"6 @$$8!!! ? !.8"6 @6"88!!!7 8!% 8$"" "&8"#8 @ 86&

2 !

Hilton, Managerial Accounting, Seventh Edition

&et Present Value+ $utsourcin, %!. <ar3 Industries is currentl) purchasing part no. &6 fro( an outside supplier for @8! per unit. +ecause of supplier reliabilit) proble(s8 the co(pan) is considering producing the part internall) in a currentl) idle (anufacturing plant. *nnual volu(e over the ne?t si? )ears is e?pected to total $!!8!!! units at variable (anufacturing costs of @&# per unit. <ar3 (ust acquire @8!8!!! of new equip(ent if it reopens the plant. The equip(ent has a si?-)ear service life and a @ 48!!! salvage value8 and will be depreciated b) the straight-line (ethod. 0epairs and (aintenance are e?pected to average @#8"!! per )ear in )ears 4-68 and the equip(ent will be sold at the end of its life. 0equired: 0ounding to the nearest dollar8 use the net-present-value (ethod 6total-cost approach7 and a "% hurdle rate to deter(ine whether <ar3 should (a3e or bu) part no. &6. Ignore inco(e ta?es. ./: 8 $ T)pe: * *nswer: <ar3 is better off to (a3e part no. &6. +u): Purchase 6$!!8!!! units ? @8!7 <a3e: ;ariable (anufacturing costs 6$!!8!!! units ? @&#7 4ew equip(ent 0epairs and (aintenance -quip(ent sale Total

@6"48!!!8!!!7 ? 4.

@6%886648!!!7

@6""8#!!8!!!7 ? 4. @68!8!!!7 ? .! @6#8"!!7 ? 64. - ".4!"7 @ 48!!! ? !.#!&

@6%"84%&8#!!7 68!8!!!7 68888&7 &8!%8 @6%"8#&%8"8%7

Chapter 16

2 8

E-aluation of an "n-est)ent .nal/sis % . The *irwa)s 'o(pan) is planning a pro5ect that is e?pected to last for si? )ears and generate annual net cash inflows of @&#8!!!. The pro5ect will require the purchase of a @"8!8!!! (achine8 which is e?pected to have a salvage value of @ !8!!! at the end of the si?-)ear period. In addition to annual operating costs8 the (achine will require a @#!8!!! overhaul at the end of the fourth )ear. The co(pan) presentl) has a "% (ini(u( desired rate of return. +ased on this infor(ation8 an accountant prepared the following anal)sis: *nnual net cash inflow *nnual depreciation *nnual average cost of overhaul *verage annual inco(e @ &#8!!! @4#8!!! 88$$$ 6#$8$$$7 @ " 866&

0eturn on invest(ent M @" 866& J @"8!8!!! M &.&4% The accountant reco((ends that the pro5ect be re5ected because it does not (eet the co(pan)9s (ini(u( desired rate of return. Ignore inco(e ta?es. 0equired: *. 1hat criticis(6s7 would )ou (a3e of the accountant9s evaluation2 +. Ase the net-present-value (ethod and deter(ine whether the pro5ect should be accepted. '. +ased on )our answer in require(ent E+8E is the internal rate of return greater or less than "%2 -?plain. ./: T)pe: *8 4

*nswer: *. The accountant is focusing on inco(e rather than cash flows. The cash flows should be discounted to reflect the ti(e value of (one)8 and depreciation should be o(itted because of the absence of ta?es. +. Purchase price *nnual net cash inflows /verhaul Calvage value Total @6"8!8!!!7 ? .! @&#8!!! ? 4. @6#!8!!!7 ? !.6$6 @ !8!!! ? !.#!& @6"8!8!!!7 $!88$"# 6$ 88!!7 #8!&! @ 8#%#

The pro5ect should be accepted because the net present value is positive. '. The net present value is positive using a discount rate of "%. Thus8 the internal rate of return is greater than "%.

2 9

Hilton, Managerial Accounting, Seventh Edition

&et Present Value+ "nternal (ate of (eturn %". Harrison Township is stud)ing a &!!-acre site for a new landfill. The new site will save @&!8!!! in annual operating costs for ! )ears8 as Harrison currentl) uses the landfill of a neighboring (unicipalit). /ther data are: Purchase price per acre: @##! Cite preparation costs: @ !8!!! Hurdle rate: 6% Ignore inco(e ta?es. 0equired: *. Ase the net-present-value (ethod and deter(ine whether the landfill should be acquired. +. ,eter(ine the landfill9s appro?i(ate internal rate of return. ./: T)pe: * @6$8#8!!!7 ? .! @6 !8!!!7 ? .! @&!8!!! ? &.$6! @6$8#8!!!7 6 !8!!!7 # #8"!! @ "!8"!!

*nswer: *. Purchase price 6&!! ? @##!7 Cite preparation Cavings in operating costs Total

=es8 the landfill should be acquired because it has a positive net present value. +. .et L M present value factor @&!8!!!L M 6@$8#8!!! K @ !8!!!7 L M &.!& * review of annuit) factors for ! )ears finds an internal rate of return that falls between 6% 6&.$6!7 and 8% 66.& !7.

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$-er-iew of the "nternal (ate of (eturn %$. Dotha( 'orporation is considering the acquisition of a new (achine that costs @ 4%8!4!. The (achine is e?pected to have a four-)ear service life and will produce annual savings in cash operating costs of @4#8!!!. Dotha( evaluates invest(ents b) using the internal rate of return and ignores inco(e ta?es. 0equired: *. +riefl) define the internal rate of return. +. 1hat relationship holds true at the internal rate of return with respect to discounted cash inflows and discounted cash outflows2 1ith respect to net present value2 '. 'o(pute the (achine9s internal rate of return. ./: T)pe: *8 4

*nswer: *. The internal rate of return is the true econo(ic )ield on a pro5ect8 ta3ing the ti(e value of (one) into consideration. +. *t the internal rate of return8 the present value of the cash inflows equals the present value of the cash outflows. Thus8 the net present value is >ero. '. @ 4%8!4! J @4#8!!! M $.$ "8 which corresponds with the factor of an 8% return on a four)ear pro5ect.

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Cash0Flow Deter)ination* !ax0Free and !ax En-iron)ents %4. Ci(on 'o(pan) is considering a @#.4 (illion asset invest(ent that has a four-)ear service life and a @4!!8!!! salvage value. The invest(ent is e?pected to produce annual savings in cash operating costs of @86!8!!! and will require a @"#!8!!! overhaul in )ear $8 which is full)deductible for ta? purposes. Ci(on uses the net-present-value (ethod to anal)>e invest(ents. *sset invest(ents are depreciated b) the straight-line (ethod8 ignoring salvage values in related co(putations. 0equired: *. Ignoring inco(e ta?es8 deter(ine the 6pre-discounted7 cash-flow a(ounts that would be used in a net-present-value anal)sis for 6 7 the asset acquisition8 6"7 annual savings in cash operating costs8 6$7 annual straight-line depreciation8 647 the overhaul in )ear $8 and 6#7 disposal of the asset in )ear 4. 4ote cash outflows in parentheses. +. 0epeat require(ent E*8E assu(ing the co(pan) is sub5ect to a $!% inco(e ta? rate. ./: "8 48 6 T)pe: * *nswer: *. *sset acquisition: @6#84!!8!!!7 *nnual savings in cash operating costs: @86!8!!! *nnual straight-line depreciation: @! =ear $ overhaul: @6"#!8!!!7 =ear 4 asset disposal: @4!!8!!! +. *sset acquisition: @6#84!!8!!!7 *nnual savings in cash operating costs: @86!8!!! ? !.& M @6!"8!!! *nnual straight-line depreciation: @#84!!8!!! J 4 )ears M @ 8$#!8!!!B @ 8$#!8!!! ? !.$ M @4!#8!!! =ear $ overhaul: @6"#!8!!!7 ? !.& M @6 &#8!!!7 =ear 4 asset disposal: @#84!!8!!! - @#84!!8!!! accu(ulated depreciation M @! boo3 valueB @! boo3 value - @4!!8!!! salvage value M @4!!8!!! gainB @4!!8!!! gain ? !.$ M @6 "!8!!!7 added ta?B @4!!8!!! salvage value - @6 "!8!!!7 added ta? M @"8!8!!!

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262

Depreciation as a !ax Shield+ M.C(S+ Discounted Cash Flow %#. C(ith 'orporation recentl) purchased a @ 8"!!8!!! asset that has a three-)ear service life and no salvage value. The co(pan) is sub5ect to a $!% inco(e ta? rate and e(plo)s a "% afterta? hurdle rate in capital invest(ent decisions. <anage(ent is stud)ing whether to depreciate the asset b) using the straight-line (ethod or the <odified *ccelerated 'ost 0ecover) C)ste( 6<*'0C7. *ssu(e that the following <*'0C factors are in effect: )ear 8 $$%B )ear "8 4#%B )ear $8 #%B and )ear 48 &% 0equired: *. 'alculate the total depreciation e?pense that will be ta3en b) each of the (ethods under consideration. +. 'alculate the total ta? savings that will occur with each (ethod. '. /n the basis of )our calculations in part E+8E which of the two (ethods will (anage(ent li3el) prefer2 -?plain )our answer. ,. 'alculate the present value of the ta? savings under each (ethod. 0ound to the nearest dollar. ./: 48 #8 6 T)pe: *8 4 *nswer: *. +oth (ethods will result in the total asset cost of @ 8"!!8!!! being written off as depreciation e?pense. +. Ctraight-line: @ 8"!!8!!! J $ )ears M @4!!8!!! per )earB @4!!8!!! ? !.$! M @ "!8!!! annual ta? savings8 or @$6!8!!! over the asset9s entire life. <*'0C: =ear : @ =ear ": @ =ear $: @ =ear 4: @ 8"!!8!!! ? !.$$ ? !.$! 8"!!8!!! ? !.4# ? !.$! 8"!!8!!! ? !. # ? !.$! 8"!!8!!! ? !.!& ? !.$! @ 888!! 6"8!!! #48!!! "#8"!! @$6!8!!!

'. *lthough the total dollar a(ounts are the sa(e8 the ti(ing differs8 with <*'0C producing greater savings in the earlier part of the asset9s life. These dollar savings can be reinvested b) the business to generate additional returns8 as verified b) the present value calculations in require(ent E,.E ,. Ctraight-line: @ "!8!!! ? ".4!" <*'0C: =ear : @ 888!! ? !.8%$ =ear ": @ 6"8!!! ? !.&%& =ear $: @#48!!! ? !.& " =ear 4: @"#8"!! ? !.6$6
263

@"888"4! @ !68!88 "%8 4 $88448 68!"&

Hilton, Managerial Accounting, Seventh Edition

@"8%86&&

Chapter 16

264

Cash Flows (elated to .sset $wnership+ Discounted Cash Flow+ !axes %6. <organ 'orporation plans to purchase @ .# (illion of equip(ent in the not-too-distant future. The equip(ent will have a @$!!8!!! salvage value and will be depreciated over a si?-)ear service life b) the straight-line (ethod. <organ is sub5ect to a 4!% inco(e ta? rate. The co(pan)9s accountant is about to perfor( a net-present-value anal)sis8 assu(ing a "% after-ta? hurdle rate. 0equired: *. ,eter(ine the discounted cash flows that would be reflected in the anal)sis in )ear ! and )ear . +. ,eter(ine the discounted cash flow that would be reflected in the anal)sis in )ear 68 assu(ing that <organ sells the equip(ent for onl) @"#!8!!! because of a recent change in (ar3et conditions. ./: 48 6 T)pe: * *nswer: *. =ear !: @6 8#!!8!!!7 ? .! M @6 8#!!8!!!7 =ear : 6@ 8#!!8!!! - @$!!8!!!7 J 6 )ears M @"!!8!!!B @"!!8!!! ? !.4! ? !.8%$ M @& 844! +. 'ost .ess: *ccu(ulated depreciation +oo3 value Celling price .oss on sale Proceeds fro( sale Ta? savings on loss: @#!8!!! ? !.4! Total cash flow ,iscounted cash flow: @"&!8!!! ? !.#!& @ 8#!!8!!! 8"!!8!!! @ $!!8!!! "#!8!!! @ #!8!!! @ "#!8!!! "!8!!! @ "&!8!!! @ $688%!

26

Hilton, Managerial Accounting, Seventh Edition

Deter)ination of Cash Flows* Discountin,* !axes %&. =ou are reviewing so(e (aterial that deals with invest(ent anal)sis8 preparing for )our first da) on the 5ob at :ran3lin -nterprises. 'onsider the cash flows that follow. . ". $. 4. The i((ediate pa)(ent required to purchase a @6!!8!!! (illing (achine. Ctraight-line depreciation of @"!8!!! in )ear " of a long-ter( invest(ent. *nnual savings in cash operating costs of @#!8!!! over the ne?t eight )ears. Cale of a (achine for @$#8!!! at the end of its si?-)ear service life. The (achine has a boo3 value of @"#8!!!. #. * @68!!! equip(ent overhaul in )ear # that is full) deductible for inco(e ta? purposes. 0equired: 'alculate the discounted cash flow that is appropriate for each of the preceding ite(s. *ssu(e a !% after-ta? hurdle rate and a $!% inco(e ta? rate8 and round to the nearest dollar. ./: 48 6 T)pe: * *nswer: . @66!!8!!!7 ? .! M @66!!8!!!7 ". @"!8!!! ? !.$! M @68!!!B @68!!! ? !.8"6 M @48%#6 $. @#!8!!! ? !.&! M @$#8!!!B @$#8!!! ? #.$$# M @ 868&"# 4. @$#8!!! - @"#8!!! M @ !8!!! gainB @ !8!!! ? !.$! M @$8!!! ta?B @$#8!!! - @$8!!! M @$"8!!!B @$"8!!! ? !.#64 M @ 88!48 #. @668!!!7 ? !.&! M @648"!!7B @648"!!7 ? !.6" M @"86!8

Chapter 16

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&et Present Value+ !axes %8. The 1arren <achine Tool 'o(pan) is considering the addition of a co(puteri>ed lathe to its equip(ent inventor). The initial cost of the equip(ent is @6!!8!!!8 and the lathe is e?pected to have a useful life of five )ears and no salvage value. The cost savings and increased capacit) attributable to the (achine are esti(ated to generate increases in the fir(9s annual cash inflows 6before considering depreciation7 of @ 8!8!!!. The (achine will be depreciated as follows for ta? purposes: @"!!8!!! in )ear 8 @"668&!! in )ear "8 @88886! in )ear $8 and @44844! in )ear 4. 1arren is currentl) in the 4!% inco(e ta? brac3et. * !% after-ta? rate of return is desired. 0equired: *. 1hat is the net present value of the invest(ent2 0ound to the nearest dollar. +. Chould the (achine be acquired b) the fir(2 '. *ssu(e that the equip(ent will be sold at the end of its useful life for @ !!8!!!. If the depreciation a(ounts are not revised8 calculate the dollar i(pact of this change on the total net present value. ./: 48 #8 6 T)pe: *8 4 *nswer: *. Purchase price Increases in cost savings and capacit) <*'0C: =ear =ear " =ear $ =ear 4 Total +. '. @66!!8!!!7 ? .! @ 8!8!!! ? !.6! ? $.&% @"!!8!!! ? !.4! ? !.%!% @"668&!! ? !.4! ? !.8"6 @88886! ? !.4! ? !.&# @44844! ? !.4! ? !.68$ @66!!8!!!7 4!%84"8 &"8&"! 888 8 "686%4 "8 4 @ %8 !

=es8 the (achine should be acquired because it has a positive net present value. 'ost .ess: *ccu(ulated depreciation +oo3 value Celling price Dain on sale Proceeds fro( sale .ess: Ta? on gain 6@ !!8!!! ? !.4!7 Total cash flow ,iscounted cash flow: @6!8!!! ? !.6" The net present value will increase b) @$&8"6!. @6!!8!!! 6!!8!!! @ -!!8!!! @ !!8!!! @ !!8!!! 4!8!!! @ 6!8!!! @ $&8"6!

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Hilton, Managerial Accounting, Seventh Edition

&et Present Value+ !axes %%. 1orrell Industries is currentl) purchasing part no. 4#6 fro( an outside supplier for @%! per unit. +ecause of supplier reliabilit) proble(s8 the co(pan) is considering producing the part internall) in a currentl) idle (anufacturing plant. *nnual volu(e over the ne?t five )ears is e?pected to total 4!!8!!! units at variable (anufacturing costs of @88 per unit. 1orrell (ust acquire @"!!8!!! of new equip(ent if it reopens the plant. The equip(ent has a five-)ear service life and a @"!8!!! salvage value8 and will be depreciated b) the straight-line (ethod. 64ote: 1orrell ignores salvage values in depreciation calculations.7 4or(al equip(ent (aintenance is e?pected to total @ "8!!! in )ear 48 and the equip(ent will be sold at the end of its life. 0equired: 0ounding to the nearest dollar8 use the net-present-value (ethod 6total-cost approach7 and a "% after-ta? hurdle rate to deter(ine whether 1orrell should (a3e or bu) part no. 4#6. The co(pan) is sub5ect to a $!% inco(e ta? rate. ./: $8 48 6 T)pe: * *nswer: 1orrell is better off to (a3e part no. 4#6. +u): Purchase 64!!8!!! units ? @%! ? !.&!7 <a3e: ;ariable (anufacturing costs 64!!8!!! units ? @88 ? !.&!7 4ew equip(ent ,epreciation 6@"!!8!!! J # )ears M @4!8!!!B @4!8!!! ? !.$!7 <aintenance 6@ "8!!! ? !.&!7 -quip(ent sale 6@"!8!!! - @! boo3 value M @"!8!!! gainB @"!8!!! ? !.$! M @68!!! ta?B @"!8!!! - @68!!!7 Total @6"#8"!!8!!!7 ? $.6!# @6%!88468!!!7

@6"4864!8!!!7 ? $.6!# @6"!!8!!!7 ? .! @ "8!!! ? $.6!# @884!! ? !.6$6 @ 48!!! ? !.#6&

@68888"&8"!!7 6"!!8!!!7 4$8"6! 6#8$4"7 &8%$8 @6888%8 8$447

Chapter 16

268

&et Present Value+ "nternal (ate of (eturn+ Pa/1ac2+ !axes !!. 1e?ler 'orporation is considering the acquisition of a new (achine that costs @$#!8!!!. The (achine is e?pected to have a four-)ear service life and will produce annual savings in cash operating costs of @ !!8!!!. 1e?ler uses straight-line depreciation8 is sub5ect to a $!% inco(e ta? rate8 has an after-ta? hurdle rate of "%8 and rounds calculations to the nearest dollar. 0equired: *. ,eter(ine the annual after-ta? cash flows that result fro( acquisition of the (achine. +. *ssu(ing that )our answer in require(ent E*E totaled @ !84 !8 calculate the (achine9s: . 4et present value. Is the (achine an attractive invest(ent2 1h)2 ". Internal rate of return. Is the (achine an attractive invest(ent2 1h)2 $. Pa)bac3 period. ./: "8 $8 48 8 T)pe: 0'8 * *nswer: *+ 'ash operating costs: @ !!8!!! ? !.& M @&!8!!! ,epreciation ta? savings: @$#!8!!! J 4 )ears M @8&8#!!B @8&8#!! ? !.$ M @"68"#! ,+ 1+ $-'% ! . 4et present value ''%!'1 % $ -1(!)&%. The (achine is not considered an attractive invest(ent because it has a negative net present value. Initial invest(ent @6$#!8!!!7 ? .! @ !84 ! ? $.!$& @$#!8!!! J @ !84 ! M $. &!8 which corresponds with the factor of a !% return on a four-)ear pro5ect. Diven the hurdle rate of "%8 the (achine is not considered an attractive invest(ent. @$#!8!!! J @ !84 ! M $. & )ears

$+

'+

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Pa/1ac2+ .ccountin, (ate of (eturn+ &et Present Value ! . Ivor) 'orporation is reviewing an invest(ent proposal that has an initial cost of @#"8#!!. *n esti(ate of the invest(ent9s end-of-)ear boo3 value8 the )earl) after-ta? net cash inflows8 and the )earl) net inco(e are presented in the schedule below. The invest(ent9s salvage value at the end of each )ear is equal to boo3 value8 and there will be no salvage value at the end of the invest(ent9s life. Initial 'ost and +oo3 ;alue @$#8!!! " 8!!! !8#!! $8#!! ---=earl) *fterTa? 4et 'ash Inflows @"!8!!! &8#!! #8!!! "8#!! !8!!! @&#8!!! =earl) 4et Inco(e @ "8#!! $8#!! 48#!! #8#!! 68#! ! @""8#! !

=ear " $ 4 #

Ivor) uses a 4% after-ta? target rate of return for new invest(ent proposals. 0equired: *. 'alculate the pro5ect9s pa)bac3 period. +. 'alculate the accounting rate of return on the initial invest(ent. '. 'alculate the proposal9s net present value. 0ound to the nearest dollar. ./: 68 8 T)pe: * *nswer: *. The pro5ect9s pa)bac3 is $ )ears. +) the conclusion of this ti(e period8 Ivor) will have recovered the invest(ent9s cost of @#"8#!! 6@"!8!!! K @ &8#!! K @ #8!!! M @#"8#!!7. +. '. The accounting rate of return is 8.6%: *verage inco(e 6@""8#!! J # )ears M @48#!!7 J initial invest(ent 6@#"8#!!7 =ear !: @6#"8#!!7 ? .! =ear : @"!8!!! ? !.8&& =ear ": @ &8#!! ? !.&6% =ear $: @ #8!!! ? !.6&# =ear 4: @ "8#!! ? !.#%" =ear #: @ !8!!! ? !.# % @6#"8#!!7 &8#4! $84#8 !8 "# &84!! #8 %! @ 8" $

Chapter 16

2!0

Pa/1ac2+ .ccountin, (ate of (eturn+ &et Present Value+ Cash0Flow Deter)ination !". .ora? 'orporation is considering the acquisition of a new (achine that is e?pected to produce annual savings in cash operating costs of @$!8!!! before inco(e ta?es. The (achine costs @ !!8!!!8 has a useful life of five )ears8 and no salvage value. .ora? uses straight-line depreciation on all assets8 is sub5ect to a $!% inco(e ta? rate8 and has an after-ta? hurdle rate of 8%. 0equired: *. 'o(pute the (achine9s pa)bac3 period. +. 'o(pute the (achine9s accounting rate of return on the initial invest(ent. '. 'o(pute the (achine9s net present value. ./: 48 68 8 T)pe: * *nswer: *. ,epreciation: @ !!8!!! J # )ears M @"!8!!! *nnual after-ta? cash flows: 6@$!8!!! ? !.&!7 K 6@"!8!!! ? !.$!7 M @"&8!!! Pa)bac3: @ !!8!!! J @"&8!!! M $.& )ears +. '. *verage inco(e: 6@$!8!!! - @"!8!!!7 ? !.&! M @&8!!! *ccounting rate of return: @&8!!! J @ !!8!!! M &% Initial invest(ent Cavings in operating costs ,epreciation ta? savings 4et present value @6 !!8!!!7 ? .! @" 8!!! ? $.%%$ @68!!! ? $.%%$ @6 !!8!!!7 8$88#$ "$8%#8 @ &88

2!1

Hilton, Managerial Accounting, Seventh Edition

Pa/1ac2+ .ccountin, (ate of (eturn !$. 'ustard Treats8 which sells fro>en custard and sandwiches8 is considering a new site that will require a @ (illion invest(ent for land acquisition and construction costs. The following operating results are e?pected: Cales revenue .ess operating e?penses: :ood N supplies 1ages N salaries Insurance N ta?es Atilities ,epreciation /perating inco(e ,isregard inco(e ta?es. 0equired: *. If (anage(ent requires a pa)bac3 period of four )ears or less8 should the new site be opened2 1h)2 +. 'o(pute the accounting rate of return on the initial invest(ent. '. 1hat significant li(itation of pa)bac3 and the accounting rate of return is overco(e b) the net-present-value (ethod2 ./: 8 T)pe: *8 4 *nswer: *. *nnual net cash inflows: @6"!8!!! - 6@4&!8!!! - @#!8!!!7 M @"!!8!!! Pa)bac3: @ 8!!!8!!! J @"!!8!!! M # )ears 4o8 because the pa)bac3 fails to (eet (anage(ent9s guideline. +. @ #!8!!! J @ 8!!!8!!! M #% '. Pa)bac3 and the accounting rate of return ignore the ti(e value of (one)8 which is the foundation of the net-present-value (ethod. @6"!8!!! @" !8!!! 8!8!!! "!8!!! !8!!! #!8!!!

4&!8!!! @ #!8!!!

Chapter 16

2!2

D"SCUSS"$& %UES!"$&S Co)parisons 3etween &et Present Value and the "nternal (ate of (eturn !4. +oth net present value 64P;7 and the internal rate of return 6I007 have a reinvest(ent assu(ption. 0equired: *. Ctate the assu(ption for each (ethod. +. /ne of the advantages of the 4P; (ethod is that users can ad5ust for ris3 considerations. -?plain how this is done. ./: " T)pe: 0' *nswer: *. In the 4P; (ethod8 cash flows are assu(ed to be reinvested at the hurdle rate. 1ith the I008 cash flows are assu(ed to be reinvested at the sa(e rate as the pro5ect9s return. +. In the 4P; (ethod8 a higher hurdle rate can be used8 either for the entire anal)sis or for the esti(ated cash inflows 6savings7 that occur late in the pro5ect9s life. Postaudits !#. Postaudits are an i(portant part of capital budgeting. 0equired: *. 1hat is a postaudit of a capital invest(ent pro5ect2 +. 1hat are the benefits of a postaudit2 '. * (anager prepared an unsuccessful proposal for a capital pro5ect8 as her fir( decided not to fund and pursue the pro5ect. The (anager observed8 EThe co(pan)9s postaudit process will show that this pro5ect should have been funded.E 'o((ent on the (anager9s understanding of the postaudit process. ./: $ T)pe: 0' *nswer: *. * postaudit is a review of the actual cash flows generated b) a pro5ect and a co(parison of the actual net present value with the original8 anticipated net present value 6or I007. +. The postaudit provides an opportunit) to identif) proble(s in the i(ple(entation of a pro5ect8 changes in the pro5ect9s environ(ent8 errors in the esti(ation of cash flows8 or wea3nesses in the process b) which the pro5ect was developed. Hopefull)8 an organi>ation will learn fro( the postaudit and8 if appropriate8 change its wa)s so that past errors are not repeated. '. The (anager9s understanding of the postaudit process is incorrect. The postaudit is applied to pro5ects that are fundedOi(ple(ented. It is not a (echanis( to show what (ight have happened if a re5ected pro5ect had been accepted.

2!3

Hilton, Managerial Accounting, Seventh Edition

Depreciation as a !ax Shield !6. ,epreciation is often described as a Eta? shield.E 0equired: *. -?plain how depreciation provides such a shield. +. <*'0C is an accelerated depreciation s)ste(. -?plain how an accelerated s)ste( can provide a (ore beneficial ta? shield than8 sa)8 a straight-line depreciation s)ste(. ./: 48 # T)pe: 0' *nswer: *. ,epreciation does not require a cash outla). 6The cash outla) occurred when the asset was acquired.7 However8 depreciation reduces ta?able inco(e and consequentl)8 reduces the cash outflow for inco(e ta?es. Thus8 depreciation provides a reduction in cash outflows for inco(e ta?es8 or in other words8 shields so(e of a fir(9s inco(e. +. Ander an accelerated depreciation s)ste(8 the asset9s cost is written off (ore rapidl) than under the straight-line s)ste(. This leaves funds for re-invest(ent sooner8 thus allowing a fir( to generate greater returns because the (one) is invested for a longer period of ti(e. Profita1ilit/ "ndex !&. * profitabilit) inde? can be used to ran3 invest(ent proposals. 0equired: *. ,efine the profitabilit) inde?. +. Two pro5ects are under consideration. Pro5ect I has a net present value of @"!8!!! whereas pro5ect II has a net present value of @"!!8!!!. 1hich pro5ect is better2 -?plain. 1hat wea3ness in a net-present-value anal)sis does the profitabilit) inde? address2 ./: & T)pe: 0' *nswer: *. The profitabilit) inde? equals the present value of a pro5ect9s cash inflows divided b) the initial invest(ent. +. +oth pro5ects provide a return greater than the hurdle rate and both are acceptable. It is not possible to sa) which one is better. The profitabilit) inde? provides a ratio that is not influenced b) the si>e of the pro5ectPa li(itation of net-present-value 64P;7 anal)sis. Thus8 a pro5ect that has a greater 4P; and a greater profitabilit) inde? generall) will be (ore attractive than another pro5ect.

Chapter 16

2!4

!he Pa/1ac2 Method !8. The pa)bac3 (ethod is a popular wa) to anal)>e invest(ent proposals. 0equired: *. -?plain how the pa)bac3 period is deter(ined. Denerall) spea3ing8 fro( a pa)bac3 perspective8 which pro5ects are viewed to be the (ost attractive2 +. ,oes the pa)bac3 (ethod ta3e inco(e ta?es into consideration2 -?plain. '. 1hat are the deficiencies of the pa)bac3 (ethod2 ./: 8 T)pe: 0' *nswer: *. The pa)bac3 period is the ti(e required to recover the initial invest(ent. Pro5ects with the shortest pa)bac3 are generall) viewed as being the (ost attractive. +. =es8 the pa)bac3 period is based on net cash inflows to the fir( 6i.e.8 those after ta?es7. '. There are two (a5or deficiencies. The pa)bac3 (ethod co(pletel) ignores cash flows that occur after the pa)bac3 point has been reached. This (ethod also ignores the ti(e value of (one). 4ustification of "n-est)ents in .d-anced Manufacturin, S/ste)s !%. *n increased nu(ber of co(panies are investing in advanced (anufacturing s)ste(s. 0equired: *. <an) proposed advanced (anufacturing s)ste(s have a negative net present value when discounted-cash-flow anal)sis is used. -?plain several reasons behind this situation. +. Two (a5or benefits of advanced s)ste(s are greater fle?ibilit) in the (anufacturing process and i(prove(ents in product qualit). -?plain how these benefits can create proble(s when perfor(ing discounted-cash-flow anal)sis. ./: % T)pe: 0'8 4 *nswer: *. 4egative net present values (a) arise fro( several factors: the invest(ents are ver) costl)B the hurdle rate (a) be ver) high to co(pensate for pro5ect ris3B the ti(e hori>on (a) be too shortB and a nu(ber of benefits associated with the pro5ect (a) have been e?cluded fro( the anal)sis because of related quantification proble(s. +. Dreater fle?ibilit) in the (anufacturing process and i(prove(ents in product qualit) are ver) difficult to quantif). *s a result8 these ite(s (a) be e?cluded fro( a discountedcash-flow anal)sis8 decreasing an invest(ent9s attractiveness.

2!

Hilton, Managerial Accounting, Seventh Edition