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Exam 12: Strategy and the Analysis of Capital Investments

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Question 51

Multiple Choice

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If the present value payback period is less than the life of the project, one may conclude that:

A) The project's internal rate of return (IRR) is less than the discount (hurdle) rate.
B) The project's accounting (book) rate of return exceeds the discount (hurdle) rate.
C) The project is not desirable in a present-value sense.
D) The project's net present value (NPV) is positive.
E) The project's IRR is equal to the weighted-average cost of capital.

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Question 52

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If a company must choose between two mutually exclusive investment projects, the best general method to employ for decision-making purposes is:

A) Cash-flow bailout.
B) Cash-flow break-even.
C) Net present value (NPV) .
D) Discounted payback.
E) Accounting (book) rate of return (ARR) , based on average investment over the life of each project.

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Question 53

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Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 10% on all investments. Rounded to the nearest whole percentage (e.g., 31.349% = 31%) , what is the annual accounting (book) rate of return (ARR) based on the initial investment?

For a typical capital investment project, the bulk of the investment-related cash outflow occurs:

Income tax effects are associated with all the following except:

Which of the following items has no after-tax consequences in the analysis of a capital investment proposal?

Fieldgard Inc. invested $800,000 in a project nine years ago. This project has generated $320,000 cash revenues per year and incurred $250,000 cash operating costs each year. The project qualified as 7-year property under MACRS (modified accelerated cost recovery system). Salvage value of this project (at the end of the tenth, and final, year of the project's life) is expected to be $200,000. The project required $80,000 net additional working capital at its inception and another $60,000 at the end of year 5. The combined increased working capital commitment is expected to be fully recoverable when the project terminates. The company is subject to a combined 40% income tax rate, t. Required: What is the expected total after-tax cash flow expected from this project next year (i.e., during the 10th and final year of the project's life)? Round answer to nearest whole number.

LaVar, Inc. has obtained probability estimates from its production and sales departments regarding the costs and selling prices it can anticipate for a new product line. The company is uncertain as to which combination of costs and selling prices will occur. The best method for determining the expected outcome of the investment, based on an assumed probability distribution associated both sales and costs, is:

Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 10% on all investments. What is the amount of net income (after taxes) in Year 2 of the investment? Round to the nearest whole number.

Paulsen Inc. is considering the purchase of a $700,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high demand and Paulsen is expected to be able to sell all that it can manufacture for the next five years. The government exempted taxes on profits from new investments to encourage capital investments. This legislation is not expected to be altered in the foreseeable future. The equipment is expected to have five years of useful life with no salvage value. The company employs straight-line depreciation. The net cash inflows are expected to be $180,000 each year for five years. Olsen uses a rate of 9% in evaluating its capital investment projects. Required: Round all answers to 2 decimal places (e.g., 0.12338 = 12.34%; 0.12333 = 12.33%). 1. Calculate the estimated payback period for this proposed investment. (Assume that cash inflows occur evenly throughout the year.) 2. Calculate the project's accounting rate of return (ARR) based on the initial investment. 3. Calculate the accounting rate of return (ARR) based on average investment, where the latter is defined as a simple average of beginning-of-project net book value and end-of-project net book value. 4. Calculate the internal rate of return (IRR) of this proposed investment. (Note: To answer this question, students need access either to Appendix C, Table 2 or to Excel.)

Quip Corporation wants to purchase a new machine for $300,000. Management predicts that the machine will produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with an assumed residual (salvage) value of $50,000. Quip's combined income tax rate, t, is 40%. What is the estimated accounting (book) rate of return (ARR) for the proposed investment, based on average investment? (Round answer to nearest whole number/percentage.)

Which of the following is not one of the four general classes of real options?

National Rodeo Association, a not-for-profit organization, is considering purchasing a new enterprise software system for $90,000. This investment is projected to have an eight-year useful life, and a salvage value of $8,800; the investment is projected to save the organization approximately $18,000 each year in operating costs. In addition to the cost of the software system, the association needs an increase of $5,000 in net working capital (other than cash) in the first year, which will not be released (that is, converted back to cash) until the end of eight years. Required: 1. What is the payback period for this proposed investment? (Assume that the cash flows, other than salvage value, occur evenly throughout the year. Round your answer to 2 decimal places, e.g., 2.452 years = 2.45 years.) 2. If the Association has a required rate of return of 10 percent, what is the net present value (NPV) of the proposed investment? Round your calculation to whole dollars (i.e., zero decimal points). (The PV annuity factor for 10%, 8 years is 5.335, while the PV $1 factor for 10%, 8 years is 0.467.) 3. What is the estimated internal rate of return (IRR) on this project (to the nearest whole percent)? (Note: The following present value factors are taken from the present value tables in Appendix C of Chapter 12, for an 8-year period.) $\begin{array}{|l|l|l|l|l|}\hline & @ 10 \% & @ 11 \% & @ 12 \% & @ 13 \% \\\hline \text { PV \$1 discount factor } & 0.467 & 0.434 & 0.404 & 0.376 \\\hline \text { PV annuity factor } & 5.335 & 5.146 & 4.968 & 4.799 \\\hline\end{array}$

The Analytic Hierarchy Process (AHP) is:

For a given income tax rate, t, after-tax cash operating receipts are calculated as follows:

Especially for projects with long lives, estimation of revenues (or benefits) , costs, and cash flows is a difficult task principally because of:

Sensitivity analysis is used in capital budgeting to

Accounting makes all the following contributions to the capital budgeting process except:

If the net present value (NPV) of an investment proposal is positive, it would indicate that the:

For dealing with uncertainty in the capital budgeting process, all of the following techniques can be used except: