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Exam 10: Planning for Capital Investments

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Question 1

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Mr.J's Bagels invested in a new oven for $14,000.The oven reduced the amount of time for baking which increased production and sales for five years by the following amounts of cash inflows: $\begin{array} { l l l l l } \text { Year } 1 & \text { Year 2 } & \text { Year 3 } & \text { Year 4 } & \text { Year 5 } \\\$ 8,000 & \$ 6,000 & \$ 5,000 & \$ 6,000 & \$ 5,000\end{array}$ Using the averaging method,the payback period for the investment in the oven would be:

A) 5.0 years.
B) 2.3 years.
C) 2.0 years.
D) 0.5 years.

E) C) and D)
F) B) and C)

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Question 2

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An investment that costs $40,000 will produce annual cash flows of $12,000 for a period of 4 years.Given a desired rate of return of 10%,what will the investment generate? (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.Do not round your intermediate calculations.Round your answer to the nearest whole dollar.)

A) A positive net present value of $38,038.
B) A positive net present value of $1,962.
C) A negative net present value of $38,038.
D) A negative net present value of $1,962.

E) All of the above
F) A) and B)

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Question 3

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Janelle Bates has just inherited $250,000 from her uncle's estate.She is considering opening a small sewing and fabric shop.She would need to purchase inventory costing $50,000.Janelle plans to rent a shop in a local shopping center for $12,000 per year.Fixtures,display equipment,and furniture will cost $18,000 and will be depreciated $3,000 per year for 5 years to its expected salvage value of $3,000.Operating costs will amount to $25,000 per year.Janelle estimates her revenues from sales and sewing services will total $65,000.Because Janelle believes she can earn a 10% return by investing in mutual funds,she does not want to start the business unless she can earn at least this rate.Ignore income taxes. (PV of $1 and PVA of $1)(Use appropriate factor(s)from the tables provided.) Required: 1)Prepare a schedule of expected cash flows for the proposed investment by completing the table provided below.In Column 1 enter a brief description of the cash flow.In Column 2 indicate whether the cash flow is an inflow (I)or an outflow (O).In Column 3 enter the years in which the cash flow will occur.For example,if the cash flow occurs immediately enter a 0.If the cash flow occurs each year,enter 1-5,etc.In Column 4 enter the cash flow amount. $\begin{array} { | l | c | c | c | } \hline \text { Item Description } & \text { Inflow/Outflow } & \text { Years } & \text { Amount } \\\hline\text { (Col. 1) } & \text { (Col. 2) } & \text { (Col. 3) } & \text { (Col. 4) } \\\hline & & & \\\hline & & & \\\hline & & & \\\hline & & & \\\hline & & & \\\hline & & & \\\hline\end{array}$ 2)What is the initial outlay for this capital investment (the amount of the cash flow at time = 0)? 3)What is the amount of the annual net cash flow for this capital investment? 4)What is the net present value of the proposed venture? Should Janelle proceed?

Select the incorrect statement concerning the internal rate of return (IRR) method of evaluating capital projects.

Kerwin Company is considering a purchase of equipment that costs $50,000.If the useful life is expected to be 5 years and Kerwin's required rate of return is 12%,what is the minimum annual cash inflow that the equipment must offer for the investment to be acceptable? (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.Do not round your intermediate calculations.Round your final answer to the nearest dollar.)

In Year 1,Chandler Company purchased equipment with an expected useful life of 5 years.The initial cost of the equipment was $85,000.Chandler's cost of capital is 12%.At the time it purchased the equipment,Chandler projected the following cash inflows from use of the equipment: $\begin{array} { l c } \text { Year } & \text { Projected Cash Inflow } \\1 & \$ 20,000 \\2 & \$ 30,000 \\3 & \$ 35,000 \\4 & \$ 25,000 \\5 & \$ 15,000\end{array}$ At the end of Year 5,the equipment had reached the end of its useful life.Chandler determined that it had actually generated the following cash flows: $\begin{array} { l c } \text { Year } & \text { Actual Cash Inflow } \\1 & \$ 10,000 \\2 & \$ 20,000 \\3 & \$ 30,000 \\4 & \$ 30,000 \\5 & \$ 30,000\end{array}$ (PV of $1 and PVA of $1)(Use appropriate factor(s)from the tables provided.) Required: 1)What was the net present value that Chandler calculated for the equipment when the company purchased the asset? 2)Calculate the net present value that the equipment achieved,based on the actual cash inflows. 3)Comment on the pattern of actual cash inflows,compared to the cash flows that had been projected. 4)Was the equipment in fact an acceptable investment,based on the cash flows actually achieved?

Nguyen Company has an opportunity to purchase an asset that will cost the company $36,000.The asset is expected to add $12,000 per year to the company's net income.Assuming the asset has a five-year useful life and zero salvage value,the unadjusted rate of return based on the average investment will be:

Southport Company is considering the purchase of a piece of equipment that costs $100,000.The equipment would be depreciated on a straight-line basis to its expected salvage value of $10,000 over its 10-year useful life.Assuming a tax rate of 40%,what is the annual amount of the depreciation tax shield provided by this investment?

Young Corporation is considering purchasing equipment that costs $80,000 and is expected to provide the following cash inflows over its five-year useful life: $\begin{array} { l r } \text { Year } & \text { Cash Inflow } \\1 & \$ 18,000 \\2 & \$ 22,000 \\3 & \$ 24,000 \\4 & \$ 16,000 \\5 & \$ 9,000\end{array}$ What is the payback period of this investment project? (Rounded to the nearest year.)

An investment that cost $30,000 provided annual cash inflows of $9,000 per year for five years.The desired rate of return is 10%.The internal rate of return from the investment is: (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

If a company has to pay a given amount of income taxes over the life of a capital investment,managers of the company should seek to pay the taxes as early as possible in the investment's life.

The present value index indicates the:

If a project has a positive net present value,its internal rate of return will exceed the firm's hurdle rate.

Which of the following statements describes the cost of capital?

The time value of money concept recognizes that a dollar today is worth more than a dollar tomorrow.Which of the following is not a factor in causing the present value of cash inflows to diminish over time?

Langdon Company is considering purchasing a capital investment that is expected to provide annual cash inflows of $10,000 per year for 3 years.Assuming that Langdon's required rate of return is 8%,what is the present value of these cash inflows? (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.Do not round your intermediate calculations.Round your final answer to the nearest dollar.)

Saget Company is considering the purchase of equipment that would cost $35,000 and offer annual cash inflows of $10,500 over its useful life of 5 years.Assuming a required rate of return of 8%,what is the net present value of this investment opportunity? (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Pierce Company is considering the purchase of new equipment that will cost $150,000.The equipment will save the company $48,000 per year in cash operating costs.The equipment has an estimated useful life of five years and no expected salvage value.The company's cost of capital is 12%. (PV of $1 and PVA of $1)(Use appropriate factor(s)from the tables provided.) Required: 1)Assuming the company is subject to a 40% tax rate,compute the net present value. 2)Compute the amount of the annual depreciation tax shield provided by the new equipment. 3)Should the equipment be purchased? Why or why not?

Cash outflows generated by capital investments include all of the following except:

Capital investment decisions involve all of the following,except: