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Exam 10: Planning for Capital Investments

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Question 31

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Generally, the unadjusted rate of return should be calculated based on the average investment rather than the amount of the original investment in a depreciable asset such as equipment.

A) True
B) False

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Question 32

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Which of the following statements about postaudits is correct?

A) A postaudit should be conducted at the time a capital investment is purchased.
B) The postaudit of a capital investment project should be made using the same analytical technique that was used in deciding to make the investment.
C) The purpose of postaudits is to improve a company's cost-volume-profit analysis.
D) The postaudit process uses expected cash flows and the company's cost of capital.

E) None of the above
F) A) and B)

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Question 33

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Indicate whether each of the following statements is true or false.If two capital investments both have positive net present values, both offer an actual rate of return that is higher than the required rate of return.Company M has two potential capital investments, each of which has a positive net present value. M can only accept one of the investments. In this situation, it should always accept the project that has the higher net present value.Net present value is calculated by dividing the present value of cash inflows by the present value of cash outflows associated with a capital investment.The present value index can be used to compare different capital investment projects.The higher the present value index, the lower the rate of return per dollar invested in the project.

An investment that costs $20,000 will produce annual cash flows of $5,000 for a period of 6 years. Further, the investment has an expected salvage value of $3,000. Given a desired rate of return of 12%, what will the investment generate? (Do not round your intermediate calculations. Round your answer to the nearest whole dollar.)

Matt needs to compute the present value of $5,000 to be received four years from now. He should multiply $5,000 by the appropriate present value interest factor obtained from the present value of $1 table.

Alcorn Company is considering purchasing equipment that costs $400,000. The equipment has an estimated useful life of 8 years and no salvage value. Alcorn believes that the annual cash inflows from using the equipment will be $80,000.Required: 1) Calculate the net present value of the equipment assuming that Alcorn's cost of capital is 12%. Is the equipment an acceptable investment? 2) Calculate the net present value of the equipment assuming that Alcorn's cost of capital is 10%. Is the equipment an acceptable investment? 3) What general conclusion can you reach from your results to parts 1) and 2)?

Gordon Company is considering a three-year capital investment that will return $150,000 per year. The present value of this annuity at the company's required rate of return of 12% is $360,275.Required: Complete the table that has been started below to show the return on investment at 12% and the amount of investment recovered each year. Remember that the investment balance should be zero at the end of the three years. (Round to the nearest whole dollar.) $\begin{array}{|c|c|c|c|c|c|}\hline & \text { a } & \text { b } & \text { c } & \text { d } & \\\hline & \text { Investment } & \text { Annual } & \text { Return on } & \text { Recovered } & \text { Year-end } \\\hline \text { Time } & \text { Balance During } & \text { Cash } & \text { Investment } & \text { Investment } & \text { Investment } \\\hline \text { Period } & \text { the Year } & \text { Inflow } & & & \text { Balance } \\\hline 1 & \$ 360,275 \\\hline 2 & & \\\hline 3 & & \\\hline\end{array}$

When the effect of income taxes is considered in a capital budgeting analysis, the amount of depreciation expense must be added back to after-tax income to calculate the annual cash inflow.

The compensation a company receives for investing in capital assets is referred to as a return on investment.

Seven Day Mini Mart is considering installing video games in its stores. The machines cost $300,000 and have an estimated six-year useful life. Ignore income taxes. The following projected income statement is provided: Required: 1) Seven Day Mini Mart would like to recoup its original investment in less than five years. Compute the payback period for the video game machine investment. Would you recommend that the machines be purchased? Why or why not? 2) Seven Day Mini Mart's target unadjusted rate of return is 12%. Compute the unadjusted rate of return on the original investment. Would you recommend that the machines be purchased? Why or why not? $\begin{array}{l|l|l|}\hline\text { Video game revenue } & & \$ 100,000 \\\hline \text { Less expenses: } & &\\\hline \text { Electricity, supplies, etc. } & \$ 2,000 \\\hline \text { Insurance } & 7,000 \\\hline \text { Maintenance } & 1,000 \\\hline \text { Depreciation } & 50,000 &60,000\\\hline\text { Net income }&&\$40,000\\\hline\\\hline\end{array}$

Cash outflows from a capital investment project include:

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

Assuming equal time intervals between the payments and a constant rate of return, which of the following cash flow patterns represents an annuity? $\begin{array} { | l | c | c | c | c | c | c | } \hline & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Year 4 } & \text { Year 5 } & \text { Year 6 } \\\hline \text { A) } & \$ 1,000 & \$ 1,000 & \$ 1,000 & \$ 1,000 & \$ 1,000 & \$ 1,000 \\\hline \text { B) } & \$ 500 & \$ - 0 - & \$ 500 & \$ 500 & \$ 500 & \$ - 0 - \\\hline \text { C) } & \$ 100 & \$ 200 & \$ 300 & \$ 400 & \$ 500 & \$ 600 \\\hline\end{array}$

For a capital investment project to be acceptable, it must generate a rate of return:

Mendez Company is considering a capital project that costs $16,000. The project will deliver the following cash flows: Using the incremental approach, the payback period for the investment is: $\begin{array} { | l | l | l | l | l | } \hline \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Year 4 } & \text { Year 5 } \\\hline \$ 8,000 & \$ 6,000 & \$ 5,000 & \$ 6,000 & \$ 5,000 \\\hline\end{array}$

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?

Which of the following is not a factor in explaining why the present value of a future dollar is less than one dollar?

The purposes of the postaudit for capital investments include all of the following except:

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.

Evergreen Company has two investment opportunities. Both investments cost $5,000 and will provide the same total future cash inflows. The cash receipt schedule for each investment is given below: Select the correct statement. $\begin{array} { | l | r | r | } \hline & \text { Investment I } & \text { Investment II } \\\hline \text { Period 1 } & \$ 1,000 & \$ 3,000 \\\hline \text { Period 2 } & 1,000 & 2,000 \\\hline \text { Period 3 } & 2,000 & 2,000 \\\hline \text { Period 4 } & \underline { 4,000 } & \underline { 1,000 } \\\hline \text { Total } & \underline { \$ 8,000 } & \underline { \$ 8,000 } \\\hline & & \\\hline\end{array}$