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Test bank Managerial Accounting by Garrison (13e) Chapter
14
Accounting (Đại học Hà Nội)
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Chapter 14 Capital Budgeting Decisions
True/False Questions
1. When cash flows are uneven and vary from year to year, the internal rate of return
method is easier to use than the net present value method.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1,2 Level: Hard
2. For capital budgeting decisions, the net present value method is superior to the simple
rate of return method.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1,6 Level: Easy
3. Depreciation is included as a cash flow in capital budgeting decisions to ensure that
the original cost of the asset is fully recovered.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Medium
4. Even when done properly, the total-cost and incremental-cost approaches to choosing
between alternatives will sometimes yield different answers.
Ans: False AACSB: Analytic
AICPA FN: Reporting LO: 1
AICPA BB: Critical Thinking
Level: Medium
5. An increase in the expected salvage value at the end of a capital budgeting project will
have no effect on the internal rate of return for that project.
Ans: False AACSB: Analytic
AICPA FN: Reporting LO: 2
AICPA BB: Critical Thinking
Level: Medium
6. The intangible benefits of automation cannot be estimated with any accuracy and
therefore should be ignored in capital budgeting decisions.
Ans: False AACSB: Analytic
AICPA FN: Reporting LO: 3
AICPA BB: Critical Thinking
Level: Medium
7. When making preference decisions about competing investment proposals, the project
profitability index is superior to the internal rate of return.
Ans: True AACSB: Analytic
AICPA FN: Reporting LO: 4
AICPA BB: Critical Thinking
Level: Medium
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Chapter 14 Capital Budgeting Decisions
8. The project profitability index is computed by dividing the net present value of the
project by the investment required by the project.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Easy
9. In calculating the “investment required” for the project profitability index, the amount
invested should be reduced by any salvage recovered from the sale of old equipment.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Medium
10. The payback method is most appropriate for projects whose cash flows extend far into
the future.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 5 Level: Medium
11. When using the payback method, any cash flows for a project that occur after the
payback period are not considered in computing the payback period for that project.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 5 Level: Medium
12. The present value of a given future cash flow will increase as the discount rate
decreases.
Ans: False AACSB: Analytic
AICPA FN: Reporting LO: 7
AICPA BB: Critical Thinking
Level: Medium
13. If a company is operating at a profit, the cash inflow resulting from the depreciation
tax shield is computed by multiplying the depreciation deduction by one minus the tax
rate.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
14. All cash inflows are taxable.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy
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Chapter 14 Capital Budgeting Decisions
15. The after-tax benefit, or net cash inflow, realized from a particular taxable cash receipt
can be obtained by multiplying the cash receipt by one minus the tax rate.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy
Multiple Choice Questions
16. Suture Corporation's discount rate is 12%. If Suture has a 5-year investment project
that has a project profitability index of zero, this means that:
A) the net present value of the project is equal to zero.
B) the internal rate of return of the project is equal to the discount rate.
C) the payback period of the project is equal to the project's useful life.
D) both A and B above are true.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1,2,4,5 Level: Hard
17. Amster Corporation has not yet decided on the required rate of return to use in its
capital budgeting. This lack of information will prevent Amster from calculating a
project's:
A)
B)
C)
D)
Payback Net Present Value Internal Rate of Return
No
No
No
Yes
Yes
Yes
No
Yes
Yes
No
Yes
No
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1,2,5 Level: Medium Source: CMA, adapted
18. If income taxes are ignored, how is depreciation used in the following capital
budgeting techniques?
A)
B)
C)
D)
Internal Rate of Return Net Present Value
Excluded
Excluded
Excluded
Included
Included
Excluded
Included
Included
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1,2 Level: Medium Source: CPA, adapted
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Chapter 14 Capital Budgeting Decisions
19. If the net present value of a project is zero based on a discount rate of 16%, then the
internal rate of return is:
A) equal to 16%.
B) less than 16%.
C) greater than 16%.
D) cannot be determined from this data.
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1,2 Level: Medium
20. Three potential investment projects (A, B, and C) at Nit Corporation all require the
same initial investment, have the same useful life (3 years), and have no expected
salvage value. Expected net cash inflows from these three projects each year is as
follows:
A
B
C
Year 1......... $1,000 $2,000 $3,000
Year 2......... $2,000 $2,000 $2,000
Year 3......... $3,000 $2,000 $1,000
What can be determined from the information provided above?
A) the net present value of project C will be the highest.
B) the internal rate of return of projects A and C cannot be computed.
C) the net present value and the internal rate of return will be the same for all three
projects.
D) both A and B above.
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Hard
21. A project's net present value, ignoring income taxes, is affected by:
A) the net book value of an asset that is replaced.
B) the depreciation on an asset that is replaced.
C) the depreciation to be taken on assets used directly on the project.
D) proceeds from the sale of an asset that is replaced.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy Source: CPA, adapted
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Chapter 14 Capital Budgeting Decisions
22. A company has unlimited funds to invest at its discount rate. The company should
invest in all projects having:
A) an internal rate of return greater than zero.
B) a net present value greater than zero.
C) a simple rate of return greater than the discount rate.
D) a payback period less than the project's estimated life.
Ans: B AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy Source: CMA, adapted
23. When the cash flows are the same every period after the initial investment in a project,
the payback period is equal to:
A) the net present value.
B) the simple rate of return.
C) the factor of the internal rate of return.
D) the payback rate of return.
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2,5 Level: Hard Source: CMA, adapted
24. The internal rate of return method assumes that a project's cash flows are reinvested at
the:
A) internal rate of return.
B) simple rate of return.
C) required rate of return.
D) payback rate of return.
Ans: A AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium Source: CMA, adapted
25. (Ignore income taxes in this problem.) Which of the following would be used in the
calculation of the internal rate of return of an investment in new machinery to replace
old machinery?
A) The annual depreciation expense on the new machinery.
B) The cost of an overhaul that would be needed on the old machinery in three
years.
C) The salvage value of the old machinery in ten years.
D) both B and C above.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
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Chapter 14 Capital Budgeting Decisions
26. The project profitability index and the internal rate of return:
A) will always result in the same preference ranking for investment projects.
B) will sometimes result in different preference rankings for investment projects.
C) are less dependable than the payback method in ranking investment projects.
D) are less dependable than net present value in ranking investment projects.
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4,5 Level: Medium
27. Zonifugal Corporation needs to purchase a new conveyor system for its factory. Four
different conveyor systems have been proposed. Which calculation would be the best
one for Zonifugal to use to determine which system to purchase?
A) payback period
B) simple rate of return
C) net present value
D) project profitability index
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Medium
28. A preference decision:
A) is concerned with whether a project clears the minimum required rate of return
hurdle.
B) comes before the screening decision.
C) is concerned with determining which of several acceptable alternatives is best.
D) responses A, B, and C are all correct.
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Easy
29. In an equipment investment decision, which of the following amounts would be
unaffected by a change in the tax rate?
A) the present value of the initial investment in the equipment.
B) the present value of the increase in working capital needed.
C) the present value of the salvage value of the equipment.
D) both A and B above.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
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Chapter 14 Capital Budgeting Decisions
30. When evaluating a project, the portion of the fixed corporate headquarters expense
that would be allocated to the project should be:
A) included as a cash outflow on an after-tax basis by multiplying the expense by
one minus the tax rate.
B) included as a cash outflow on an after-tax basis by multiplying the expense by
the tax rate.
C) included as a cash outflow on a before-tax basis.
D) ignored.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Hard
31. (Ignore income taxes in this problem.) Given the following data:
Cost of equipment..............
Annual cash inflows...........
Internal rate of return.........
$55,750
$10,000
16%
The life of the equipment must be:
A) it is impossible to determine from the data given
B) 15 years
C) 12.5 years
D) 5.75 years
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Hard
Solution:
The internal rate of return factor is 5.575, or $55,750 ÷ $10,000. In the table for the
Present Value of an Annuity of $1 in Arrears, the factor of 5.575 can be found in the
16% column in the 15th row; 15 then represents the life of the equipment.
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Chapter 14 Capital Budgeting Decisions
32. (Ignore income taxes in this problem.) Heap Company is considering an investment in
a project that will have a two year life. The project will provide a 10% internal rate of
return, and is expected to have a $40,000 cash inflow the first year and a $50,000 cash
inflow in the second year. What investment is required in the project?
A) $74,340
B) $77,660
C) $81,810
D) $90,000
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1,2 Level: Hard Source: CMA, adapted
Solution:
st
Cash inflow−1 year..........
Cash inflow−2nd year..........
Net present value................
Year(s)
1
2
Amount
40,000
50,000
10% Factor
0.909
0.826
PV
$36,360
41,300
$77,660
For the net present value of this project to be zero, the initial investment should be
equal to the present value of the cash inflows, or $77,660.
33. (Ignore income taxes in this problem.) Congener Beverage Corporation is considering
an investment in a capital budgeting project that has an internal rate of return of 20%.
The only cash outflow for this project is the initial investment. The project is estimated
to have an 8 year life and no salvage value. Cash inflows from this project are
expected to be $100,000 per year in each of the 8 years. Congener's discount rate is
16%. What is the net present value of this project?
A) $5,215
B) $15,464
C) $50,700
D) $55,831
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1,2 Level: Hard
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Chapter 14 Capital Budgeting Decisions
Solution:
Internal rate of return factor = Initial investment ÷ Annual inflows
Look up the factor in the table Present Value of an Annuity of $1 in Arrears for 8
periods, 20% column; the factor is 3.837. Substituting into the above equation, 3.837 =
Initial investment ÷ $100,000
Initial investment = $383,700.
Initial investment...............
Annual net cash receipts....
Net present value................
Year(s)
Amount 16% Factor
PV
Now ($383,700)
1.000
($383,700)
434,400
1-8
$100,000
4.344
$ 50,700
34. (Ignore income taxes in this problem.) The Able Company is considering buying a
new donut maker. This machine will replace an old donut maker that still has a useful
life of 2 years. The new machine will cost $2,500 a year to operate, as opposed to the
old machine, which costs $2,700 per year to operate. Also, because of increased
capacity, an additional 10,000 donuts a year can be produced. The company makes a
contribution margin of $0.02 per donut. The old machine can be sold for $5,000 and
the new machine costs $25,000. The incremental annual net cash inflows provided by
the new machine would be:
A) $200
B) $400
C) $5,200
D) $5,400
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Hard
Solution:
Operating cost savings per year ($2,700 − $2,500)........................
Additional contribution margin provided by the new donut maker
($0.02 × 10,000)..........................................................................
Incremental annual net cash inflows provided by new machine....
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$200
200
$400
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Chapter 14 Capital Budgeting Decisions
35. (Ignore income taxes in this problem.) Given the following data:
Initial investment...............
Annual cash inflow............
Salvage value.....................
Net present value................
Life of the project...............
Discount rate......................
$80,000
?
$0
$13,600
6 years
16%
Based on the data given above, the annual cash inflow from the project after the initial
investment is closest to:
A) $50,116
B) $21,710
C) $25,400
D) $38,376
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Hard
Solution:
First, set up table:
Initial investment...............
Annual cash inflows...........
Net present value................
Year(s)
Now
1-6
Amount 16% Factor
$80,000
1.000
?
3.685
PV
($80,000)
?
$13,600
Second, solve for the present value of the annual cash inflow:
PV of annual cash inflow = $13,600 − (-$80,000) = $93,600
Finally, solve for the annual cash inflow:
Annual cash inflow × 3.685 = $93,600
Annual cash inflow = $25,400
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Chapter 14 Capital Budgeting Decisions
36. (Ignore income taxes in this problem.) Virginia Company invested in a four-year
project. Virginia's discount rate is 10%. The cash inflows from this project are:
Year Cash Inflow
1
$4,000
2
$4,400
3
$4,800
4
$5,200
Assuming a positive net present value of $1,000, the amount of the original investment
was closest to:
A) $2,552
B) $4,552
C) $13,427
D) $17,400
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Hard Source: CPA, adapted
Solution:
Net present value of cash inflows − Original investment = Net present value of project
Original investment = NPV of cash inflows − NPV of project
= $14,427 − $1,000 = $13,427
Year 1 inflow................................
Year 2 inflow................................
Year 3 inflow................................
Year 4 inflow................................
Net present value of cash inflows
Year(s)
1
2
3
4
Amount
$4,000
$4,400
$4,800
$5,200
10% Factor
0.909
0.826
0.751
0.683
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PV
$ 3,636
3,634
3,605
3,552
$14,427
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Chapter 14 Capital Budgeting Decisions
37. (Ignore income taxes in this problem.) Para Corporation is reviewing the following
data relating to an energy saving investment proposal:
Initial investment...............
Life of the project...............
Salvage value.....................
Annual cash savings...........
$50,000
5 years
$10,000
?
What annual cash savings would be needed in order to satisfy the company's 12%
required rate of return (rounded to the nearest one hundred dollars)?
A) $10,600
B) $11,100
C) $12,300
D) $13,900
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Hard Source: CPA, adapted
Solution:
Total investment.................
Annual cash savings...........
Salvage value.....................
Net present value................
Years Amount 12% Factor
Now ($50,000)
1.000
1-5
?
3.605
5
$10,000
0.567
Present Value
($50,000)
?
5,670
$
0
To solve for the present value of the annual cash savings:
-$50,000 + PV of annual cash savings + $5,670 = $0
PV of annual cash savings = $44,330
To solve for the amount of the annual cash savings:
Amount of annual cash savings × 3.605 = $44,330
Amount of annual cash savings = $12,297, which rounds to $12,300
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Chapter 14 Capital Budgeting Decisions
38. (Ignore income taxes in this problem.) Nevus Tattoo Parlor is considering a capital
budgeting project. This project will initially require a $25,000 investment in
equipment and a $3,000 working capital investment. The useful life of this project is 5
years with an expected salvage value of zero on the equipment. The working capital
will be released at the end of the 5 years. The new system is expected to generate net
cash inflows of $9,000 per year in each of the 5 years. Nevus' discount rate is 14%.
The net present value of this project is closest to:
A) $(3,088)
B) $3,383
C) $4,454
D) $5,897
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Medium
Solution:
Initial investment...............
Working capital needed......
Annual cost savings...........
Working capital released....
Net present value................
Year(s)
Now
Now
1-5
5
Amount 14% Factor
($25,000)
1.000
($3,000)
1.000
$9,000
3.433
$3,000
0.519
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PV
($25,000)
( 3,000)
30,897
1,557
$ 4,454
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Chapter 14 Capital Budgeting Decisions
39. (Ignore income taxes in this problem.) The Malaise Prevention Agency is a non-profit
organization that does all of its own informational printing. The printing press that
Malaise currently is using needs a $20,000 overhaul. This will extend the useful life of
the press by 8 years. As an alternative, Malaise could buy a brand new modern press
for $45,000. The new press would also last 8 years. The annual operating expenses of
the old press are $12,000. The annual operating expenses of the new press will only be
$7,000. The old press is not expected to have a salvage value in 8 years. The new press
is expected to have a $6,000 salvage value in 8 years. Malaise's discount rate is 14%.
The net present value of the decision to buy the new press instead of overhauling the
old press is closest to:
A) $301
B) $(301)
C) $4,195
D) $(46,089)
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Hard
Solution:
Initial investment...............
Annual cost savings
($12,000 − $7,000).........
Salvage value.....................
Net present value of new
press................................
Year(s)
Now
1-8
8
Amount 14% Factor
($45,000)
1.000
$5,000
$6,000
4.639
0.351
PV
($45,000)
23,195
2,106
($19,699)
Cost to overhaul old press................ $20,000
NPV of new press............................. 19,699
NPV of new press vs. old press........ $ 301
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Chapter 14 Capital Budgeting Decisions
40. (Ignore income taxes in this problem.) Nevland Corporation is considering the
purchase of a machine that would cost $130,000 and would last for 6 years. At the end
of 6 years, the machine would have a salvage value of $18,000. By reducing labor and
other operating costs, the machine would provide annual cost savings of $44,000. The
company requires a minimum pretax return of 19% on all investment projects. The net
present value of the proposed project is closest to:
A) $38,040
B) $26,376
C) $74,902
D) $20,040
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Initial investment...............
Annual cost savings...........
Salvage value.....................
Net present value................
Year(s)
Amount 19% Factor
PV
Now ($130,000)
1.000
($130,000)
1-6
$44,000
3.410
150,040
6,336
6
$18,000
0.352
$ 26,376
41. (Ignore income taxes in this problem) The management of Penfold Corporation is
considering the purchase of a machine that would cost $440,000, would last for 7
years, and would have no salvage value. The machine would reduce labor and other
costs by $102,000 per year. The company requires a minimum pretax return of 16% on
all investment projects. The net present value of the proposed project is closest to:
A) -$28,022
B) $96,949
C) -$79,196
D) $274,000
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Initial investment...............
Annual cost savings...........
Net present value................
Year(s)
Amount 16% Factor
PV
Now ($440,000)
1.000
($440,000)
411,978
1-7
$102,000
4.039
($ 28,022)
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Chapter 14 Capital Budgeting Decisions
42. (Ignore income taxes in this problem.) Dowlen, Inc., is considering the purchase of a
machine that would cost $150,000 and would last for 6 years. At the end of 6 years,
the machine would have a salvage value of $23,000. The machine would reduce labor
and other costs by $36,000 per year. Additional working capital of $6,000 would be
needed immediately. All of this working capital would be recovered at the end of the
life of the machine. The company requires a minimum pretax return of 12% on all
investment projects. The net present value of the proposed project is closest to:
A) $9,657
B) -$2,004
C) $6,699
D) $13,223
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Initial investment...............
Working capital needed......
Annual cost savings...........
Working capital released....
Salvage value.....................
Net present value................
Year(s)
Amount 12% Factor
PV
Now ($150,000)
1.000
($150,000)
Now
($6,000)
1.000
(6,000)
1-6
$36,000
4.111
147,996
6
$6,000
0.507
3,042
11,661
6
$23,000
0.507
$ 6,699
43. (Ignore income taxes in this problem.) The Poteran Company is considering a machine
that will save $3,000 a year in cash operating costs each year for the next six years. At
the end of six years it would have no salvage value. If this machine costs $9,060 now,
the machine's internal rate of return is closest to:
A) 18%
B) 20%
C) 22%
D) 24%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $9,060 ÷ $3,000 = 3.020
The factor of 3.020 for 6 years represents an internal rate of return of 24%.
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Chapter 14 Capital Budgeting Decisions
44. (Ignore income taxes in this problem) The management of Elamin Corporation is
considering the purchase of a machine that would cost $365,695 and would have a
useful life of 9 years. The machine would have no salvage value. The machine would
reduce labor and other operating costs by $61,000 per year. The internal rate of return
on the investment in the new machine is closest to:
A) 9%
B) 11%
C) 12%
D) 10%
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Easy
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $365,695 ÷ $61,000 = 5.995
The factor of 5.995 for 9 years represents an internal rate of return of 9%.
45. (Ignore income taxes in this problem.) Bau Long-Haul, Inc., is considering the
purchase of a tractor-trailer that would cost $281,656, would have a useful life of 7
years, and would have no salvage value. The tractor-trailer would be used in the
company's hauling business, resulting in additional net cash inflows of $76,000 per
year. The internal rate of return on the investment in the tractor-trailer is closest to:
A) 19%
B) 18%
C) 21%
D) 16%
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Easy
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $281,656 ÷ $76,000 = 3.706
The factor of 3.706 for 7 years represents an internal rate of return of 19%.
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Chapter 14 Capital Budgeting Decisions
46. (Ignore income taxes in this problem.) Golab Roofing is considering the purchase of a
crane that would cost $69,846, would have a useful life of 6 years, and would have no
salvage value. The use of the crane would result in labor savings of $21,000 per year.
The internal rate of return on the investment in the crane is closest to:
A) 18%
B) 20%
C) 19%
D) 17%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Easy
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $69,846 ÷ $21,000 = 3.326
The factor of 3.326 for 6 years represents an internal rate of return of 20%.
47. (Ignore income taxes in this problem) Boe Corporation is investigating buying a small
used aircraft for the use of its executives. The aircraft would have a useful life of 9
years. The company uses a discount rate of 10% in its capital budgeting. The net
present value of the investment, excluding the salvage value of the aircraft, is $439,527. Management is having difficulty estimating the salvage value of the
aircraft. To the nearest whole dollar how large would the salvage value of the aircraft
have to be to make the investment in the aircraft financially attractive?
A) $439,527
B) $43,953
C) $4,395,270
D) $1,036,620
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $439,527 ÷ 0.424 = $1,036,613 (answer is slightly off due to rounding)
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Chapter 14 Capital Budgeting Decisions
48. (Ignore income taxes in this problem) The management of Byrge Corporation is
investigating buying a small used aircraft to use in making airborne inspections of its
above-ground pipelines. The aircraft would have a useful life of 8 years. The company
uses a discount rate of 10% in its capital budgeting. The net present value of the
investment, excluding the intangible benefits, is -$448,460. To the nearest whole
dollar how large would the annual intangible benefit have to be to make the
investment in the aircraft financially attractive?
A) $44,846
B) $56,058
C) $84,060
D) $448,460
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $448,460 ÷ 5.335 = $84,060
49. (Ignore income taxes in this problem) The management of Osborn Corporation is
investigating an investment in equipment that would have a useful life of 8 years. The
company uses a discount rate of 12% in its capital budgeting. The net present value of
the investment, excluding the annual cash inflow, is -$401,414. To the nearest whole
dollar how large would the annual cash inflow have to be to make the investment in
the equipment financially attractive?
A) $48,170
B) $50,177
C) $80,800
D) $401,414
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum annual cash flows
= Negative net present value to be offset ÷ Present value factor
= $401,414 ÷ 4.968 = $80,800
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Chapter 14 Capital Budgeting Decisions
50. (Ignore income taxes in this problem.) Croce, Inc., is investigating an investment in
equipment that would have a useful life of 7 years. The company uses a discount rate
of 8% in its capital budgeting. The net present value of the investment, excluding the
salvage value, is -$515,967. To the nearest whole dollar how large would the salvage
value of the equipment have to be to make the investment in the equipment financially
attractive?
A) $41,277
B) $885,021
C) $515,967
D) $6,449,588
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $515,967 ÷ 0.583 = $885,021
51. A project has an initial investment of $100,000 and a project profitability index of
0.15. The discount rate is 12%. The net present value of the project is closest to:
A) $15,000
B) $115,000
C) $112,000
D) $12,000
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Medium Source: CMA, adapted
Solution:
Project profitability index = Net present value ÷ Investment required
0.15 = Net present value ÷ $100,000
Net present value = $15,000
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Chapter 14 Capital Budgeting Decisions
52. A company is pondering an investment project that has an internal rate of return which
is equal to the company's discount rate. The project profitability index of this
investment project is:
A) 0.0
B) 0.5
C) 1.0
D) 1.5
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Medium
53. (Ignore income taxes in this problem.) The management of Solar Corporation is
considering the following three investment projects:
Investment required.......................
Present value of cash inflows.........
Project L Project M Project N
$37,000 $55,000
$82,000
$38,480 $62,150
$90,200
Rank the projects according to the profitability index, from most profitable to least
profitable.
A) M,N,L
B) L,N,M
C) N,L,M
D) N,M,L
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Easy
Solution:
Investment required (a).........................
Present value of cash inflows...............
Net present value (b).............................
Project profitability index (b) ÷ (a).......
Ranked by project profitability index...
Project L Project M Project N
($37,000) ($55,000) ($82,000)
38,480
62,150
90,200
$ 1,480
$ 7,150
$ 8,200
0.04
0.13
0.10
3
1
2
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Chapter 14 Capital Budgeting Decisions
54. (Ignore income taxes in this problem.) Trovato Corporation is considering a project
that would require an investment of $48,000. No other cash outflows would be
involved. The present value of the cash inflows would be $51,840. The profitability
index of the project is closest to:
A) 0.07
B) 0.08
C) 0.92
D) 1.08
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Easy
Solution:
Investment required (a).........................
Present value of cash inflows...............
Net present value (b).............................
Project profitability index (b) ÷ (a).......
Project Q
($48,000)
51,840
$ 3,840
0.08
55. (Ignore income taxes in this problem.) Ryner Corporation is considering three
investment projects-S, T, and U. Project S would require an investment of $20,000,
Project T of $69,000, and Project U of $83,000. No other cash outflows would be
involved. The present value of the cash inflows would be $23,200 for Project S,
$77,970 for Project T, and $94,620 for Project U. Rank the projects according to the
profitability index, from most profitable to least profitable.
A) U,T,S
B) T,S,U
C) U,S,T
D) S,U,T
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Easy
Solution:
Project S Project T Project U
Investment required (a)......................... ($20,000) ($69,000) ($83,000)
Present value of cash inflows...............
23,200
77,970
94,620
Net present value (b)............................. $ 3,200
$ 8,970
$11,620
Project profitability index (b) ÷ (a).......
0.16
0.13
0.14
Ranked by project profitability index...
1
3
2
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Chapter 14 Capital Budgeting Decisions
56. (Ignore income taxes in this problem.) The management of Leitheiser Corporation is
considering a project that would require an initial investment of $51,000. No other
cash outflows would be required. The present value of the cash inflows would be
$57,630. The profitability index of the project is closest to:
A) 1.13
B) 0.87
C) 0.13
D) 0.12
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Easy
Solution:
Project Q
Investment required (a)......................... ($51,000)
57,630
Present value of cash inflows...............
Net present value (b)............................. $ 6,630
Project profitability index (b) ÷ (a).......
0.13
57. (Ignore income taxes in this problem.) Olinick Corporation is considering a project
that would require an investment of $343,000 and would last for 8 years. The
incremental annual revenues and expenses generated by the project during those 8
years would be as follows:
Sales...................................
Variable expenses...............
Contribution margin...........
Fixed expenses:
Salaries............................
Rents...............................
Depreciation....................
Total fixed expenses...........
Net operating income.........
$227,000
52,000
175,000
27,000
41,000
40,000
108,000
$ 67,000
The scrap value of the project's assets at the end of the project would be $23,000. The
payback period of the project is closest to:
A) 3.0 years
B) 5.1 years
C) 3.2 years
D) 4.8 years
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 5 Level: Easy
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Chapter 14 Capital Budgeting Decisions
Solution:
Net annual cash flow = Net operating income + Depreciation
= $67,000 + $40,000 = $107,000
Payback period = Investment required ÷ Net annual cash flow
= $343,000 ÷ $107,000 = 3.2 years
In this case the salvage value plays no part in the payback period since all of the
investment is recovered before the end of the project.
58. (Ignore income taxes in this problem.) The management of Lanzilotta Corporation is
considering a project that would require an investment of $263,000 and would last for
8 years. The annual net operating income from the project would be $66,000, which
includes depreciation of $31,000. The scrap value of the project's assets at the end of
the project would be $15,000. The payback period of the project is closest to:
A) 3.8 years
B) 2.6 years
C) 2.7 years
D) 4.0 years
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 5 Level: Easy
Solution:
Net annual cash flow = Net operating income + Depreciation
= $66,000 + $31,000 = $97,000
Payback period = Investment required ÷ Net annual cash flow
= $263,000 ÷ $97,000 = 2.7 years
In this case the salvage value plays no part in the payback period since all of the
investment is recovered before the end of the project.
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Chapter 14 Capital Budgeting Decisions
59. (Ignore income taxes in this problem.) Slomkowski Corporation is contemplating
purchasing equipment that would increase sales revenues by $298,000 per year and
cash operating expenses by $143,000 per year. The equipment would cost $712,000
and have a 8 year life with no salvage value. The annual depreciation would be
$89,000. The simple rate of return on the investment is closest to:
A) 9.3%
B) 21.8%
C) 22.1%
D) 12.5%
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 6 Level: Easy
Solution:
The simple rate of return is computed as follows:
Cost of machine, net of salvage value (a)...........
Useful life (b)......................................................
Annual depreciation (a) ÷ (b)..............................
$712,000
8 years
$89,000
Annual incremental revenue ($298,000 −
$143,000).........................................................
Less annual depreciation.....................................
Annual incremental net operating income..........
$155,000
89,000
$ 66,000
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= $66,000 ÷ $712,000 = 9.3%
60. (Ignore income taxes in this problem.) The management of Plotnik Corporation is
investigating purchasing equipment that would increase sales revenues by $269,000
per year and cash operating expenses by $156,000 per year. The equipment would cost
$294,000 and have a 6 year life with no salvage value. The simple rate of return on the
investment is closest to:
A) 16.7%
B) 38.4%
C) 23.8%
D) 21.8%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 6 Level: Easy
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Chapter 14 Capital Budgeting Decisions
Solution:
The simple rate of return is computed as follows:
Cost of machine, net of salvage value (a)..........................
Useful life (b).....................................................................
Annual depreciation (a) ÷ (b).............................................
$294,000
6 years
$49,000
Annual incremental revenue ($269,000 − $156,000)........
Less annual depreciation....................................................
Annual incremental net operating income.........................
$113,000
49,000
$ 64,000
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= $64,000 ÷ $294,000 = 21.8%
61. (Ignore income taxes in this problem.) An expansion at Fey, Inc., would increase sales
revenues by $150,000 per year and cash operating expenses by $47,000 per year. The
initial investment would be for equipment that would cost $328,000 and have a 8 year
life with no salvage value. The annual depreciation on the equipment would be
$41,000. The simple rate of return on the investment is closest to:
A) 41.3%
B) 18.9%
C) 12.5%
D) 31.4%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 6 Level: Easy
Solution:
The simple rate of return is computed as follows:
Annual incremental revenue ($150,000 − $47,000)............. $103,000
Less annual depreciation.......................................................
41,000
Annual incremental net operating income............................ $ 62,000
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= $62,000 ÷ $328,000 = 18.9%
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Chapter 14 Capital Budgeting Decisions
62. (Ignore income taxes in this problem.) Crowl Corporation is investigating automating
a process by purchasing a machine for $792,000 that would have a 9 year useful life
and no salvage value. By automating the process, the company would save $132,000
per year in cash operating costs. The new machine would replace some old equipment
that would be sold for scrap now, yielding $21,000. The annual depreciation on the
new machine would be $88,000. The simple rate of return on the investment is closest
to:
A) 11.1%
B) 16.7%
C) 5.7%
D) 5.6%
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 6 Level: Easy
Solution:
The simple rate of return is computed as follows:
Cost of machine, net of scrap (a) ($792,000 − $21,000)..
$771,000
Annual cost savings..........................................................
Less annual depreciation..................................................
Annual incremental net operating income........................
$132,000
88,000
$ 44,000
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= $44,000 ÷ $771,000 = 5.7%
63. (Ignore income taxes in this problem.) The management of Ro Corporation is
investigating automating a process. Old equipment, with a current salvage value of
$11,000, would be replaced by a new machine. The new machine would be purchased
for $243,000 and would have a 9 year useful life and no salvage value. By automating
the process, the company would save $69,000 per year in cash operating costs. The
simple rate of return on the investment is closest to:
A) 18.1%
B) 11.1%
C) 28.4%
D) 17.3%
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 6 Level: Easy
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Chapter 14 Capital Budgeting Decisions
Solution:
The simple rate of return is computed as follows:
Cost of machine, net of salvage value (a)...........
Useful life (b)......................................................
Annual depreciation (a) ÷ (b)..............................
$243,000
9 years
$27,000
Annual cost savings............................................
Less annual depreciation.....................................
Annual incremental net operating income..........
$69,000
27,000
$42,000
Simple rate of return = Annual incremental net operating income ÷ Initial investment,
less salvage value = $42,000 ÷ ($243,000 − $11,000) = 18.1%
64. (Ignore income taxes in this problem.) A company wants to have $20,000 at the end
of a ten-year period by investing a single sum now. How much needs to be invested in
order to have the desired sum in ten years, if the money can be invested at 12%?
A) $3,254.68
B) $3,539.82
C) $6,440.00
D) $7,720.00
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 7 Level: Easy
Solution:
Factor from Present Value of $1 table, 12%, 10 years: 0.322
$20,000 × 0.322 = $6,440.00
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Chapter 14 Capital Budgeting Decisions
65. (Ignore income taxes in this problem.) At an interest rate of 14%, approximately how
much would you need to invest today if you wanted to have $2,000,000 in 10 years?
A) $383,436
B) $540,000
C) $740,741
D) $1,043,200
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 7 Level: Easy
Solution:
Factor from Present Value of $1 table, 14%, 10 years: 0.270
$2,000,000 × 0.270 = $540,000
66. (Ignore income taxes in this problem.) How much would you have to invest today in
the bank at an interest rate of 8% to have an annuity of $4,800 per year for 7 years,
with nothing left in the bank at the end of the 7 years? Select the amount below that is
closest to your answer.
A) $33,600
B) $2,798
C) $24,989
D) $31,111
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 7 Level: Easy
Solution:
Factor from Present Value of an Annuity of $1 in Arrears Table, 8%, 7 years: 5.206
$4,800 × 5.206 = $24,989
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Chapter 14 Capital Budgeting Decisions
67. (Ignore income taxes in this problem.) You have deposited $24,764 in a special
account that has a guaranteed interest rate. If you withdraw $4,300 at the end of each
year for 9 years, you will completely exhaust the balance in the account. The
guaranteed interest rate is closest to:
A) 6%
B) 10%
C) 17%
D) 56%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 7 Level: Hard
Solution:
$4,300 × Factor from PV of Annuity table = $24,764
Factor from PV of Annuity table = 5.759
Looking in Present Value of an Annuity of $1 in Arrears in the 9th row, 5.759 is found
in the 10% column which is the guaranteed interest rate.
68. (Ignore income taxes in this problem.) You have deposited $7,620 in a special account
that has a guaranteed interest rate of 19% per year. If you are willing to completely
exhaust the account, what is the maximum amount that you could withdraw at the end
of each of the next 7 years? Select the amount below that is closest to your answer.
A) $1,295
B) $2,056
C) $2,219
D) $1,089
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 7 Level: Medium
Solution:
Factor from Present Value of an Annuity of $1 in Arrears table, 19%, 7 years: 3.706
$7,620 ÷ 3.706 = $2,056
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Chapter 14 Capital Budgeting Decisions
69. (Ignore income taxes in this problem.) Suddeth Corporation has entered into a 6 year
lease for a building it will use as a warehouse. The annual payment under the lease
will be $2,468. The first payment will be at the end of the current year and all
subsequent payments will be made at year-ends. What is the present value of the lease
payments if the discount rate is 5%?
A) $12,528
B) $14,103
C) $14,808
D) $11,050
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 7 Level: Easy
Solution:
Factor from Present Value of an Annuity of $1 in Arrears table, 5%, 6 years: 5.076
$2,468 × 5.076 = $12,528
70. (Ignore income taxes in this problem.) Domebo Corporation has entered into a 7 year
lease for a piece of equipment. The annual payment under the lease will be $3,400,
with payments being made at the beginning of each year. If the discount rate is 14%,
the present value of the lease payments is closest to:
A) $9,511
B) $16,623
C) $20,877
D) $23,800
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 7 Level: Hard
Solution:
Annual payments made at the beginning of the year mean that the first lease payment
would be paid immediately; the present value of the first lease payment is therefore
$3,400. The next six lease payments for years 2-7 made at the beginning of each year
is equivalent to six payments at the end of each year for years 1 through 6. The table
for the Present Value of an Annuity of $1 in Arrears can be used to calculate the years
1-6.
Factor from Present Value of an Annuity of $1 in Arrears table, 14%, 6 years: 3.889
($3,400 × 3.889) + $3,400 = $16,623
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Chapter 14 Capital Budgeting Decisions
71. Wedge Corporation uses a discount rate of 14% and has a tax rate of 30%. The
following cash flows occur in the last year of a 10-year equipment selection
investment project:
Cost savings for the year............................
Working capital released............................
Salvage value from sale of equipment.......
$180,000
$120,000
$25,000
At the end of the ten years when the equipment is sold, its net book value for tax
purposes is zero. The total after-tax present value of the cash flows above is closest to:
A) $45,765
B) $48,465
C) $61,425
D) $71,145
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Solution:
Net cash inflow...................
Salvage value......................
Working capital released.....
Net present value................
Net annual cash inflow.......
Salvage value......................
Working capital released.....
Net present value................
14-38
Years
10
10
10
Amount
$180,000
$25,000
$120,000
After-Tax
Cash
Flows
$126,000
$17,500
$120,000
14%
Factor
0.270
0.270
0.270
Tax
Effect
0.70
0.70
Present
Value
$34,020
4,725
32,400
$71,145
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Chapter 14 Capital Budgeting Decisions
72. A company anticipates a taxable cash receipt of $80,000 in year 3 of a project. The
company's tax rate is 30% and its discount rate is 10%. The present value of this future
cash flow is closest to:
A) $42,056
B) $56,000
C) $24,000
D) $18,032
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Solution:
After-tax cash flow = Before-tax cash flow × (1 − Tax rate)
= $80,000 × (1 − 0.30) = $56,000
Present value factor from Present Value of $1: 0.751
Present value = $56,000 × 0.751 = $42,056
73. A company anticipates a taxable cash expense of $30,000 in year 4 of a project. The
company's tax rate is 30% and its discount rate is 14%. The present value of this future
cash flow is closest to:
A) $(21,000)
B) $(5,329)
C) $(9,000)
D) $(12,432)
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Solution:
After-tax cash flow = Before-tax cash flow × (1 − Tax rate)
= $30,000 × (1 − 0.30) = $21,000
Present value factor from Present Value of $1: 0.592
Present value = $21,000 × 0.592 = $12,432
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Chapter 14 Capital Budgeting Decisions
74. A company anticipates a depreciation deduction of $70,000 in year 4 of a project. The
company's tax rate is 30% and its discount rate is 12%. The present value of the
depreciation tax shield resulting from this deduction is closest to:
A) $31,140
B) $49,000
C) $21,000
D) $13,356
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Solution:
Depreciation tax shield = $70,000 × 30% = $21,000
Present value of depreciation shield = $21,000 × 0.636* = $13,356
*Factor from Present Value of $1 table, 12%, 4 years
75. A company needs an increase in working capital of $50,000 in a project that will last 4
years. The company's tax rate is 30% and its discount rate is 14%. The present value of
the release of the working capital at the end of the project is closest to:
A) $15,000
B) $20,723
C) $29,600
D) $35,000
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Solution:
Present value of working capital release = $50,000 × 0.592* = $29,600
*Factor from Present Value of $1 table
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Chapter 14 Capital Budgeting Decisions
76. Dunn Construction, Inc., has a large crane that cost $35,000 when purchased ten years
ago. Depreciation taken to date totals $25,000. The crane can be sold now for $6,000.
Assuming a tax rate of 40%, if the crane is sold the total after-tax cash inflow for
capital budgeting purposes will be:
A) $8,400
B) $12,000
C) $7,600
D) $10,000
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Hard
Solution:
Sale proceeds....................................................... $ 6,000
10,000
Less book value of crane ($35,000 − $25,000)....
Loss on sale of crane............................................ ($ 4,000)
Cash proceeds from sale...................................... $6,000
Add tax benefit of loss ($4,000 × 0.40)............... 1,600
Total after-tax cash inflow from sale................... $7,600
77. If an investment of $90,000 made now has annual cash operating inflows of $5,000,
and if the tax rate is 40%, then the after-tax cash operating inflow each year would be:
A) $2,000
B) $36,000
C) $3,000
D) $54,000
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy
Solution:
After-tax cash operating inflow = $5,000 × (1 – 0.40) = $3,000
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Chapter 14 Capital Budgeting Decisions
78. If a company's income tax rate is 30% and its annual depreciation deduction is
$80,000, then the annual tax savings from the depreciation tax shield is:
A) $56,000
B) $24,000
C) $80,000
D) $32,000
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Easy
Solution:
Annual tax savings from depreciation tax shield = $80,000 × 0.30 = $24,000
79. Garfield, Inc., is considering a ten-year investment project with forecasted cash
revenues of $40,000 per year and forecasted cash expenses of $29,000 per year. The
initial cost of the equipment for the project is $23,000. The salvage value of the
equipment is $9,000 at the end of the ten years of the project. The net book value of
the equipment for tax purposes will be zero at the end of the ten years. The project
requires a working capital investment of $7,000 at its inception and another working
capital infusion of $5,000 at the end of year five. All of this working capital would be
released for use elsewhere at the end of the project. The company's tax rate is 40%.
What is the after-tax net cash flow in the tenth year of the project?
A) $32,000
B) $24,000
C) $20,000
D) $11,000
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting Appendix: 14C LO: 8 Level: Medium
Source: CMA, adapted
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Chapter 14 Capital Budgeting Decisions
Solution:
Salvage sale proceeds......... $9,000
Less book value..................
0
Gain on sale........................ $9,000
Net after-tax cash flow in year 10:
Gain on sale [$9,000 × (1 − 0.40)].......................................
Initial working capital..........................................................
5th year working capital........................................................
Net revenue per year [($40,000 − $29,000) × (1 − 0.40)]....
Net after-tax cash flow.........................................................
$ 5,400
7,000
5,000
6,600
$24,000
Use the following to answer questions 80-81:
The Golden Company is analyzing projects A, B, and C as possible investment opportunities.
Each of these projects has a useful life of eight years. The following information has been
obtained:
Initial investment.......................................
Present value of future net cash inflows....
Internal rate of return.................................
Project A Project B Project C
$250,000 $475,000 $380,000
$290,000 $503,000 $422,000
16%
20%
18%
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Chapter 14 Capital Budgeting Decisions
80. Consider the following statements:
I.
II.
Project A is preferred to Project B according to a net present value ranking.
Project A is preferred to Project B according to an internal rate of return
ranking.
III.
Project A is preferred to Project B according to a project profitability index
ranking.
Which is true?
A) Only I
B) Only II
C) Only I and II
D) Only I and III
Ans: D AACSB: Analytic
ACIPA FN: Decision Making
AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1,2,4
Level: Easy
Solution:
Initial investment (a)..................................
Present value of future net cash inflows....
Net present value (b)..................................
Project profitability index (b) ÷ (a)............
Internal rate of return.................................
Project A Project B Project C
$250,000 $475,000 $380,000
$290,000 $503,000 $422,000
$40,000 $28,000 $42,000
0.16
0.06
0.11
16%
20%
18%
81. Consider the following statements:
I.
Project A has the highest ranking according to the project profitability index
criterion.
II.
Project B has the highest ranking according to the internal rate of return
criterion.
III.
Project C has the highest ranking according to the net present value criterion.
Which is true?
A) Only II
B) Only I and III
C) Only II and III
D) I, II and III
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1,2,4 Level: Easy
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Chapter 14 Capital Budgeting Decisions
Solution:
Initial investment (a)..................................
Present value of future net cash inflows....
Net present value (b)..................................
Project profitability index (b) ÷ (a)............
Internal rate of return.................................
Project A Project B Project C
$250,000 $475,000 $380,000
$290,000 $503,000 $422,000
$40,000 $28,000 $42,000
0.16
0.06
0.11
16%
20%
18%
Use the following to answer questions 82-85:
(Ignore income taxes in this problem.) Chee Company has gathered the following data on a
proposed investment project:
Investment required in equipment.............
Annual cash inflows...................................
Salvage value.............................................
Life of the investment................................
Required rate of return...............................
$240,000
$50,000
$0
8 years
10%
82. The payback period for the investment is closest to:
A) 0.2 years
B) 2.5 years
C) 4.8 years
D) 5.0 years
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 5 Level: Easy
Solution:
Payback period = Investment required ÷ Annual cash inflows
= $240,000 ÷ $50,000
= 4.8 years
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Chapter 14 Capital Budgeting Decisions
83. The simple rate of return on the investment is closest to:
A) 12.5%
B) 10.0%
C) 20.8%
D) 8.3%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 6 Level: Medium
Solution:
The simple rate of return is computed as follows:
Cost of machine, net of salvage value (a). . $240,000
Useful life (b).............................................
8 years
Annual depreciation (a) ÷ (b).....................
$30,000
Annual cash inflows...................................
Less annual depreciation............................
Annual incremental net operating income.
$50,000
30,000
$20,000
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= $20,000 ÷ $240,000 = 8.3%
84. The net present value on this investment is closest to:
A) $160,000
B) $240,024
C) $58,800
D) $26,750
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Medium
Solution:
Annual cash inflows.....
Initial investment.........
Net present value..........
14-46
Year(s)
Amount
10% Factor
1-8
$50,000
5.335
Now ($240,000)
1.000
PV
$266,750
( 240,000)
$ 26,750
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Chapter 14 Capital Budgeting Decisions
85. The internal rate of return on the investment is closest to:
A) 11%
B) 13%
C) 15%
D) 17%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $240,000 ÷ $50,000 = 4.800
The factor of 4.800 for 8 years represents an internal rate of return of close to 13%.
Use the following to answer questions 86-87:
(Ignore income taxes in this problem.) The Rapp Company is considering buying a new
machine which will require an initial outlay of $15,000. The company estimates that over the
next four years this machine would save $6,000 per year in cash operating expenses. At the
end of four years, the machine would have no salvage value. The company's required rate of
return is 14%.
86. The net present value of this investment is closest to:
A) $(12,632)
B) $17,484
C) $2,484
D) $3,612
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Medium
Solution:
Annual cost savings.....
Initial investment.........
Net present value..........
Year(s)
1-4
Now
Amount
14% Factor
$6,000
2.914
($15,000)
1.000
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PV
$17,484
( 15,000)
$ 2,484
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Chapter 14 Capital Budgeting Decisions
87. The machine's internal rate of return is closest to:
A) 16%
B) 18%
C) 20%
D) 22%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
Solution:
Factor of the internal rate of return = Investment required ÷ Net annual cash inflow =
$15,000 ÷ $6,000 = 2.500
The factor of 2.500 for 4 years represents an internal rate of return of almost 22%.
Use the following to answer questions 88-89:
(Ignore income taxes in this problem.) Allo Foundation, a tax-exempt organization, invested
$200,000 in cost-saving equipment. The equipment has a five-year useful life with no salvage
value. Allo estimates that the annual cash savings from this project will amount to $65,000.
On investments of this type, Allo's required rate of return is 12%.
88. The net present value of the project is closest to:
A) $34,300
B) $36,400
C) $90,000
D) $125,000
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Medium Source: CPA, adapted
Solution:
Annual cost savings.....
Initial investment.........
Net present value..........
14-48
Year(s)
Amount
12% Factor
1-5
$65,000
3.605
Now ($200,000)
1.000
PV
$234,325
( 200,000)
$ 34,325
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Chapter 14 Capital Budgeting Decisions
89. Allo's internal rate of return on this project is closest to:
A) 13%
B) 15%
C) 17%
D) 19%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium Source: CPA, adapted
Solution:
Factor of the internal rate of return = Investment required ÷ Net annual cash inflow =
$200,000 ÷ $65,000 = 3.077
The factor of 3.077 for 5 years represents an internal rate of return of almost 19%.
Use the following to answer questions 90-91:
(Ignore income taxes in this problem.) Dumora Corporation is considering an investment
project that will require an initial investment of $9,400 and will generate the following net
cash inflows in each of the five years of its useful life:
Year 1 Year 2 Year 3 Year 4 Year 5
Net cash inflows..... $1,000 $2,000 $4,000 $6,000 $5,000
Dumora’s discount rate is 16%.
90. Dumora's payback period for this investment project is closest to:
A) 1.91 years
B) 2.61 years
C) 2.89 years
D) 3.40 years
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 5 Level: Medium
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Chapter 14 Capital Budgeting Decisions
Solution:
Remaining
Balance
$9,400
$1,000
$8,400
$2,000
$6,400
$4,000
$2,400
Amount
Initial investment.........
Year 1 cash inflow........
Year 2 cash inflow........
Year 3 cash inflow........
Year 4: $2,400 ÷ $6,000 = 0.4
Therefore, the payback period for this investment is 3.4 years.
91. Dumora's net present value for this investment project is closest to:
A) $(832)
B) $1,204
C) $1,376
D) $2,386
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Medium
Solution:
Cost savings−Year 1.....
Cost savings−Year 2.....
Cost savings−Year 3.....
Cost savings−Year 4.....
Cost savings−Year 5.....
Initial investment.........
Net present value..........
14-50
Year(s)
1
2
3
4
5
Now
Amount
16% Factor
$1,000
0.862
$2,000
0.743
$4,000
0.641
$6,000
0.552
$5,000
0.476
($9,400)
1.000
PV
$ 862
1,486
2,564
3,312
2,380
( 9,400)
$1,204
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Chapter 14 Capital Budgeting Decisions
Use the following to answer questions 92-93:
(Ignore income taxes in this problem.) Vandezande Inc. is considering the acquisition of a
new machine that costs $370,000 and has a useful life of 5 years with no salvage value. The
incremental net operating income and incremental net cash flows that would be produced by
the machine are:
Year 1......
Year 2......
Year 3......
Year 4......
Year 5......
Incremental net operating income Incremental net cash flows
$54,000
$128,000
$31,000
$105,000
$52,000
$126,000
$49,000
$123,000
$48,000
$122,000
92. If the discount rate is 10%, the net present value of the investment is closest to:
A) $370,000
B) $457,479
C) $234,000
D) $87,479
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Medium Source: CMA, adapted
Solution:
Initial investment...............
Year 1 incremental net cash
inflow..............................
Year 2 incremental net cash
inflow..............................
Year 3 incremental net cash
inflow..............................
Year 4 incremental net cash
inflow..............................
Year 5 incremental net cash
inflow..............................
Net present value................
Year(s)
Amount 10% Factor
PV
Now ($370,000)
1.000
($370,000)
1
$128,000
0.909
116,352
2
$105,000
0.826
86,730
3
$126,000
0.751
94,626
4
$123,000
0.683
84,009
5
$122,000
0.621
75,762
$ 87,479
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Chapter 14 Capital Budgeting Decisions
93. The payback period of this investment, rounded off to the nearest tenth of a year, is
closest to:
A) 2.9 years
B) 4.9 years
C) 3.1 years
D) 5.0 years
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 5 Level: Medium Source: CMA, adapted
Solution:
Remaining
Amount
Balance
Initial investment.........
$370,000
Year 1 cash inflow........ $128,000
$242,000
Year 2 cash inflow........ $105,000
$137,000
Year 3 cash inflow........ $126,000
$11,000
Year 4: $11,000 ÷ $123,000 = 0.1 (rounded to nearest tenth)
Therefore, the payback period for this investment is 3.1 years.
Use the following to answer questions 94-95:
(Ignore income taxes in this problem.) Oriol Inc. is considering the acquisition of equipment
that costs $360,000 and has a useful life of 6 years with no salvage value. The incremental net
cash flows that would be generated by the equipment are:
Year 1.........
Year 2.........
Year 3.........
Year 4.........
Year 5.........
Year 6.........
14-52
Incremental net cash flows
$115,000
$138,000
$95,000
$91,000
$133,000
$134,000
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Chapter 14 Capital Budgeting Decisions
94. If the discount rate is 19%, the net present value of the investment is closest to:
A) $346,000
B) $398,667
C) $38,667
D) $121,841
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy Source: CMA, adapted
Solution:
Initial investment...............
Year 1 incremental net cash
inflow..............................
Year 2 incremental net cash
inflow..............................
Year 3 incremental net cash
inflow..............................
Year 4 incremental net cash
inflow..............................
Year 5 incremental net cash
inflow..............................
Year 6 incremental net cash
inflow..............................
Net present value................
Year(s)
Amount 19% Factor
PV
Now ($360,000)
1.000
($360,000)
1
$115,000
0.840
96,600
2
$138,000
0.706
97,428
3
$95,000
0.593
56,335
4
$91,000
0.499
45,409
5
$133,000
0.419
55,727
6
$134,000
0.352
47,168
$38,667
95. The payback period of this investment is closest to:
A) 4.1 years
B) 2.9 years
C) 5.0 years
D) 3.1 years
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 5 Level: Easy Source: CMA, adapted
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Chapter 14 Capital Budgeting Decisions
Solution:
Remaining
Balance
Initial investment.........
$360,000
Year 1 cash inflow........ $115,000
245,000
Year 2 cash inflow........ 138,000
107,000
Year 3 cash inflow........
95,000
12,000
Amount
Year 4: $12,000 ÷ $91,000 = 0.1 (rounded to nearest tenth)
Therefore, the payback period for this investment is 3.1 years.
Use the following to answer questions 96-98:
(Ignore income taxes in this problem.) Morrel University has a small shuttle bus that is in
poor mechanical condition. The bus can be either overhauled now or replaced with a new
shuttle bus. The following data have been gathered concerning these two alternatives:
Purchase cost new..........................
Remaining net book value.............
Major repair needed now...............
Annual cash operating costs...........
Salvage value now.........................
Trade-in value in seven years.........
Present Bus New Bus
$32,000 $40,000
$21,000
—
$9,000
—
$12,000
$8,000
$10,000
—
$2,000
$5,000
The University could continue to use the present bus for the next seven years. Whether the
present bus is used or a new bus is purchased, the bus would be traded in for another bus at
the end of seven years. The University uses a discount rate of 12% and the total cost approach
to net present value analysis in evaluating its investment decisions.
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Chapter 14 Capital Budgeting Decisions
96. If the new bus is purchased, the present value of the annual cash operating costs
associated with this alternative is (rounded off to the nearest hundred dollars):
A) $(54,800)
B) $(36,500)
C) $(16,200)
D) $(42,800)
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Annual cash operating costs.
Year(s)
1-7
Amount 12% Factor
($8,000)
4.564
PV
($36,512)
97. If the present bus is repaired, the present value of the annual cash operating costs
associated with this alternative is (rounded off to the nearest hundred dollars):
A) $(36,500)
B) $(16,200)
C) $(47,200)
D) $(54,800)
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Annual cash operating costs
Year(s)
1-7
Amount 12% Factor
($12,000)
4.564
PV
($54,768)
98. If the present bus is repaired, the present value of the salvage received on sale of the
bus seven years from now is:
A) $(2,260)
B) $2,260
C) $904
D) $(904)
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Salvage value.....................
Year(s)
7
Amount 12% Factor
$2,000
0.452
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PV
$904
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Chapter 14 Capital Budgeting Decisions
Use the following to answer questions 99-100:
(Ignore income taxes in this problem.) Becker Billing Systems, Inc., has an antiquated highcapacity printer that needs to be upgraded. The system either can be overhauled or replaced
with a new system. The following data have been gathered concerning these two alternatives:
Purchase cost when new.............
Accumulated depreciation..........
Overhaul costs needed now........
Annual cash operating costs........
Salvage value now......................
Salvage value in ten years...........
Working capital required.............
Overhaul
Present System
$300,000
$220,000
$250,000
$120,000
$90,000
$30,000
—
Purchase New
System
$400,000
—
—
$90,000
—
$80,000
$50,000
The company uses a 10% discount rate and the total-cost approach to capital budgeting
analysis. The working capital required under the new system would be released for use
elsewhere at the conclusion of the project. Both alternatives are expected to have a useful life
of ten years.
99. The net present value of the overhaul alternative (rounded to the nearest hundred
dollars) is:
A) $(750,300)
B) $(725,800)
C) $(975,800)
D) $(987,400)
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Hard
Solution:
Annual operating costs.......
Overhaul costs....................
Salvage value.....................
Net present value................
14-56
Year(s)
Amount 10% Factor
PV
1-10 ($120,000)
6.145
($737,400)
Now ($250,000)
1.000
(250,000)
11,580
10
$30,000
0.386
($975,820)
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Chapter 14 Capital Budgeting Decisions
100. The net present value of the new system alternative (rounded to the nearest hundred
dollars) is:
A) $(862,900)
B) $(552,900)
C) $(758,400)
D) $(987,400)
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Hard
Solution:
Initial investment...............
Annual operating costs.......
Salvage value−old equip....
Salvage value.....................
Working capital required....
Working capital released....
Net present value................
Year(s)
Amount 10% Factor
PV
Now ($400,000)
1.000
($400,000)
1-10
($90,000)
6.145
(553,050)
Now
$90,000
1.000
90,000
10
$80,000
0.386
30,880
Now
($50,000)
1.000
(50,000)
19,300
10
$50,000
0.386
($862,870)
Use the following to answer questions 101-102:
(Ignore income taxes in this problem.) Almendarez Corporation is considering the purchase of
a machine that would cost $320,000 and would last for 7 years. At the end of 7 years, the
machine would have a salvage value of $51,000. By reducing labor and other operating costs,
the machine would provide annual cost savings of $72,000. The company requires a minimum
pretax return of 18% on all investment projects.
101. The present value of the annual cost savings of $72,000 is closest to:
A) $22,608
B) $874,298
C) $504,000
D) $274,464
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Annual cost savings...........
Year(s)
1-7
Amount
$72,000
18% Factor
3.812
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PV
$274,464
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Chapter 14 Capital Budgeting Decisions
102. The net present value of the proposed project is closest to:
A) -$29,522
B) -$45,536
C) $5,464
D) -$94,042
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Initial investment...............
Annual cost savings...........
Salvage value.....................
Net present value................
Year(s)
Amount 18% Factor
PV
Now ($320,000)
1.000
($320,000)
1-7
$72,000
3.812
274,464
16,014
7
$51,000
0.314
($ 29,522)
Use the following to answer questions 103-104:
(Ignore income taxes in this problem.) The management of Opray Corporation is considering
the purchase of a machine that would cost $360,000, would last for 7 years, and would have
no salvage value. The machine would reduce labor and other costs by $78,000 per year. The
company requires a minimum pretax return of 11% on all investment projects.
103. The present value of the annual cost savings of $78,000 is closest to:
A) $763,064
B) $177,027
C) $546,000
D) $367,536
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Annual labor savings..........
14-58
Year(s)
1-7
Amount
$78,000
11% Factor
4.712
PV
$367,536
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Chapter 14 Capital Budgeting Decisions
104. The net present value of the proposed project is closest to:
A) $15,646
B) $89,588
C) $7,536
D) $186,000
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Initial investment...............
Annual net cash receipts....
Net present value................
Year(s)
Amount 11% Factor
PV
Now ($360,000)
1.000
($360,000)
1-7
$78,000
4.712
367,536
$ 7,536
Use the following to answer questions 105-106:
(Ignore income taxes in this problem.) Paragas, Inc., is considering the purchase of a machine
that would cost $370,000 and would last for 8 years. At the end of 8 years, the machine would
have a salvage value of $52,000. The machine would reduce labor and other costs by $96,000
per year. Additional working capital of $4,000 would be needed immediately. All of this
working capital would be recovered at the end of the life of the machine. The company
requires a minimum pretax return of 19% on all investment projects.
105. The combined present value of the working capital needed at the beginning of the
project and the working capital released at the end of the project is closest to:
A) -$3,004
B) $0
C) -$12,080
D) $11,816
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Year(s) Amount 19% Factor
PV
Working capital required.... Now ($4,000)
1.000
($4,000)
996
Working capital released....
8
$4,000
0.249
Net present value................
($3,004)
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Chapter 14 Capital Budgeting Decisions
106. The net present value of the proposed project is closest to:
A) $9,584
B) $78,530
C) $22,532
D) $19,528
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Initial investment...............
Annual labor savings..........
Working capital required....
Working capital released....
Salvage value.....................
Net present value................
Year(s)
Amount 19% Factor
PV
Now ($370,000)
1.000
($370,000)
1-8
$96,000
3.954
379,584
Now
($4,000)
1.000
(4,000)
8
$4,000
0.249
996
12,950
8
$52,000
0.249
$ 19,530
Use the following to answer questions 107-108:
(Ignore income taxes in this problem.) Undersymington Company has an opportunity to invest
in a machine that would cost $28,000, and that would produce cost savings of $8,000 each
year for the next five years.
107. If the machine has zero salvage value, then the internal rate of return is closest to:
A) 10.4%
B) 10.9%
C) 12.8%
D) 13.2%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
Solution:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $28,000 ÷ $8,000 = 3.500.
The factor of 3.500 for 5 years represents an internal rate of return of somewhat more
than 13%, or 13.2%.
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Chapter 14 Capital Budgeting Decisions
108. If the machine's salvage value at the end of the project is $4,000, then the internal rate
of return is:
A) less than 11%
B) less than 12%, but greater than 11%
C) less than 13%, but greater than 12%
D) greater than 13%
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Hard
Solution:
Factor of the internal rate of return without considering salvage value
= Investment required ÷ Net annual cash inflow = $28,000 ÷ $8,000 = 3.500.
The factor of 3.500 for 5 years represents an internal rate of return of somewhat more
than 13%, or 13.2%.
Since the IRR is more than 13% without considering the salvage value, adding in the
present value of the salvage value will further increase the IRR.
Use the following to answer questions 109-110:
(Ignore income taxes in this problem.) Cabe Corporation uses a discount rate of 18% in its
capital budgeting. Partial analysis of an investment in automated equipment with a useful life
of 7 years has thus far yielded a net present value of -$155,606. This analysis did not include
any estimates of the intangible benefits of automating this process nor did it include any
estimate of the salvage value of the equipment.
109. Ignoring any salvage value, to the nearest whole dollar how large would the additional
cash flow per year from the intangible benefits have to be to make the investment in
the automated equipment financially attractive?
A) $40,820
B) $22,229
C) $28,009
D) $155,606
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $155,606 ÷ 3.812 = $40,820
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Chapter 14 Capital Budgeting Decisions
110. Ignoring any cash flows from intangible benefits, to the nearest whole dollar how
large would the salvage value of the automated equipment have to be to make the
investment in the automated equipment financially attractive?
A) $495,561
B) $28,009
C) $155,606
D) $864,478
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $155,606 ÷ 0.314 = $495,561
Use the following to answer questions 111-112:
(Ignore income taxes in this problem.) The management of Hansley Corporation is
investigating an investment in equipment that would have a useful life of 5 years. The
company uses a discount rate of 18% in its capital budgeting. Good estimates are available for
the initial investment and the annual cash operating outflows, but not for the annual cash
inflows and the salvage value of the equipment. The net present value of the initial investment
and the annual cash outflows is -$273,300.
111. Ignoring any salvage value, to the nearest whole dollar how large would the annual
cash inflow have to be to make the investment in the equipment financially attractive?
A) $54,660
B) $49,194
C) $87,400
D) $273,300
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $273,300 ÷ 3.127 = $87,400
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Chapter 14 Capital Budgeting Decisions
112. Ignoring the cash inflows, to the nearest whole dollar how large would the salvage
value of the equipment have to be to make the investment in the equipment financially
attractive?
A) $625,400
B) $1,518,333
C) $273,300
D) $49,194
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $273,300 ÷ 0.437 = $625,400
Use the following to answer questions 113-114:
(Ignore income taxes in this problem.) Lem Corporation is investigating buying a small used
aircraft for the use of its executives. The aircraft would have a useful life of 7 years. The
company uses a discount rate of 11% in its capital budgeting. The net present value of the
initial investment and the annual operating cash cost is -$317,966. Management is having
difficulty estimating the annual benefit of having the aircraft and estimating the salvage value
of the aircraft.
113. Ignoring the annual benefit, to the nearest whole dollar how large would the salvage
value of the aircraft have to be to make the investment in the aircraft financially
attractive?
A) $2,890,600
B) $317,966
C) $34,976
D) $659,680
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $317,966 ÷ 0.482 = $659,680
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Chapter 14 Capital Budgeting Decisions
114. Ignoring any salvage value, to the nearest whole dollar how large would the annual
benefit have to be to make the investment in the aircraft financially attractive?
A) $67,480
B) $317,966
C) $34,976
D) $45,424
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Easy
Solution:
Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $317,966 ÷ 4.712 = $67,480
Use the following to answer questions 115-116:
(Ignore income taxes in this problem.) Eddie Corporation is considering the following three
investment projects:
Investment required.......................
Present value of cash inflows.........
Project C Project D Project E
$36,000 $41,000 $85,000
$39,960 $47,560 $92,650
115. The profitability index of investment project D is closest to:
A) 0.16
B) 0.84
C) 0.14
D) 1.16
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Easy
Solution:
Project D
Investment required (a)......................... ($41,000)
47,560
Present value of cash inflows...............
Net present value (b)............................. $ 6,560
Project profitability index (b) ÷ (a).......
0.16
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Chapter 14 Capital Budgeting Decisions
116. Rank the projects according to the profitability index, from most profitable to least
profitable.
A) E,C,D
B) E,D,C
C) D,C,E
D) C,E,D
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Medium
Solution:
Investment required (a).........................
Present value of cash inflows...............
Net present value (b).............................
Project profitability index (b) ÷ (a).......
Ranked by project profitability index...
Project C Project D Project E
($36,000) ($41,000) ($85,000)
39,960
47,560
92,650
$ 3,960
$ 6,560
$ 7,650
0.11
0.16
0.09
2
1
3
Use the following to answer questions 117-118:
(Ignore income taxes in this problem.) The management of Hibert Corporation is considering
three investment projects-W, X, and Y. Project W would require an investment of $21,000,
Project X of $66,000, and Project Y of $95,000. The present value of the cash inflows would
be $22,470 for Project W, $73,920 for Project X, and $98,800 for Project Y.
117. The profitability index of investment project X is closest to:
A) 0.11
B) 0.88
C) 1.12
D) 0.12
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Easy
Solution:
Project X
Investment required (a)......................... ($66,000)
Present value of cash inflows............... 73,920
Net present value (b)............................. $ 7,920
Project profitability index (b) ÷ (a).......
0.12
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Chapter 14 Capital Budgeting Decisions
118. Rank the projects according to the profitability index, from most profitable to least
profitable.
A) Y,W,X
B) X,Y,W
C) X,W,Y
D) W,Y,X
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 4 Level: Medium
Solution:
Project W Project X
Investment required (a)......................... ($21,000) ($66,000)
73,920
Present value of cash inflows............... 22,470
Net present value (b)............................. $ 1,470
$ 7,920
Project profitability index (b) ÷ (a).......
0.07
0.12
Ranked by project profitability index...
2
1
Project Y
($95,000)
98,800
$ 3,800
0.04
3
Use the following to answer questions 119-123:
(Appendix 14C) Gibboney Inc. has provided the following data to be used in evaluating a
proposed investment project:
Initial investment...............
Annual cash receipts..........
Life of the project...............
Annual cash expenses........
Salvage value.....................
Tax rate...............................
$880,000
$660,000
8 years
$330,000
$88,000
30%
For tax purposes, the entire initial investment without any reduction for salvage value will be
depreciated over 7 years. The company uses a discount rate of 12%.
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Chapter 14 Capital Budgeting Decisions
119. When computing the net present value of the project, what are the annual after-tax
cash receipts?
A) $462,000
B) $396,000
C) $198,000
D) $69,300
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)
= $660,000 × (1 − 0.30) = $462,000
120. When computing the net present value of the project, what are the annual after-tax
cash expenses?
A) $429,000
B) $242,000
C) $99,000
D) $231,000
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash expenses = Annual cash expenses × (1 − Tax rate)
= $330,000 × (1 − 0.30)
= $231,000
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Chapter 14 Capital Budgeting Decisions
121. When computing the net present value of the project, what is the annual amount of the
depreciation tax shield? In other words, by how much does the depreciation deduction
reduce taxes each year in which the depreciation deduction is taken?
A) $37,714
B) $88,000
C) $77,000
D) $33,000
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Initial investment........................ $880,000
Life in years................................
7 years
Annual amount of depreciation... $125,714
Annual amount of depreciation tax shield = $125,714 × 0.30
= $37,714
122. When computing the net present value of the project, what is the after-tax cash flow
from the salvage value in the final year?
A) $0
B) $88,000
C) $26,400
D) $61,600
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Gain on sale (asset fully depreciated)..... $88,000
× (1 − Tax rate)........................................
0.70
After-tax cash flow from salvage value. . $61,600
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Chapter 14 Capital Budgeting Decisions
123. The net present value of the project is closest to:
A) $464,622
B) $439,736
C) $292,494
D) $267,608
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)
= $660,000 × (1 − 0.30) = $462,000
Annual after-tax cash expenses = Annual cash expenses × (1 − Tax rate)
= $330,000 × (1 − 0.30)
= $231,000
Initial investment........................ $880,000
Life in years................................ 7 years
Annual amount of depreciation... $125,714
Annual amount of depreciation tax shield = $125,714 × 0.30
= $37,714
Initial investment...............
Annual net cash receipts (after-tax)
Annual net cash expenses (after-tax)
Salvage value (after-tax)....
Annual depreciation tax shield
Net present value................
Year(s)
Amount 12% Factor
PV
Now ($880,000)
1.000
($ 880,000)
1-8
$462,000
4.968
2,295,216
1-8
($231,000)
4.968
(1,147,608)
8
$61,600
0.404
24,886
172,127
1-7
$37,714
4.564
$ 464,621
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Use the following to answer questions 124-127:
(Appendix 14C) Shufflebarger Inc. has provided the following data to be used in evaluating a
proposed investment project:
Initial investment............... $280,000
Annual cash receipts.......... $196,000
Life of the project...............
6 years
Annual cash expenses........ $78,000
Salvage value..................... $28,000
The company's tax rate is 30%. For tax purposes, the entire initial investment will be
depreciated over 5 years without any reduction for salvage value. The company uses a
discount rate of 16%.
124. When computing the net present value of the project, what are the annual after-tax
cash receipts?
A) $112,000
B) $137,200
C) $29,400
D) $58,800
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)
= $196,000 × (1 − 0.30) = $137,200
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Chapter 14 Capital Budgeting Decisions
125. When computing the net present value of the project, what are the annual after-tax
cash expenses?
A) $101,400
B) $50,000
C) $54,600
D) $23,400
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash expenses = Annual cash expenses × (1 − Tax rate)
= $78,000 × (1 − 0.30) = $54,600
126. When computing the net present value of the project, what is the annual amount of the
depreciation tax shield? In other words, by how much does the depreciation deduction
reduce taxes each year in which the depreciation deduction is taken?
A) $16,800
B) $39,200
C) $14,000
D) $32,667
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Initial investment........................ $280,000
Life in years................................
5 years
Annual amount of depreciation... $56,000
Annual amount of depreciation tax shield = $56,000 × 0.30
= $16,800
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127. When computing the net present value of the project, what is the after-tax cash flow
from the salvage value in the final year?
A) $28,000
B) $8,400
C) $19,600
D) $0
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Gain on sale (asset fully depreciated)..... $28,000
× (1 − Tax rate)........................................
0.70
After-tax cash flow from salvage value. . $19,600
Use the following to answer questions 128-129:
(Appendix 14C) Valentin Inc. has provided the following data concerning an investment
project that has been proposed:
Initial investment...............
Annual cash receipts..........
Life of the project...............
Annual cash expenses........
Salvage value.....................
$890,000
$534,000
5 years
$267,000
$45,000
The company's tax rate is 30%. For tax purposes, the entire initial investment will be
depreciated over 3 years without any reduction for salvage value. The company uses a
discount rate of 10%.
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128. When computing the net present value of the project, what is the after-tax cash flow
from the salvage value in the final year?
A) $13,500
B) $45,000
C) $0
D) $31,500
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Gain on sale (asset fully depreciated)..... $45,000
× (1 − Tax rate)........................................
0.70
After-tax cash flow from salvage value. . $31,500
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Chapter 14 Capital Budgeting Decisions
129. The net present value of the project is closest to:
A) $39,881
B) $59,442
C) -$181,462
D) -$161,901
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Gain on sale (asset fully depreciated)..... $45,000
× (1 − Tax rate)........................................
0.70
After-tax cash flow from salvage value. . $31,500
Initial investment.................................... $890,000
Depreciable life in years.........................
3 years
Annual depreciation................................ $296,667
× Tax rate................................................
0.30
Annual depreciation tax shield................ $89,000
Annual net cash inflows = Annual cash receipts − Annual cash expenses
= $534,000 − $267,000
= $267,000
After-tax cash inflows = $267,000 × (1 − 0.30)
= $186,900
Initial investment...............
Annual net cash inflows
(after-tax)........................
Depreciation tax shield......
Salvage value (after-tax)....
Net present value................
14-74
Year(s)
Amount 10% Factor
PV
Now ($890,000)
1.000
($890,000)
1-5
1-3
5
$186,900
$89,000
$31,500
3.791
2.487
0.621
708,538
221,343
19,562
$ 59,443
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Chapter 14 Capital Budgeting Decisions
Use the following to answer questions 130-131:
(Appendix 14C) Nunoz Inc. is considering an investment project that would require an initial
investment of $250,000 and that would last for 9 years. The annual cash receipts from the
project would be $175,000 and the annual cash expenses would be $79,000. The equipment
used in the project could be sold at the end of the project for a salvage value of $13,000. The
company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated
over 7 years without any reduction for salvage value. The company uses a discount rate of
10%.
130. When computing the net present value of the project, what are the annual after-tax
cash receipts?
A) $52,500
B) $122,500
C) $139,286
D) $96,000
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)
= $175,000 × (1 − 0.30) = $122,500
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Chapter 14 Capital Budgeting Decisions
131. The net present value of the project is closest to:
A) $140,863
B) $137,005
C) $193,020
D) $189,162
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 8 Level: Medium
Solution:
Annual after-tax cash receipts = Annual cash receipts × (1 − Tax rate)
= $175,000 × (1 − 0.30) = $122,500
Annual after-tax expenses = Annual expenses × (1 − Tax rate)
= $79,000 × (1 − 0.30) = $55,300
Initial investment.................................... $250,000
Depreciable life in years.........................
7 years
Annual depreciation................................ $35,714
× Tax rate................................................
0.30
Annual depreciation tax shield................ $10,714
Gain on sale (asset fully depreciated)..... $13,000
× (1 − Tax rate)........................................
0.70
After-tax cash flow from salvage value. . $9,100
Year(s)
Initial investment............... Now
Annual cash receipts
(after-tax)........................ 1-9
Annual cash expenses
(after-tax)........................ 1-9
Depreciation tax shield
1-7
Salvage value.....................
9
Net present value................
14-76
Amount 10% Factor
($250,000)
1.000
PV
($250,000)
$122,500
5.759
705,478
($55,300)
$10,714
$9,100
5.759
4.868
0.424
(318,473)
52,156
3,858
$193,019
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Chapter 14 Capital Budgeting Decisions
Essay Questions
132. (Ignore income taxes in this problem.) Cooney Inc. has provided the following data
concerning a proposed investment project:
Initial investment............... $160,000
Life of the project...............
7 years
Annual net cash inflows..... $40,000
Salvage value..................... $16,000
The company uses a discount rate of 17%.
Required:
Compute the net present value of the project.
Ans:
Initial investment...............
Annual net cash receipts....
Salvage value.....................
Net present value................
Year(s)
Amount 17% Factor
PV
Now ($160,000)
1.000
($160,000)
1-7
$40,000
3.922
156,880
5,328
7
$16,000
0.333
$ 2,208
AACSB: Analytic AICPA BB: Critical Thinking
LO: 1 Level: Easy
AICPA FN: Reporting
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Chapter 14 Capital Budgeting Decisions
133. (Ignore income taxes in this problem.) Strausberg Inc. is considering investing in a
project that would require an initial investment of $270,000. The life of the project
would be 6 years. The annual net cash inflows from the project would be $81,000. The
salvage value of the assets at the end of the project would be $27,000. The company
uses a discount rate of 10%.
Required:
Compute the net present value of the project.
Ans:
Initial investment...............
Annual net cash receipts....
Salvage value.....................
Net present value................
Year(s)
Amount 10% Factor
PV
Now ($270,000)
1.000
($270,000)
1-6
$81,000
4.355
352,755
15,228
6
$27,000
0.564
$ 97,983
AACSB: Analytic AICPA BB: Critical Thinking
LO: 1 Level: Easy
AICPA FN: Reporting
134. (Ignore income taxes in this problem.) Tiff Corporation has provided the following
data concerning a proposed investment project:
Initial investment..................
Life of the project..................
Working capital required.......
Annual net cash inflows........
Salvage value........................
$960,000
6 years
$20,000
$288,000
$144,000
The company uses a discount rate of 16%. The working capital would be released at
the end of the project.
Required:
Compute the net present value of the project.
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Chapter 14 Capital Budgeting Decisions
Ans:
Initial investment.....................
Annual net cash inflows...........
Working capital invested..........
Working capital released..........
Salvage value...........................
Net present value......................
Year(s)
Amount 16% Factor
Now ($960,000)
1.000
1-6
$288,000
3.685
Now
($20,000)
1.000
6
$20,000
0.410
6
$144,000
0.410
AACSB: Analytic AICPA BB: Critical Thinking
LO: 1 Level: Easy
PV
($ 960,000)
1,061,280
(20,000)
8,200
59,040
$ 148,520
AICPA FN: Reporting
135. (Ignore income taxes in this problem.) Mattice Corporation is considering investing
$490,000 in a project. The life of the project would be 7 years. The project would
require additional working capital of $34,000, which would be released for use
elsewhere at the end of the project. The annual net cash inflows would be $123,000.
The salvage value of the assets used in the project would be $49,000. The company
uses a discount rate of 11%.
Required:
Compute the net present value of the project.
Ans:
Initial investment...............
Annual net cash inflows.....
Working capital invested....
Working capital released....
Salvage value.....................
Net present value................
Year(s)
Amount 11% Factor
PV
Now ($490,000)
1.000
($490,000)
1-7
$123,000
4.712
579,576
Now
($34,000)
1.000
(34,000)
7
$34,000
0.482
16,388
7
$49,000
0.482
23,618
$ 95,582
AACSB: Analytic AICPA BB: Critical Thinking
LO: 1 Level: Easy
AICPA FN: Reporting
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Chapter 14 Capital Budgeting Decisions
136. (Ignore income taxes in this problem.) Wary Corporation is considering the purchase
of a machine that would cost $240,000 and would last for 9 years. At the end of 9
years, the machine would have a salvage value of $29,000. The machine would reduce
labor and other costs by $63,000 per year. The company requires a minimum pretax
return of 19% on all investment projects.
Required:
Determine the net present value of the project. Show your work!
Ans:
Annual cost savings.....
Initial investment.........
Salvage value...............
Net present value..........
Year(s)
Amount 19% Factor
1-9
$63,000
4.163
Now ($240,000)
1.000
9
$29,000
0.209
AACSB: Analytic AICPA BB: Critical Thinking
LO: 1 Level: Easy
PV
$262,269
(240,000)
6,061
$ 28,330
AICPA FN: Reporting
137. (Ignore income taxes in this problem.) The management of Kinion Corporation is
considering the purchase of a machine that would cost $170,000, would last for 7
years, and would have no salvage value. The machine would reduce labor and other
costs by $50,000 per year. The company requires a minimum pretax return of 17% on
all investment projects.
Required:
Determine the net present value of the project. Show your work!
Ans:
Annual cost savings.....
Initial investment.........
Net present value..........
Year(s)
Amount
17% Factor
1-7
$50,000
3.922
Now ($170,000)
1.000
AACSB: Analytic AICPA BB: Critical Thinking
LO: 1 Level: Easy
14-80
PV
$196,100
( 170,000)
$ 26,100
AICPA FN: Reporting
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Chapter 14 Capital Budgeting Decisions
138. (Ignore income taxes in this problem.) Joanette, Inc., is considering the purchase of a
machine that would cost $240,000 and would last for 5 years, at the end of which, the
machine would have a salvage value of $48,000. The machine would reduce labor and
other costs by $62,000 per year. Additional working capital of $7,000 would be
needed immediately, all of which would be recovered at the end of 5 years. The
company requires a minimum pretax return of 17% on all investment projects.
Required:
Determine the net present value of the project. Show your work!
Ans:
Initial investment...............
Working capital needed......
Annual cost savings...........
Working capital released....
Salvage value.....................
Net present value................
Year(s)
Amount 17% Factor
PV
Now ($240,000)
1.000
($240,000)
Now
($7,000)
1.000
(7,000)
1-5
$62,000
3.199
198,338
5
$7,000
0.456
3,192
5
$48,000
0.456
21,888
($ 23,582)
AACSB: Analytic AICPA BB: Critical Thinking
LO: 1 Level: Easy
AICPA FN: Reporting
139. (Ignore income taxes in this problem.) The management of Harling Corporation is
considering the purchase of a machine that would cost $90,504 and would have a
useful life of 5 years. The machine would have no salvage value. The machine would
reduce labor and other operating costs by $27,000 per year.
Required:
Determine the internal rate of return on the investment in the new machine. Show your
work!
Ans:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $90,504 ÷ $27,000 = 3.352
The factor of 3.352 for 5 years represents an internal rate of return of 15%.
AACSB: Analytic AICPA BB: Critical Thinking
LO: 2 Level: Easy
AICPA FN: Reporting
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Chapter 14 Capital Budgeting Decisions
140. (Ignore income taxes in this problem.) Maxcy Limos, Inc., is considering the purchase
of a limousine that would cost $187,335, would have a useful life of 9 years, and
would have no salvage value. The limousine would bring in cash inflows of $45,000
per year in excess of its cash operating costs.
Required:
Determine the internal rate of return on the investment in the new limousine. Show
your work!
Ans:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $187,335 ÷ $45,000 = 4.163
The factor of 4.163 for 9 years represents an internal rate of return of 19%.
AACSB: Analytic AICPA BB: Critical Thinking
LO: 2 Level: Easy
AICPA FN: Reporting
141. (Ignore income taxes in this problem.) The management of Zachery Corporation is
considering the purchase of a automated molding machine that would cost $203,255,
would have a useful life of 5 years, and would have no salvage value. The automated
molding machine would result in cash savings of $65,000 per year due to lower labor
and other costs.
Required:
Determine the internal rate of return on the investment in the new automated molding
machine. Show your work!
Ans:
Factor of the internal rate of return
= Investment required ÷ Net annual cash inflow = $203,255 ÷ $65,000 = 3.127
The factor of 3.127 for 5 years represents an internal rate of return of 18%.
AACSB: Analytic AICPA BB: Critical Thinking
LO: 2 Level: Easy
14-82
AICPA FN: Reporting
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Chapter 14 Capital Budgeting Decisions
142. (Ignore income taxes in this problem.) The management of an amusement park is
considering purchasing a new ride for $60,000 that would have a useful life of 15
years and a salvage value of $8,000. The ride would require annual operating costs of
$26,000 throughout its useful life. The company's discount rate is 10%. Management
is unsure about how much additional ticket revenue the new ride would generateparticularly since customers pay a flat fee when they enter the park that entitles them
to unlimited rides. Hopefully, the presence of the ride would attract new customers.
Required:
How much additional revenue would the ride have to generate per year to make it an
attractive investment?
Ans:
Cost of asset.......................
Annual operating costs.......
Salvage value.....................
Net present value................
Years Amount 10%Factor Present Value
Now $(60,000)
1.000
($ 60,000)
1-15 $(26,000)
7.606
( 197,756)
15
$8,000
0.239
1,912
($255,844)
$255,844 ÷ 7.606 = $33,637 additional revenue per year would be necessary to justify
the investment. This much additional revenue would result in a zero net present value.
Any less than this and the net present value would be negative. Any more than this and
the net present value would be positive.
AACSB: Analytic AICPA BB: Critical Thinking
LO: 3 Level: Hard
AICPA FN: Reporting
143. (Ignore income taxes in this problem.) Devon Corporation uses a discount rate of 8%
in its capital budgeting. Partial analysis of an investment in automated equipment with
a useful life of 8 years has thus far yielded a net present value of -$496,541. This
analysis did not include any estimates of the intangible benefits of automating this
process nor did it include any estimate of the salvage value of the equipment.
Required:
a. Ignoring any salvage value, how large would the additional cash flow per year
from the intangible benefits have to be to make the investment in the automated
equipment financially attractive?
b. Ignoring any cash flows from intangible benefits, how large would the salvage
value of the automated equipment have to be to make the investment in the
automated equipment financially attractive?
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Chapter 14 Capital Budgeting Decisions
Ans:
a. Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $496,541 ÷ 5.747 = $86,400
b. Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $496,541 ÷ 0.540 = $919,520
AACSB: Analytic AICPA BB: Critical Thinking
LO: 3 Level: Easy
AICPA FN: Reporting
144. (Ignore income taxes in this problem.) The management of Crosson Corporation is
investigating the purchase of a new satellite routing system with a useful life of 9
years. The company uses a discount rate of 17% in its capital budgeting. The net
present value of the investment, excluding its intangible benefits, is -$173,055.
Required:
How large would the additional cash flow per year from the intangible benefits have to
be to make the investment in the automated equipment financially attractive?
Ans:
Minimum annual cash flows from the intangible benefits
= Negative net present value to be offset ÷ Present value factor
= $173,055 ÷ 4.451 = $38,880
AACSB: Analytic AICPA BB: Critical Thinking
LO: 3 Level: Easy
AICPA FN: Reporting
145. (Ignore income taxes in this problem.) Chipps Corporation uses a discount rate of 9%
in its capital budgeting. Management is considering an investment in
telecommunications equipment with a useful life of 5 years. Excluding the salvage
value of the equipment, the net present value of the investment in the equipment is $530,985.
Required:
How large would the salvage value of the telecommunications equipment have to be to
make the investment in the telecommunications equipment financially attractive?
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Chapter 14 Capital Budgeting Decisions
Ans:
Minimum salvage value
= Negative net present value to the offset ÷ Present value factor
= $530,985 ÷ 0.650 = $816,900
AACSB: Analytic AICPA BB: Critical Thinking
LO: 3 Level: Easy
AICPA FN: Reporting
146. (Ignore income taxes in this problem.) Choudhury Corporation is considering the
following three investment projects:
Investment required.......................
Present value of cash inflows.........
Project H Project I Project J
$11,000 $53,000 $89,000
$12,980 $61,480 $96,120
Required:
Rank the investment projects using the project profitability index. Show your work
Ans:
Investment required (a).........................
Present value of cash inflows...............
Net present value (b).............................
Project profitability index (b) ÷ (a).......
Ranked by project profitability index...
Project H Project I Project J
($11,000) ($53,000) ($89,000)
12,980
61,480
96,120
$ 1,980
$ 8,480
$ 7,120
0.18
0.16
0.08
1
2
3
AACSB: Analytic AICPA BB: Critical Thinking
LO: 4 Level: Easy
AICPA FN: Reporting
147. (Ignore income taxes in this problem.) The management of Winstead Corporation is
considering the following three investment projects:
Investment required.......................
Present value of cash inflows.........
Project Q Project R Project S
$14,000 $48,000 $74,000
$14,140 $54,720 $82,140
The only cash outflows are the initial investments in the projects.
Required:
Rank the investment projects using the project profitability index. Show your work
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Chapter 14 Capital Budgeting Decisions
Ans:
Project Q Project R Project S
Investment required (a)......................... ($14,000) ($48,000) ($74,000)
Present value of cash inflows...............
14,140
54,720
82,140
Net present value (b).............................
$ 140
$ 6,720
$ 8,140
Project profitability index (b) ÷ (a).......
0.01
0.14
0.11
Ranked by project profitability index...
3
1
2
AACSB: Analytic AICPA BB: Critical Thinking
LO: 4 Level: Easy
AICPA FN: Reporting
148. (Ignore income taxes in this problem.) Hady Company is considering purchasing a
machine that would cost $688,800 and have a useful life of 7 years. The machine
would reduce cash operating costs by $118,759 per year. The machine would have no
salvage value.
Required:
a. Compute the payback period for the machine.
b. Compute the simple rate of return for the machine.
Ans:
a. Payback period = Investment required ÷ Net annual cash flow
= $688,800 ÷ $118,759 = 5.80 years
b. The simple rate of return is computed as follows:
Cost of machine, net of salvage value (a)........
Useful life (b)...................................................
Annual depreciation (a) ÷ (b)...........................
$688,800
7 years
$98,400
Annual cost savings.........................................
Less annual depreciation..................................
Annual incremental net operating income.......
$118,759
98,400
$ 20,359
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= $20,359 ÷ $688,800 = 2.96%
AACSB: Analytic AICPA BB: Critical Thinking
LO: 5,6 Level: Easy
14-86
AICPA FN: Reporting
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Chapter 14 Capital Budgeting Decisions
149. (Ignore income taxes in this problem.) Ramson Company is considering purchasing a
machine that would cost $756,000 and have a useful life of 8 years. The machine
would reduce cash operating costs by $132,632 per year. The machine would have a
salvage value of $151,200 at the end of the project.
Required:
a. Compute the payback period for the machine.
b. Compute the simple rate of return for the machine.
Ans:
a. Payback period = Investment required ÷ Net annual cash flow
= $756,000 ÷ $132,632 = 5.70 years
In this case the salvage value plays no part in the payback period since all of the
investment is recovered before the end of the project.
b. The simple rate of return is computed as follows:
Cost of machine, net of salvage value (a)...........
Useful life (b)......................................................
Annual depreciation (a) ÷ (b)..............................
$604,800
8 years
$75,600
Annual cost savings............................................
Less annual depreciation.....................................
Annual incremental net operating income..........
$132,632
75,600
$ 57,032
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= $57,032 ÷ $756,000 = 7.54%
AACSB: Analytic AICPA BB: Critical Thinking
LO: 5,6 Level: Medium
AICPA FN: Reporting
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Chapter 14 Capital Budgeting Decisions
150. (Ignore income taxes in this problem.) Ostermeyer Corporation is considering a
project that would require an initial investment of $247,000 and would last for 7 years.
The incremental annual revenues and expenses for each of the 7 years would be as
follows:
Sales...................................
Variable expenses...............
Contribution margin...........
Fixed expenses:
Salaries............................
Rents...............................
Depreciation....................
Total fixed expenses...........
Net operating income.........
$198,000
46,000
152,000
22,000
32,000
33,000
87,000
$ 65,000
At the end of the project, the scrap value of the project's assets would be $16,000.
Required:
Determine the payback period of the project. Show your work!
Ans:
Net operating income.................................
Add noncash deduction for depreciation. . .
Net annual cash inflow...............................
$65,000
33,000
$98,000
Payback period = Investment required ÷ Net annual cash inflow
= $247,000 ÷ $98,000 = 2.52 years
AACSB: Analytic AICPA BB: Critical Thinking
LO: 5 Level: Easy
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AICPA FN: Reporting
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Chapter 14 Capital Budgeting Decisions
151. (Ignore income taxes in this problem.) The management of Truelove Corporation is
considering a project that would require an initial investment of $321,000 and would
last for 7 years. The annual net operating income from the project would be $28,000,
including depreciation of $42,000. At the end of the project, the scrap value of the
project's assets would be $27,000.
Required:
Determine the payback period of the project. Show your work!
Ans:
Net operating income.................................
Add noncash deduction for depreciation. . .
Net annual cash inflow...............................
$28,000
42,000
$70,000
Payback period = Investment required ÷ Net annual cash inflow
= $321,000 ÷ $70,000 = 4.59 years
AACSB: Analytic AICPA BB: Critical Thinking
LO: 5 Level: Easy
AICPA FN: Reporting
152. (Ignore income taxes in this problem.) Ducey Corporation is contemplating purchasing
equipment that would increase sales revenues by $79,000 per year and cash operating
expenses by $27,000 per year. The equipment would cost $150,000 and have a 6 year
life with no salvage value. The annual depreciation would be $25,000.
Required:
Determine the simple rate of return on the investment to the nearest tenth of a percent.
Show your work!
Ans:
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= [Incremental revenues − (Cash operating expenses + Depreciation)] ÷ Initial
investment
=79,000 − ($27,000 + $25,000) ÷ $150,000
= 27,000 ÷ $150,000 = 18.0%
AACSB: Analytic AICPA BB: Critical Thinking
LO: 6 Level: Easy
AICPA FN: Reporting
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Chapter 14 Capital Budgeting Decisions
153. (Ignore income taxes in this problem.) The management of Nixon Corporation is
investigating purchasing equipment that would cost $518,000 and have a 7 year life
with no salvage value. The equipment would allow an expansion of capacity that
would increase sales revenues by $364,000 per year and cash operating expenses by
$211,000 per year.
Required:
Determine the simple rate of return on the investment to the nearest tenth of a percent.
Show your work!
Ans:
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= [Incremental revenues − (Cash operating expenses + Depreciation)] ÷ Initial
investment
= 364,000 − ($211,000 + $74,000) ÷ $518,000
= 79,000 ÷ $518,000 = 15.3%
AACSB: Analytic AICPA BB: Critical Thinking
LO: 6 Level: Easy
AICPA FN: Reporting
154. (Ignore income taxes in this problem.) Russnak Corporation is investigating
automating a process by purchasing a new machine for $198,000 that would have a 9
year useful life and no salvage value. By automating the process, the company would
save $68,000 per year in cash operating costs. The company's current equipment
would be sold for scrap now, yielding $18,000. The annual depreciation on the new
machine would be $22,000.
Required:
Determine the simple rate of return on the investment to the nearest tenth of a percent.
Show your work!
Ans:
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= (Cost savings - Depreciation) ÷ Initial investment
= ($68,000 − $22,000) ÷ ($198,000 − $18,000)
= $46,000 ÷ $180,000 = 25.6%
AACSB: Analytic AICPA BB: Critical Thinking
LO: 6 Level: Easy
14-90
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Chapter 14 Capital Budgeting Decisions
155. (Ignore income taxes in this problem.) The management of Schenk Corporation is
investigating automating a process by replacing old equipment by a new machine. The
old equipment would be sold for scrap now for $13,000. The new machine would cost
$648,000, would have a 9 year useful life, and would have no salvage value. By
automating the process, the company would save $186,000 per year in cash operating
costs.
Required:
Determine the simple rate of return on the investment to the nearest tenth of a percent.
Show your work!
Ans:
Depreciation on the new machine = $648,000 ÷ 9 = $72,000
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= (Cost savings − Depreciation) ÷ Initial investment
= ($186,000 − $72,000) ÷ ($648,000 - $13,000)
= $114,000 ÷ $635,000 = 18.0%
AACSB: Analytic AICPA BB: Critical Thinking
LO: 6 Level: Easy
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Chapter 14 Capital Budgeting Decisions
156. A company is considering purchasing an asset for $70,000 that would have a useful
life of 5 years and would have a salvage value of $12,000. For tax purposes, the entire
original cost of the asset would be depreciated over 5 years using the straight-line
method and the salvage value would be ignored. The asset would generate annual net
cash inflows of $22,000 throughout its useful life. The project would require
additional working capital of $8,000, which would be released at the end of the
project. The company's tax rate is 40% and its discount rate is 9%.
Required:
What is the net present value of the asset?
Ans:
Cost of asset........................
Working capital needed......
Net annual cash inflows......
Depreciation tax shield.......
Salvage value......................
Working capital released.....
Net present value................
Cost of asset........................
Working capital needed......
Net annual cash inflows......
Depreciation tax shield.......
Salvage value......................
Working capital released.....
Net present value................
Years Amount
Now ($70,000)
Now
($8,000)
1-5
$22,000
1-5
$14,000
5
$12,000
5
$8,000
After-Tax
Cash
Flows
($70,000)
($8,000)
$13,200
$5,600
$7,200
$8,000
Tax
Effect
9%
Factor
1.000
1.000
3.890
3.890
0.650
0.650
AACSB: Analytic AICPA BB: Critical Thinking
Appendix: 14C LO: 8 Level: Medium
14-92
0.60
0.40
0.60
Present
Value
($70,000)
(8,000)
51,348
21,784
4,680
5,200
$ 5,012
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Chapter 14 Capital Budgeting Decisions
157. Management is considering purchasing an asset for $40,000 that would have a useful
life of 8 years and no salvage value. For tax purposes, the entire original cost of the
asset would be depreciated over 8 years using the straight-line method. The asset
would generate annual net cash inflows of $20,000 throughout its useful life. The
project would require additional working capital of $5,000, which would be released
at the end of the project. The company's tax rate is 40% and its discount rate is 12%.
Required:
What is the net present value of the asset?
Ans:
Cost of asset........................
Working capital needed.......
Net annual cash inflows......
Depreciation tax shield.......
Working capital released.....
Net present value.................
Cost of asset........................
Working capital needed.......
Net annual cash inflows......
Depreciation tax shield.......
Working capital released.....
Net present value.................
Tax
Years Amount Effect
Now ($40,000)
Now
($5,000)
1-8
$20,000
0.60
1-8
$5,000
0.40
8
$5,000
After-Tax
Cash
Present
Flows
12%Factor
Value
($40,000)
1.000
($40,000)
($5,000)
1.000
(5,000)
$12,000
4.968
59,616
$2,000
4.968
9,936
2,020
$5,000
0.404
$26,572
AACSB: Analytic AICPA BB: Critical Thinking
Appendix: 14C LO: 8 Level: Medium
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Chapter 14 Capital Budgeting Decisions
158. Belling Inc. has provided the following data concerning a proposed investment
project:
Initial investment...............
Annual cash receipts..........
Life of the project...............
Annual cash expenses........
Salvage value.....................
$168,000
$126,000
9 years
$50,000
$8,000
The company's tax rate is 30%. For tax purposes, the entire initial investment without
any reduction for salvage value will be depreciated over 7 years. The company uses a
discount rate of 14%.
Required:
Compute the net present value of the project.
Ans:
Annual cash receipts........................................ $126,000
50,000
Annual cash expenses......................................
Annual net cash receipts.................................. $ 76,000
Initial investment (a)........................................ $168,000
Tax life (b)........................................................
7 years
Annual depreciation deduction (a) ÷ (b).......... $24,000
Initial investment...........................
Annual net cash receipts................
Salvage value.................................
Annual depreciation deductions.....
Initial investment...........................
Annual net cash receipts................
Salvage value.................................
Annual depreciation deductions.....
Net present value............................
Year(s)
Amount
Now ($168,000)
1-9
$76,000
9
$8,000
1-7
$24,000
After-Tax
Cash Flows
($168,000)
$53,200
$5,600
$7,200
AACSB: Analytic AICPA BB: Critical Thinking
Appendix: 14C LO: 8 Level: Medium
14-94
14%
Factor
1.000
4.946
0.308
4.288
Tax
Effect
0.70
0.70
0.30
After-Tax
Cash Flows
($168,000)
$53,200
$5,600
$7,200
PV
($168,000)
263,127
1,725
30,874
$127,726
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Chapter 14 Capital Budgeting Decisions
159. Camel Inc. is considering a project that would require an initial investment of
$210,000 and would have a useful life of 6 years. The annual cash receipts would be
$126,000 and the annual cash expenses would be $57,000. The salvage value of the
assets used in the project would be $32,000. The company's tax rate is 30%. For tax
purposes, the entire initial investment without any reduction for salvage value will be
depreciated over 5 years. The company uses a discount rate of 10%.
Required:
Compute the net present value of the project.
Ans:
Annual cash receipts........................................ $126,000
Annual cash expenses......................................
57,000
Annual net cash receipts.................................. $ 69,000
Initial investment (a)........................................ $210,000
Tax life (b)........................................................
5 years
Annual depreciation deduction (a) ÷ (b).......... $42,000
Initial investment...........................
Annual net cash receipts................
Salvage value.................................
Annual depreciation deductions.....
Initial investment...........................
Annual net cash receipts................
Salvage value.................................
Annual depreciation deductions.....
Net present value............................
Year(s)
Amount
Now ($210,000)
1-6
$69,000
6
$32,000
1-5
$42,000
After-Tax
Cash Flows
($210,000)
$48,300
$22,400
$12,600
AACSB: Analytic AICPA BB: Critical Thinking
Appendix: 14C LO: 8 Level: Medium
10%
Factor
1.000
4.355
0.564
3.791
Tax
Effect
0.70
0.70
0.30
After-Tax
Cash Flows
($210,000)
$48,300
$22,400
$12,600
PV
($210,000)
210,347
12,634
47,767
$ 60,747
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Chapter 14 Capital Budgeting Decisions
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