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Exam 16: Planning for Capital Investments

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Question 1

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The process by which management evaluates long-term investment decisions involving long term operational assets is called:

A) capital investment analysis.
B) activity based management.
C) strategic business analysis.
D) fixed cost analysis.

E) A) and C)
F) B) and C)

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Question 2

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The amount of the depreciation tax shield can be calculated by multiplying the amount of depreciation expense by the tax rate.

A) True
B) False

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Question 3

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Columbus Company is considering a project that requires an initial investment of $400,000. Its incremental cash flows are expected to be $150,000 per year for five years. The project would be depreciated on a straight-line basis over 5 years with no expected salvage value. The company has a stated policy that all projects must return their required investment dollars within the first 75% of the project's life. The company is subject to a 40% income tax rate, and its cost of capital is 10%. Required: 1) Compute the project's after-tax net cash flows (NCF) by completing the following table: $\begin{array} { | c | c | c | c | c | c | } \hline & \text { Cash } & & \text { Taxable } & \text { Cash Outflow } & \text { After-tax } \\\hline \text { Year } & \text { Inflows } & \text { Depreciation } & \text { Income } & \text { for Taxes } & \text { NCF } \\\hline 1.5 & & & & & \\\hline\end{array}$ 2) Compute the project's net present value by completing the following table: $\begin{array} { | c | c | c | c | } \hline & \text { After-tax } & \text { Present Value } & \text { Total } \\\hline \text { Year } & \text { NCF } & \text { Factor } & \text { Present Value } \\\hline 0 & & & \\\hline 1-5 & & & \\\hline\end{array}$ 3) Compute the project's payback period. 4) Should the project be accepted? Why or why not?

Which capital budgeting technique defines returns in terms of income instead of cash flows?

Montana Company is evaluating two different capital investments, Project X and Y. Either X or Y would cost $210,000, and the company cannot afford to do both. The company expects that Project X would provide net cash inflows of $62,000 per year for 5 years. For Project Y, the net cash inflows are expected to be as follows: $\begin{array}{|l|l|}\hline\text { Year } & \text { Cash inflows from Project Y}\\\hline1 & \$ 44,000\\\hline 2 & 48,000 \\\hline 3 & 60,000 \\\hline 4 & 76,000 \\\hline 5 & 80,000 \\\hline \text {total }&\$308,000\\\hline\end{array}$ Montana's cost of capital is 12%. Required: 1) Calculate the present value index for Project X and for Project Y. Round your answer to three decimal places. 2) Indicate whether each of the projects is an acceptable investment. 3) Based on present value index, which of the two projects should Montana implement?

Fenwick Company is considering purchase of equipment that costs $60,000 and is expected to offer annual cash inflows of $16,000 for 5 years. Fenwick Company's required rate of return is 10%. What is the internal rate of return of this investment project?

Newton Company is considering the purchase of an asset that will provide a depreciation tax shield of $10,000 per year for 10 years. Assuming the company is subject to a 40% tax rate during the period, and a zero salvage value, what is the depreciable cost of the new asset?

Garrison Company has two investment opportunities. A cash flow schedule for the investments is provided below: $\begin{array} { | l | c | c | } \hline \text { Year } & \text { Investment } A & \text { Investment } \mathrm { B } \\\hline 0 & ( \$ 5,000 ) & ( \$ 6,000 ) \\\hline 1 & 2,000 & 3,000 \\\hline 2 & 2,000 & 2,000 \\\hline 3 & 2,000 & 2,000 \\\hline 4 & 2,000 & 1,000 \\\hline\end{array}$ Considering the unequal investments, which of the following techniques would be most appropriate for choosing between Investment A and Investment B?

Southport Company is considering the purchase of a piece of equipment that costs $100,000. The equipment would be depreciated on a straight-line basis to its expected salvage value of $10,000 over its 16-year useful life. Assuming a tax rate of 40%, what is the annual amount of the depreciation tax shield provided by this investment?

The length of time required to recover the initial investment in a capital asset is known as the:

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

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

The review of a capital budgeting decision to determine whether a project was accepted that should have been rejected is referred to as:

Jiminez Company has two investment opportunities. Both investments cost $5,000 and will provide the following net cash flows: $\begin{array} { | l | r | r | } \hline \text { Year } & \text { Investment } A & \text { Investment B } \\\hline 1 & \$ 3,000 & \$ 3,000 \\\hline 2 & 3,000 & 4,000 \\\hline 3 & 3,000 & 2,000 \\\hline 4 & 3,000 & 1,000 \\\hline\end{array}$ The total present value of Investment A's cash flows assuming an 8% minimum rate of return is (Do not round your PV factors and intermediate calculations. Round your answer to the nearest whole dollar) :

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

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

Why is the time value of money often taken into account in analyzing a capital investment?

Capital investment decisions involve investments in current assets.

Grayson Company is considering purchase of equipment that costs $49,000 and is expected to offer annual cash inflows of $13,000. Grayson's minimum required rate of return is 10%. How many years must the cash flows last, for the investment to be acceptable? (Do not round your PV factors and intermediate calculations. Round to nearest whole year.)

The difference between an ordinary annuity and an annuity due is: