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Exam 10: Planning for Capital Investments

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Question 81

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

A) an audit.
B) a preaudit.
C) a postaudit.
D) a capital review.

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

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Question 82

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

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Question 83

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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.

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

The cost of capital represents the maximum acceptable rate of return that a capital investment should earn.

Which method for evaluating capital investment proposals reduces the present value of cash outflows from the present value of cash inflows?

Why does a company use its cost of capital as the minimum required rate of return for its capital investment decisions?

The assumption regarding ordinary annuities is that cash flows occur at the end of each period.

Bristles Hair Salon is considering installing spray tanning booths.The booths cost $220,000 and have an estimated five-year useful life.Ignore income taxes.The following pro forma income statement is provided: $\begin{array}{|l|r|r|}\hline \text { Spray booth revenue } & &\$ 95,000\\\hline \text {Less expenses: } \\\hline \text { Supplies } & \$ 15,000 \\\hline \text { Insurance } & 5,000 \\\hline \text { Depreciation } & 44,000 \\\hline \text { Maintenance } & \underline{6,000} &\underline { 70,000 } \\\hline \text { Net income } &&\underline { \$25,000 } \\\hline\end{array}$ Required: 1)Bristles would like to recoup its original investment in less than four years.Compute the payback period for the tanning booth investment.Would you recommend that the booths be purchased? Why or why not? 2)Bristles' minimum acceptable unadjusted rate of return is 11%.Compute the unadjusted rate of return on the original investment.Would you recommend that the booths be purchased? Why or why not?

Investment projects A and B offer equal cash inflows over their lives,but the cash inflows for project A occur sooner than those for project B.B.The two projects are otherwise identical (the cost is the same,for example)Based on this information,the internal rate of return for A is lower than for

Redmond Company is considering investing in one of the following two projects: $\begin{array}{c}\text { Annual Cash Inflows }\\\begin{array}{lll}\text { Year: } \\1 \\2 \\3 \\4 \\\text { Total }\end{array}\begin{array}{r} \underline { \text { Project A } } \\\$2,000 \\ 3,000 \\3,000 \\ \underline { 1,000} \\ \underline { \$ 9,000 }\\\end{array}\begin{array}{r} \underline { \text { Project B } } \\\$ 4,000 \\ 2,000 \\2,000 \\ \underline { 1,000} \\ \underline { \$ 9,000 }\\\end{array}\end{array}$ Required: 1)Which project is more desirable strictly in terms of cash inflows? Why? 2)Compute the present value of each project's cash inflows assuming the company's required rate of return is 12%. 3)What is the maximum amount Redmond should be willing to pay for each project? 4)Suppose each project costs $7,000.Which project(s)should be accepted? Note that only one project can be accepted.

Morrisey Company has two investment opportunities.Both investments cost $5,500 and will provide the same total future cash inflows.The cash receipt schedule for each investment is given below: $\begin{array}{|l|r|r|}\hline & \underline{\text { Investment I }} &\underline{ \text { Investment II }} \\\hline \text { Period 1 } & \$ 1,000 & \$ 1,000 \\\hline \text { Period 2 } & 1,000 & 2,000 \\\hline \text { Period 3 } & 2,000 & 3,000 \\\hline \text { Period 4 } & \underline{4,000} & \underline{2,000} \\\hline \text { Total } & \underline{\$ 8,000} & \underline{\$ 8,000} \\\hline & & \\\hline\end{array}$ What is the net present value of Investment II assuming an 8% minimum rate of return? (Do not round your intermediate calculations.Round your answer to nearest whole dollar. )

A capital investment project may provide cash inflows from:

A project's net present value can be found by subtracting the cost of the project from the total present value of the future cash flows generated by the project.

How would an organization benefit from conducting postaudits of its capital investment decisions?