Question;Chapter 21;Review Questions and Exercises;1.;The ______ method of capital budgeting is based on income rather than cash;flows.;2.;The discount rate that makes the net present value of a project equal to zero;is called the __ 3. In a capital-budgeting project, the investment required for;accounts receivable and inventories is called _ ____.;4.;(Appendix) __ ___ is the decline in the general purchasing power of the;monetary unit.;True-False;1. The planning and control tools used for year-to-year operating decisions are;well suited for capital-budgeting decisions.;2. The present value of $1 million to be received ten years from now is lower;if computed at a discount rate of 10% rather than 14%.;3. Assume a required rate of return of 12% is used to compute the NPV of a;project. If NPV is negative, IRR is less than 12%.;4. The payback method does not consider a project?s cash flows after the payback;period.;5. If the income tax rate for a profitable company is 30%, a depreciation;deduction of $10,000 results in a tax savings of $7,000 (before considering;time value of money).;6. For a profitable company, the gain or loss on the recovery of working;capital in a capital-budgeting project is subject to income tax.;7. It is consistent to use NPV as best for capital-budgeting decisions and then;use AARR to evaluate a manager?s performance over short time horizons.;Multiple Choice;1. (CMA) Amster Corporation has not yet decided on its required rate of return;for use in the evaluation of capital budgeting projects for the current year. This;lack of information prohibits Amster from calculating a project?s;2. (CPA adapted) Brewster Co. is reviewing the following data relating to an;energy- saving investment proposal;Net initial investment;$50,000;After-tax cash flow from disposal of the investment at the end;of 5 years;10,000;Present value of an annuity of $1 at 12% for 5 years;3.60;Present value of $1 at 12% in 5 years;0.57;What;is the amount of after-tax annual savings (including the depreciation effects) needed;for the investment to provide a 12% return?;3. (CMA) Making the common assumption in capital-budgeting analysis that cash inflows;occur in a lump sum at the end of individual years during the life of an investment;project when, in fact, they flow more or less continuously during those years;4. (CPA adapted) Apex Corp. is considering the purchase of a machine costing $100,000.;The machine?s expected useful life is five years. The estimated annual after-tax;cash flow from operations is: $60,000 in year 1, $30,000 in year 2, $20,000 in;year 3, $20,000 in year 4, and $20,000 in year 5. Assuming these cash flows;will be received evenly during each year, the payback is;5. (CMA) Fast Freight Inc. is planning to purchase equipment to make its operations;more efficient. The equipment has an estimated life of six years. At the time;of acquiring the equipment, a $9,000 investment in working capital is required.;In a discounted cash-flow analysis, this investment in working capital;D;6. Assume in the current year that a profitable company pays $10,000 for;advertising and has depreciation of $10,000. If the income tax rate is 40%, the;after-tax effects on cash flow before considering time value of money are a net;outflow of;7. (CMA) Garfield Inc. is considering a 10-year capital investment project with;forecasted cash revenues of $40,000 per year and forecasted cash operating;costs of $29,000 per year. The initial cost of the equipment for the project is;$23,000, and Garfield expects to sell the equipment for $9,000 at the end of;the tenth year. The equipment will be depreciated on a straight-line basis over;seven years for tax purposes. The project requires a working capital investment;of $7,000 at its inception and another $5,000 at the end of year 5. The working;capital is fully recoverable at the end of the life of the project. Assuming a;40% tax rate, expected net after-tax cash flow from the project for the tenth;year is;8. (CMA) Superstrut is considering replacing an old press that cost $80,000 six;years ago with a new one with a purchase cost of $225,000. Shipping and installation;cost an additional $20,000. The old press has a book value of $15,000 and can;be sold currently for $5,000. The increased production of the new press would;increase inventories by $4,000, accounts receivable by $16,000, and accounts;payable by $14,000. Superstrut?s net initial investment for analyzing the;acquisition of the new press, assuming a 40% income tax rate;9. (CMA) Brownel Inc. currently has annual cash revenues of $240,000 and annual;operating costs of $185,000 (all cash items except depreciation of $35,000).;The company is considering the purchase of a new mixing machine costing;$120,000 that would increase cash revenues to $290,000 per year and operating;costs (including depreciation) to $205,000 per year. The new machine would increase;depreciation to $50,000 per year. Using a 40% income tax rate, Brownel?s annual;incremental after-tax cash flow from the new mixing machine is;Items;Present Situation;Proposed Situation;Cash-flow Difference;Cash;revenues;$240,000;$290,000;$50,000;Operating;Cost;Cash operating costs (excludes;depreciation);$185,000 ? 35,000;150,000;$205,000 ? 50,000;155,000;(5,000);Depreciation;35,000;50,000;Total operation Cost;185,000;205,000;Operating;income;55,000;85,000;10. (Appendix) If the nominal rate of interest is 16% and the inflation rate is;5%, the real rate of interest (rounded to the nearest tenth of a percent) is;Review Exercises;1.;The following information pertains to a machine recently sold by Powers;Enterprises;Net initial investment;$300,000;Estimated useful life for tax purposes;8 years;Terminal disposal value for tax purposes;zero;Age at the time of sale;6 years;Cash received from the sale;$60,000;Income tax rate;30%;Assuming;Powers uses straight-line depreciation and is a profitable company, calculate;the after-tax cash flow from the sale of the machine.;2.;(CMA adapted) Jasper Company has a payback requirement of three years on new;equipment acquisitions. A new sorter is being evaluated that costs $450,000 and;has an estimated useful life of five years. Straight-line depreciation will be;used with a zero terminal disposal value. Jasper is subject to a 40% income tax;rate.;Calculate;the amount of savings in after-tax annual cash operating costs that must be;generated by the new sorter to meet the company?s payback requirement.;3.;(Appendix) Massey Company?s nominal rate of return for capital-budgeting projects;is 20%, which includes a 10% inflation rate. The present value of $1 at 20% for;one year is 0.833. Assume a 40% income tax rate.;Calculate;the after-tax present value (expressed in nominal dollars) of;a.;Before-tax cash operating savings of $100,000 (expressed in year 0 dollars) to;be received at the end of year 1.;b. Year 1 depreciation of $70,000.
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