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Exam 13: Capital Budgeting Decisions

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Question 1

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The Morgan Company has been awarded a six-year contract to provide repair service to a commercial bus line. Morgan Company has gathered the following data associated with the items needed for this contract: $\begin{array}{|l|r|}\hline \text { Cost of the Special equipment needed now } & \$ 300,00 \\\hline \text { Working capital needed now } & \$ 80,000 \\\hline \text { Net annual operating cash inflows } & \$ 120,000 \\\hline \text { Equipment maintenance overhaul at the End of Four Years } & \$ 20,000 \\\hline \text { Salvage Value of the Equipment in six Years } & \$ 20,000 \\\hline\end{array}$ The special equipment is in Class 7 with a maximum $15 \% \mathrm { CCA }$ rate. The income tax rate is $40 \%$ , and Morgan's after-tax cost of capital is $14 \%$ . At the end of six years, the working capital will be released for use elsewhere. - The effective cost to Morgan of the need for working capital on the contract is closest to which of the following? (Do not round your intermediate calculations and round your final answer to the nearest whole number.)

A) $36,480.
B) $43,553.
C) $58,131.
D) $80,000.

E) B) and C)
F) C) and D)

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Question 2

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The following data are available on a proposed investment project: $\begin{array}{|l|r|}\hline \text { Initial investment } & \$ 142,500 \\\hline \text { Annual Cash Inflows } & \$ 30,000 \\\hline \text { Life of the investment } & 8 \text { years } \\\hline\end{array}$ $\begin{array} { | l | l |} \hline \text { Required Rate of Return } & 10 \%\\\hline\end{array}$ Which of the following statements best describes the internal rate of return on the proposed investment project? (Ignore income taxes in this problem.)

A) It is between 11% and 12%.
B) It is between 12% and 13%.
C) It is between 13% and 14%.
D) It is less than the required rate of return.

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

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Question 3

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Apex Corp. is planning to buy a production machine costing $\$ 120,000$ . This machine's expected useful life is five years, with no residual value. Apex uses a discount rate of $8 \%$ and has calculated the following data pertaining to the purchase and operation of this machine: $\begin{array}{|l|r|}\hline \text { Year } & \text { Estimated Annual Net Cash Inflow } \\\hline 1 & \$ 50,000 \\\hline 2 & \$ 40,000 \\\hline 3 & \$ 20,000 \\\hline 4 & \$ 20,000 \\\hline 5 & \$ 20,000 \\\hline\end{array}$ (Ignore income taxes in this problem.) -What is the payback period for this investment?

Hanley Company has purchased a machine for $125,000 that will be depreciated on the straight-line basis over a five-year period with no salvage value. The related cash flow from operations is expected to be $45,000 a year. These cash flows from operations occur uniformly throughout the year. (Ignore income taxes in this problem.) -What is the payback period for this investment? (Round your answer to the one decimal place.)

At what amount should the capital cost allowance (CCA) tax shield be included in the calculation of the net present value of an investment project?

The present value of a given sum to be received in five years will be exactly twice as great as the present value of an equal sum to be received in ten years.

A piece of equipment has a cost of $20,000.The equipment will provide cost savings of $3,500 each year for ten years,after which time it will have a salvage value of $2,500.If the company's discount rate is 12%,what is the equipment's net present value? (Ignore income taxes in this problem.) (Do not round your intermediate calculations and round the final answer to the nearest whole dollar.)

Treads Corporation is considering the replacement of an old machine that is currently being used. The old machine is fully depreciated but can be used by the corporation for five more years. If Treads decides to replace the old machine, Picco Company has offered to purchase the old machine for $60,000. The old machine would have no salvage value in five years. The new machine would be acquired from Hillcrest Industries for $1,000,000 in cash. The new machine has an expected useful life of five years with no salvage value. Due to the increased efficiency of the new machine, estimated annual cash savings of $300,000 would be generated. Treads Corporation uses a discount rate of 12%. (Ignore income taxes in this problem.) - The internal rate of return of the project is closest to which of the following?

A company anticipates a taxable cash receipt of $50,000 in year 3 of a project.The company's tax rate is 30%,and its discount rate is 14%.What is the approximate present value of this future cash flow? Do not round your intermediate calculations and round the final answer to the nearest whole dollar.)

If a company operates at a profit,the after-tax cost of a tax-deductible cash expense is determined by multiplying the cash expense by one minus the tax rate.

Eureka Company is considering replacing an old computer with a new computer. The following data relate to this investment decision: $\begin{array}{|l|r|}\hline \text { Cost of the new computer } & \$ 40,000 \\\hline \text { Annual cash operating costs of the new computer } & \$ 10,000 \\\hline \text { Working capital needed now for the new computer } & \$ 2,000 \\\hline \text { Useful life of the new computer } & 6 \text { Years } \\\hline \text { Salvage value of the new computer at the End of six years } & \$ 3,000 \\\hline \text { Original cost of the old van two years ago } & \$ 18,000 \\\hline \text { Salvage value of the old computer now } & \$ 4,000 \\\hline \text { Salvage value of the old computer six years from now } & \$ 0 \\\hline\end{array}$ The new computer will belong to Class 10 with a maximum CCA rate of $30 \%$ . The income tax rate is also $30 \%$ , and the company's after-tax cost of capital is $12 \%$ . -What is the present value of the before-tax proceeds that will be received on the sale of the old computer?

General Manufacturing Company consists of several divisions,one of which is the Transportation Division.The company has decided to dispose of this division because it no longer fits the company's long-term strategy.An offer of $9,000,000 has been received from a prospective buyer.If General retained the division,the company would operate the division for only nine years,after which the division would no longer be needed and would be sold for $600,000.If the company retains the division,an immediate investment of $500,000 would need to be made to update equipment to current standards.Annual net operating cash flows would be $1,805,000 if the division is retained.The company's discount rate is 12%.(Ignore income taxes in this problem.) Required: Using the net present value method,determine whether General Manufacturing should accept or reject the offer made by the potential buyer.

Selah Company bought a new computer-assisted design (CAD)software for $10,000,000 at the beginning of Year 1.The software has a useful life of 3 years and will save the company annual cash operating expenses of $4,000,000 in each of those 3 years.The software will have a zero net salvage value at the end of 3 years.It belongs to Class 12 with a capital cost allowance (CCA)rate of 100%.With special permission from the Canada Revenue Agency,the half-year CCA rule has been waived for the company to permit a maximum 100% CCA deduction for Year 1.The company's income tax rate and after-tax cost of capital are 40% and 12%,respectively. Required: a)Calculate the maximum total CCA tax shied available to the company. b)Calculate the present value of the annual cash savings in operating expenses. c)Calculate the net present value (NPV)of the investment. d)Was the internal rate of return (IROR)greater than or less than the company's after-tax cost of capital of 12%? (Note: Do NOT try to calculate the implied actual internal rate or return.) e)By how much must the annual savings in operating expenses be increased or decreased to make the investment just worthwhile,that is,either zero NPV or 12% IROR?

Kane Company is in the process of purchasing a new machine for its production line.It is near the end of the year,and the machine is being offered at a special discount if purchased before the end of the year.Kane has determined that the capital cost allowance (CCA) deduction on the new machine for the year of purchase would be $13,000.The tax rate is 30%.If Kane purchases the machine and reports a positive net income for the year,what would be the tax savings from the CCA tax shield related to this machine for the year of purchase?

In order to receive $12,000 at the end of three years and $10,000 at the end of five years,how much must be invested now if you can earn 14% rate of return? (Ignore income taxes in this problem.) (Round your PV factor to 5 decimal places and final answer to nearest whole dollar amount.)

White Company's required rate of return on capital budgeting projects is 12%.The company is considering an investment opportunity that would yield a cash flow of $10,000 in five years.What is the most that the company should be willing to invest in this project? (Ignore income taxes in this problem.) (Round your PV factor to 5 decimal places and final answer to nearest whole dollar amount.)

The net present value method assumes that cash flows from a project are immediately reinvested at a rate of return equal to the discount rate.

Vernon Company has been offered a seven-year contract to supply a part for the military.After careful study,the company has estimated the following data relating to the contract: $\begin{array}{|l|r|}\hline \text { Cost of equipment needed } & \$ 300,000 \\\hline \text { Working capital needed } & \$ 50,000 \\\hline \text { Annual cash receipts from the delivery of parts, less cash operating costs } & \$ 70,000 \\\hline \text { Salvage value of equipment at termination of the contract } & \$ 5,000 \\\hline\end{array}$ It is not expected that the contract would be extended beyond the initial contract period.The company's discount rate is 10%.(Ignore income taxes in this problem.) Required: Use the net present value method to determine if the contract should be accepted.Round all computations to the nearest dollar.

A company anticipates a tax-deductible cash expense of $10,000 in year 2 of a project.The company's tax rate is 30%,and its discount rate is 8%.What is the approximate present value of this future cash outflow? Do not round your intermediate calculations and round the final answer to the nearest whole dollar.)

A company anticipates a capital cost allowance (CCA) deduction of $30,000 in year 3 of a project.The company's tax rate is 30%,and its discount rate is 12%.What is the approximate present value of the CCA tax shield resulting from this deduction? (Do not round your intermediate calculations and round the final answer to the nearest whole dollar.)