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Exam 11: Capital Budgeting and Investment Analysis

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Question 51

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In using a capital budgeting method that takes the time value of money into consideration, management must consider a hurdle rate in making its decisions. What is a hurdle rate? What factors does management have to consider in selecting a hurdle rate?

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A hurdle rate is a company's required, o...

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Question 52

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The process of restating future cash flows in today's dollars is known as:

A) Budgeting.
B) Annualization.
C) Discounting.
D) Payback period.
E) Capitalizing.

F) B) and D)
G) All of the above

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Question 53

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A company is considering purchasing a machine for $85,000. The machine is expected to generate a net after-tax income of $11,250 per year. Depreciation expense would be $8,500. What is the payback period for this machine?

The internal rate of return method is not subject to the limitations of the net present value method when comparing projects with different amounts invested because:

A company buys a machine for $60,000 that has an expected life of 9 years and no salvage value. The company anticipates a yearly net income of $2,850 after taxes of 30%, with the cash flows to be received evenly throughout each year. What is the accounting rate of return?

Projects with shorter payback periods have higher risk, as the company has less time to respond to unanticipated changes.

Alfarsi Industries uses the net present value method to make investment decisions and requires a 15% annual return on all investments. The company is considering two different investments. Each require an initial investment of $15,000 and will produce cash flows as follows: End of Investment Year A B $\begin{array} { | r | r | r | } \hline 1 & \$ 8,000 & \$ 0 \\\hline 2 & 8,000 & 0 \\\hline 3 & 8,000 & 24,000 \\\hline\end{array}$ The present value factors of $1 each year at 15% are: $\begin{array}{llcc} \text {1 } &0.8696\\ \text { 2} &0.7561\\ \text { 3 } &0.6575\\\end{array}$ The present value of an annuity of $1 for 3 years at 15% is 2.2832 The net present value of Investment B is:

A company is considering a 5-year project. The company plans to invest $60,000 now and it forecasts cash flows for each year of $16,200. The company requires a hurdle rate of 12%. Calculate the internal rate of return to determine whether it should accept this project. Selected factors for a present value of an annuity of $1 for five years are shown below: $\begin{array} { c c } \text { Interest rate } & \text { Present value of ard annuity } \\ & \text { of } \$ 1 \text { factor for year } 5 \\10 \% & 3.7908 \\12 \% & 3.6048 \\14 \% & 3.433\end{array}$

Butler Corporation is considering the purchase of new equipment costing $30,000. The projected annual after-tax net income from the equipment is $1,200, after deducting $10,000 for depreciation. The revenue is to be received at the end of each year. The machine has a useful life of 3 years and no salvage value. Butler requires a 12% return on its investments. The present value of an annuity of $1 for different periods follows: $\begin{array} { c l } \text { Periods } & 12 \% \\1 & 0.8929 \\2 & 1.6901 \\3 & 2.4018 \\4 & 3.0373\end{array}$ What is the net present value of the machine?

The following present value factors are provided for use in this problem. $\begin{array} { c c c } \text { Periods } & \text { Presert Value } & \text { Presert Value of arl } \\ & \text { of } \$ 1 \text { at } 8 \% & \text { Annuity of } \$ 1 \text { at } 8 \% \\1 & 0.9259 & 0.9259 \\2 & 0.8573 & 1.7833 \\3 & 0.7938 & 2.5771\\4&0.07350&3.3121\end{array}$ Xavier Co. wants to purchase a machine for $37,000 with a four year life and a $1,000 salvage value. Xavier requires an 8% return on investment. The expected year-end net cash flows are $12,000 in each of the four years. What is the machine's net present value?

If the internal rate of return (IRR) of an investment is lower than the hurdle rate, the project should be rejected.

A given project requires a $30,000 investment and is expected to generate end-of-period annual cash inflows as follows: $\begin{array} { l l l l } \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Total } \\\$ 12,000 & \$ 8,000 & \$ 10,000 & \$ 30,000\end{array}$ Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below: $\begin{array} { c c c } i = 10\% & i = 10 \% & i = 10\%\\n = 1 & n = 2 & n = 3 \\.9091 & .8264 & .7513\end{array}$

A new manufacturing machine is expected to cost $278,000, have an eight-year life, and a $30,000 salvage value. The machine will yield an annual incremental after-tax income of $35,000 after deducting the straight-line depreciation. Compute the accounting rate of return for the investment.

A company is considering a proposal to invest $40,000 in a project that would provide the following net cash flows: Year 1 $ 6,500 Year 2 12,700 Year 3 15,000 Year 4 12,800 Compute the project's payback period.

Tressor Company is considering a 5-year project. The company plans to invest $90,000 now and it forecasts cash flows for each year of $27,000. The company requires that investments yield a discount rate of at least 14%. Selected factors for a present value of an annuity of $1 for five years are shown below: $\begin{array} { c c } \text { Interest rate } & \text { Present value of ard annuity } \\ & \text { of } \$ 1 \text { factor for year } 5 \\10 \% & 3.7908 \\12 \% & 3.6048 \\14& 34331\end{array}$ Calculate the internal rate of return to determine whether it should accept this project.

A limitation of the internal rate of return method is that it:

A company is considering purchasing a machine for $21,000. The machine will generate an after-tax net income of $2,000 per year. Annual depreciation expense would be $1,500. What is the payback period for the new machine?

A positive profitability index indicates a positive net present value.

When comparing investments with similar lives and risks, a company will prefer the investment with the higher rate of return.

An advantage of the break-even time (BET) method over the payback period method is that it recognizes the time value of money.