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Exam 25: Capital Budgeting and Managerial Decisions

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Question 91

True/False

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An out-of-pocket cost requires a future outlay of cash and is relevant for current and future decision making.

A) True
B) False

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Question 92

Multiple Choice

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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: Interest rate Present value of an annuity of $1 factor for year 5 10 % 3.7908 12 % 3.6048 14 % 3.4331 Calculate the internal rate of return to determine whether it should accept this project.

A) The project should be accepted because it will earn more than 14%.
B) The project will earn more than 12% but less than 14%. At a hurdle rate of 14%, the project should be rejected.
C) The project should be rejected because it will earn less than 14%.
D) The project should be accepted because it will earn more than 10%.
E) The project should be rejected because it will not earn exactly 14%.

F) A) and E)
G) C) and E)

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Question 93

Multiple Choice

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The discount rate that yields a net present value of zero for an investment is the:

Generalware, Inc. sells a single product and reports the following results from sales of 100,000 units: $\begin{array}{llr} \text {Sales (\$45 unit) } &\$4,500,000\\ \text { Less costs and expenses:} &\\ \text { Direct materials (\$16/unit). } &\$1,600,000\\ \text { Direct labor (\$9/unit).} &900,000\\ \text { Variable overhead (\$3/unit). } &300,000\\ \text {Fixed overhead (\$8.10/unit) } &810,000\\\text { Variable administrative (\$4.50/unit)} &450,000\\ \text { Fixed administrative (\$4/unit)} &400,000\\ \text {Total costs and expenses } &\$(4,460,000)\\ \text { Operating income } &\$40,000\end{array}$ A foreign company wants to purchase 15,000 units. However, they are willing to pay only $36 per unit for this one-time order. They also agree to pay all freight costs. To fill the order, Generalware will incur normal production costs. Total fixed overhead will have to be increased by $60,000 to pay for equipment rentals and insurance. No additional administrative costs (variable or fixed) will be incurred in association with this special order. Required: (1) Should Generalware accept the order if it does not affect regular sales? Explain. (2) Assume that Generalware can accept the special order only by giving up 5,000 units of its normal sales. Should the company accept the special order under these circumstances?

A company paid $200,000 ten years ago for a specialized machine that has no salvage value and is being depreciated at the rate of $10,000 per year. The company is considering using the machine in a new project that will have incremental revenues of $28,000 per year and annual cash expenses of $20,000. In analyzing the new project, the $200,000 original cost of the machine is an example of a(n) :

A(n) ________ arises from a past decision and cannot be avoided or changed; it is irrelevant to future decisions.

Match the following definitions with the appropriate term

An opportunity cost:

Maxim manufactures a hamster food product called Green Health. Maxim currently has 10,000 bags of Green Health on hand. The variable production costs per bag are $1.80 and total fixed costs are $10,000. The hamster food can be sold as it is for $9.00 per bag or be processed further into Premium Green and Green Deluxe at an additional cost. The additional processing will yield 10,000 bags of Premium Green and 3,000 bags of Green Deluxe, which can be sold for $8 and $6 per bag, respectively. -The incremental revenue of processing Green Health further into Premium Green and Green Deluxe would be:

The hurdle rate is often set at:

What is one advantage and one disadvantage of using the accounting rate of return to evaluate investment alternatives?

________ is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

The net present value decision rule requires that when an asset's expected cash flows are discounted at the required rate and yield a positive net present value, the project should be ________.

The calculation of annual net cash flow from a particular investment project should include all of the following except:

You have evaluated three projects of similar investment amount and risk using the net present value (NPV) method. How would you decide which one of the projects to select?

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

Mays Company can sell all of product A that it produces but only 160,000 units of Z and it has limited production capacity. It can produce 6 units of A per hour or 10 units of Z per hour, and it has 30,000 production hours available. Contribution margin per unit is $12 for A and $10 for Z. What is the most profitable sales mix for this company?

A company is evaluating the purchase of a machine for $750,000 with a six-year useful life and no salvage value. The company uses straight-line depreciation and it assumes that the annual net cash flow from using the machine will be received uniformly throughout each year. In calculating the accounting rate of return, what is the company's average investment?

In business decision-making, managers typically examine the two fundamental factors of:

A(n) ________ is the potential benefit lost by taking a specific action when two or more alternative choices are available.