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Chapter 14

Capital Budgeting Decisions

True/False
1.
F
Medium

Thepresentvalueofagivensumtobereceivedinfiveyears
willbeexactlytwiceasgreatasthepresentvalueofanequal
sumtobereceivedintenyears.

2.
F
Medium

Anincreaseinthediscountratewillresultinanincreasein
thepresentvalueofagivencashflow.

3.
T
Easy

Thepresentvalueofacashflowdecreasesasitmovesfurther
intothefuture.

4.
F
Medium

Whenthenetpresentvaluemethodisused,theinternalrateof
returnisthediscountrateusedtocomputethenetpresentvalue
ofaproject.

5.
F
Medium

Ifnetpresentvalueisnegative,theninterpolationisneededin
ordertomakeaproposedinvestmentacceptable.

6.
T
Medium

Thenetpresentvaluemethodassumesthatcashflowsfroma
projectareimmediatelyreinvestedatarateofreturnequalto
thediscountrate.

7.
F
Easy

Whenusinginternalrateofreturntoevaluateinvestment
projects,iftheinternalrateofreturnislessthanthe
requiredrateofreturn,theprojectshouldbeaccepted.

8.
T
Easy

Theinternalrateofreturnforaprojectisthediscountrate
thatmakesthenetpresentvalueoftheprojectequaltozero.

9.
T
Medium

Incomparingtwoinvestmentalternatives,thedifferencebetween
thenetpresentvaluesofthetwoalternativesobtainedusingthe
totalcostapproachwillbethesameasthenetpresentvalue
obtainedusingtheincrementalcostapproach.

10.
T
Easy

Thepaybackperiodisthelengthoftimeittakesforan
investmenttorecoupitsowninitialcostoutofthecash
receiptsitgenerates.

ManagerialAccounting,9/e

11.
F
Medium

Projectswithshorterpaybackperiodsarealwaysmoreprofitable
thanprojectswithlongerpaybackperiods.

12.
F
Easy

Thepaybackmethodofmakingcapitalbudgetingdecisionsgives
fullconsiderationtothetimevalueofmoney.

13.
F
Easy

Ifnewequipmentisreplacingoldequipment,anysalvagereceived
fromsaleoftheoldequipmentshouldnotbeconsideredin
computingthepaybackperiodofthenewequipment.

14.
F
Easy

Onestrengthofthesimplerateofreturnmethodisthatittakes
intoaccountthetimevalueofmoneyincomputingthereturnon
aninvestmentproject.

15.
T
Easy

Thepreferenceruleforrankingprojectsbytheprofitability
indexis:thehighertheprofitabilityindex,themoredesirable
theproject.

Multiple Choice
16.
C
Medium

Anincreaseinthediscountrate:
a.willincreasethepresentvalueoffuturecashflows.
b.willhavenoeffectonnetpresentvalue.
c.willreducethepresentvalueoffuturecashflows.
d.isonemethodofcompensatingforreducedrisk.

17.
B
Medium

SupposeaninvestmenthascashinflowsofRdollarsattheendof
eachyearfortwoyears.Thepresentvalueofthesecashinflows
usinga12%discountratewillbe:
a.greaterthanundera10%discountrate.
b.lessthanundera10%discountrate.
c.equaltothatundera10%discountrate.
d.sometimesgreaterthanundera10%discountrateand
sometimesless;itdependsonR.

18.
B
Medium
CPAadapted

Thenetpresentvalueandinternalrateofreturnmethodsof
capitalbudgetingaresuperiortothepaybackmethodinthat
they:
a.areeasiertoimplement.
b.considerthetimevalueofmoney.
c.requirelessinput.
d.reflecttheeffectsofdepreciationandincometaxes.

ManagerialAccounting,9/e

19.
C
Medium
CPA
adapted

Howarethefollowingusedinthecalculationofthenet
presentvalueofaproposedproject?Ignoreincometax
considerations.

20.
D
Medium
CPA
adapted

Thenetpresentvaluemethodtakesintoaccount:

21.
C
Easy
CMA
adapted

Thenetpresentvaluemethodofcapitalbudgetingassumesthat
cashflowsarereinvestedat:
a.theinternalrateofreturnontheproject.
b.therateofreturnonthecompany'sdebt.
c.thediscountrateusedintheanalysis.
d.azerorateofreturn.

22.
C
Medium

Someinvestmentprojectsrequirethatacompanyexpandits
workingcapitaltoservicethegreatervolumeofbusinessthat
willbegenerated.Underthenetpresentvaluemethod,the
investmentofworkingcapitalshouldbetreatedas:
a.aninitialcashoutflowforwhichnodiscountingis
necessary.
b.afuturecashinflowforwhichdiscountingisnecessary.
c.bothaninitialcashoutflowforwhichnodiscountingis
necessaryandafuturecashinflowforwhichdiscountingis
necessary.
d.irrelevanttothenetpresentvalueanalysis.

23.
A
Medium
CMA
adapted

(Ignoreincometaxesinthisproblem.)Howisdepreciation
handledbythefollowingcapitalbudgetingtechniques?

DepreciationexpenseSalvagevalue
a.IncludeInclude
b.IncludeExclude
c.ExcludeInclude
d.ExcludeExclude

CashFlowOverTimeValue
LifeofProjectofMoney
a.NoYes
b.NoNo
c.YesNo
d.YesYes

InternalSimple
RateofReturnRateofReturnPayback
a.ExcludedIncludedExcluded
b.IncludedExcludedIncluded
c.ExcludedExcludedIncluded
d.IncludedIncludedExcluded

ManagerialAccounting,9/e

24.
B
Easy
CPA
adapted

Whichofthefollowingcapitalbudgetingtechniquesconsider(s)
cashflowovertheentirelifeoftheproject?

25.
C
Medium
CMA
adapted

Aweaknessoftheinternalrateofreturnmethodforscreening
investmentprojectsisthatit:
a.doesnotconsiderthetimevalueofmoney.
b.implicitlyassumesthatthecompanyisabletoreinvestcash
flowsfromtheprojectatthecompany'sdiscountrate.
c.implicitlyassumesthatthecompanyisabletoreinvestcash
flowsfromtheprojectattheinternalrateofreturn.
d.doesnottakeintoaccountallofthecashflowsfroma
project.

26.
A
Medium

Ifthenetpresentvalueofaprojectiszerobasedona
discountrateofsixteenpercent,thenthetimeadjustedrate
ofreturn:
a.isequaltosixteenpercent.
b.islessthansixteenpercent.
c.isgreaterthansixteenpercent.
d.cannotbedeterminedfromtheinformationgiven.

27.
A
Easy
CMAadapted

Thepaybackmethodmeasures:
a.howquicklyinvestmentdollarsmayberecovered.
b.thecashflowfromaninvestment.
c.theeconomiclifeofaninvestment.
d.theprofitabilityofaninvestment.

28.
B
Medium

Aninvestmentprojectthatrequiresapresentinvestmentof
$210,000willhavecashinflowsof"R"dollarseachyearfor
thenextfiveyears.Theprojectwillterminateinfiveyears.
Considerthefollowingstatements(ignoreincometax
considerations):

InternalrateofreturnPayback
a.YesYes
b.YesNo
c.NoYes
d.NoNo

I.If"R"islessthan$42,000,thepaybackperiodexceeds
thelifeoftheproject.
II.If"R"isgreaterthan$42,000,thepaybackperiodexceeds
thelifeoftheproject.
III.If"R"equals$42,000,thepaybackperiodequalsthelife
oftheproject.
Whichstatement(s)is(are)true?
a.OnlyIandII.
b.OnlyIandIII.
c.OnlyIIandIII.
d.I,II,andIII.

ManagerialAccounting,9/e

29.
A
Easy
CMA
adapted

Whichoneofthefollowingstatementsaboutthepaybackmethod
ofcapitalbudgetingiscorrect?
a.Thepaybackmethoddoesnotconsiderthetimevalueof
money.
b.Thepaybackmethodconsiderscashflowsafterthepayback
hasbeenreached.
c.Thepaybackmethodusesdiscountedcashflowtechniques.
d.Thepaybackmethodwillleadtothesamedecisionasother
methodsofcapitalbudgeting.

30.
B
Medium

Theevaluationofaninvestmenthavingunevencashflowsusing
thepaybackmethod:
a.cannotbedone.
b.canbedoneonlybymatchingcashinflowsandinvestment
outflowsonayearbyyearbasis.
c.willproductessentiallythesameresultsasthoseobtained
throughtheuseofdiscountedcashflowtechniques.
d.requirestheuseofasophisticatedcalculatororcomputer
software.

31.
B
Medium
CMAadapted

Thecapitalbudgetingmethodthatdividesaproject'sannual
incrementalnetincomebytheinitialinvestmentisthe:
a.internalrateofreturnmethod.
b.thesimple(oraccounting)rateofreturnmethod.
c.thepaybackmethod.
d.thenetpresentvaluemethod.

32.
B
Medium
CMA
adapted

Whendetermininganetpresentvalueinaninflationary
environment,adjustmentsshouldbemadeto:
a.decreasethediscountrateonly.
b.increasetheestimatedcashflowsandincreasethediscount
rate.
c.increasetheestimatedcashflowsonly.
d.increasetheestimatedcashflowsanddecreasethediscount
rate.

33.
B
Hard
CPA
adapted

(Ignoreincometaxesinthisproblem.)KiplingCompanyhas
investedinaprojectthathasaneightyearlife.Itis
expectedthattheannualcashinflowfromtheprojectwillbe
$20,000.Assumingthattheprojecthasainternalrateof
returnof12%,howmuchwastheinitialinvestmentinthe
project?
a.$160,000
b.$99,360
c.$80,800
d.$64,640

ManagerialAccounting,9/e

34.
D
Medium

(Ignoreincometaxesinthisproblem.)WhiteCompany'srequired
rateofreturnoncapitalbudgetingprojectsis12%.The
companyisconsideringaninvestmentopportunitywhichwould
yieldacashflowof$10,000infiveyears.Whatisthemost
thatthecompanyshouldbewillingtoinvestinthisproject?
a.$36,050.
b.$2,774.
c.$17,637.
d.$5,670.

35.
C
Easy

(Ignoreincometaxesinthisproblem.)Inordertoreceive
$12,000attheendofthreeyearsand$10,000attheendof
fiveyears,howmuchmustbeinvestednowifyoucanearn14%
rateofreturn?
a.$12,978.
b.$8,100.
c.$13,290.
d.$32,054.

36.
C
Hard

(Ignoreincometaxesinthisproblem.)SueFallsisthe
presidentofSports,Inc.Sheisconsideringbuyinganew
machinethatwouldcost$14,125.Suehasdeterminedthatthe
newmachinepromisesainternalrateofreturnof12%,butSue
hasmisplacedthepaperwhichtellstheannualcostsavings
promisedbythenewmachine.Shedoesrememberthatthemachine
hasaprojectedlifeof10years.Basedonthesedata,the
annualcostsavingsare:
a.itisimpossibletodeterminefromthedatagiven.
b.$1,412.50.
c.$2,500.00.
d.$1,695.00.

37.
C
Hard

(Ignoreincometaxesinthisproblem.)Thefollowing
informationisavailableonanewpieceofequipment:
Costoftheequipment......$21,720
Annualcashinflows........$5,000
Internalrateofreturn...16%
Requiredrateofreturn...10%
Thelifeoftheequipmentisapproximately:
a.6years.
b.4.3years.
c.8years.
d.itisimpossibletodeterminefromthedatagiven.

10 ManagerialAccounting,9/e

38.
C
Hard
CPAadapted

(Ignoreincometaxesinthisproblem.)Aplannedfactory
expansionprojecthasanestimatedinitialcostof$800,000.
Usingadiscountrateof20%,thepresentvalueoffuturecost
savingsfromtheexpansionis$843,000.Toyieldexactlya20%
internalrateofreturn,theactualinvestmentcostcannot
exceedthe$800,000estimatebymorethan:
a.$160,000.
b.$20,000.
c.$43,000.
d.$1,075.

39.
D
Hard
CPAadapted

(Ignoreincometaxesinthisproblem.)HilltopCompanyinvested
$100,000inatwoyearproject.Thecashflowwas$40,000for
thefirstyear.Assumingthattheinternalrateofreturnwas
exactly12%,whatwasthecashflowforthesecondyearofthe
project?
a.$51,247.
b.$60,000.
c.$64,284.
d.$80,652.

40.
C
Hard

(Ignoreincometaxesinthisproblem.)JoeFlubupisthe
presidentofFlubup,Inc.Heisconsideringbuyinganew
machinethatwouldcost$25,470.Joehasdeterminedthatthe
newmachinepromisesainternalrateofreturnof14%,butJoe
hasmisplacedthepaperwhichtellstheannualcostsavings
promisedbythenewmachine.Hedoesrememberthatthemachine
hasaprojectedlifeof12years.Basedonthesedata,the
annualcostsavingsare:
a.impossibletodeterminefromthedatagiven.
b.$2,122.50.
c.$4,500.00.
d.$4,650.00.

41.
B
Hard

(Ignoreincometaxesinthisproblem.)TheBakerCompany
purchasedapieceofequipmentwiththefollowingexpected
results:

Usefullife...................7years
Yearlynetcashinflow........$50,000
Salvagevalue.................0
Internalrateofreturn.......20%
Discountrate.................16%
Theinitialcostoftheequipmentwas:
a.$300,100.
b.$180,250
c.$190,600.
d.Cannotbedeterminedfromtheinformationgiven.

ManagerialAccounting,9/e

11

42.
B
Hard

(Ignoreincometaxesinthisproblem.)Highpoint,Inc.,is
consideringinvestinginautomatedequipmentwithatenyear
usefullife.ManagersatHighpointhaveestimatedthecash
flowsassociatedwiththetangiblecostsandbenefitsof
automation,buthavebeenunabletoestimatethecashflows
associatedwiththeintangiblebenefits.Usingthecompany's
10%discountrate,thenetpresentvalueofthecashflows
associatedwithjustthetangiblecostsandbenefitsisa
negative$184,350.Howlargewouldtheannualnetcashinflows
fromtheintangiblebenefitshavetobetomakethisa
financiallyacceptableinvestment?
a.$18,435.
b.$30,000.
c.$35,000.
d.$37,236.

43.
B
Hard

(Ignoreincometaxesinthisproblem.)Giventhefollowing
data:
Presentinvestmentrequired..$12,000
Netpresentvalue............$430
Annualcostsavings..........$?
Discountrate................12%
Lifeoftheproject..........10years
Basedonthedatagiven,theannualcostsavingswouldbe:
a.$1,630.00.
b.$2,200.00.
c.$2,123.89.
d.$2,553.89.

44.
A
Medium

(Ignoreincometaxesinthisproblem.)Thefollowingdata
pertaintoaninvestmentinequipment:
Investmentintheproject..........$10,000
Netannualcashinflows............2,400
Workingcapitalrequired...........5,000
Salvagevalueoftheequipment.....1,000
Lifeoftheproject................8years
Atthecompletionoftheproject,theworkingcapitalwillbe
releasedforuseelsewhere.Computethenetpresentvalueof
theproject,usingadiscountrateof10%:
a.$606.
b.$8,271.
c.($1,729).
d.$1,729.

12 ManagerialAccounting,9/e

45.
A
Medium

(Ignoreincometaxesinthisproblem.)Apieceofequipmenthas
acostof$20,000.Theequipmentwillprovidecostsavingsof
$3,500eachyearfortenyears,afterwhichtimeitwillhavea
salvagevalueof$2,500.Ifthecompany'sdiscountrateis12%,
theequipment'snetpresentvalueis:
a.$580.
b.($225).
c.$17,500.
d.$2,275.

46.
D
Medium

(Ignoreincometaxesinthisproblem.)ParksCompanyis
consideringaninvestmentproposalinwhichaworkingcapital
investmentof$10,000wouldberequired.Theinvestmentwould
providecashinflowsof$2,000peryearforsixyears.The
workingcapitalwouldbereleasedforuseelsewherewhenthe
projectiscompleted.Ifthecompany'sdiscountrateis10%,
theinvestment'snetpresentvalueis:
a.$1,290.
b.($1,290).
c.$2,000.
d.$4,350.

47.
A
Medium

(Ignoreincometaxesinthisproblem.)Thefollowingdata
pertaintoaninvestmentproposal:
Investmentintheproject(equipment)..$14,000
Netannualcashinflowspromised.......2,800
Workingcapitalrequired...............5,000
Salvagevalueoftheequipment.........1,000
Lifeoftheproject....................10years
Theworkingcapitalwouldbereleasedforuseelsewherewhen
theprojectiscompleted.Whatisthenetpresentvalueofthe
project,usingadiscountrateof8%?
a.$2,566.
b.($251).
c.$251.
d.$5,251.

ManagerialAccounting,9/e

13

48.
C
Medium

(Ignoreincometaxesinthisproblem.)BostonCompanyis
contemplatingthepurchaseofanewmachineonwhichthe
followinginformationhasbeengathered:
Costofthemachine...............$38,900
Annualcashinflowsexpected......$10,000
Salvagevalue.....................$5,000
Lifeofthemachine...............6years
Thecompany'sdiscountrateis16%,andthemachinewillbe
depreciatedusingthestraightlinemethod.Giventhesedata,
themachinehasanetpresentvalueof:
a.$26,100.
b.$23,900.
c.$0.
d.+$26,100.

49.
B
Hard

(Ignoreincometaxesinthisproblem.)BenzCompanyis
consideringthepurchaseofamachinethatcosts$100,000and
hasausefullifeof18years.Thecompany'srequireddiscount
rateis12%.Ifthemachine'snetpresentvalueis$5,850,then
theannualcashinflowsassociatedwiththemachinemustbe
(roundtothenearestwholedollar):
a.$42,413.
b.$14,600.
c.$13,760.
d.itisimpossibletodeterminefromthedatagiven.

50.
C
Hard
CPAadapted

(Ignoreincometaxesinthisproblem.)HornCorporationis
consideringinvestinginafouryearproject.Cashinflowsfrom
theprojectareexpectedtobeasfollows:Year1,$2,000;Year
2,$2,200;Year3,$2,400;Year4,$2,600.Ifusingadiscount
rateof8%,theprojecthasapositivenetpresentvalueof
$500,whatwastheamountoftheoriginalinvestment?
a.$1,411.
b.$2,411.
c.$7,054.
d.$8,054.

51.
B
Medium

(Ignoreincometaxesinthisproblem.)TheWhittonCompanyuses
adiscountrateof16%.Thecompanyhasanopportunitytobuya
machinenowfor$18,000thatwillyieldcashinflowsof$10,000
peryearforeachofthenextthreeyears.Themachinewould
havenosalvagevalue.Thenetpresentvalueofthismachineto
thenearestwholedollaris:
a.$22,460.
b.$4,460.
c.$(9,980).
d.$12,000.

14 ManagerialAccounting,9/e

52.
D
Medium

(Ignoreincometaxesinthisproblem.)Thefollowingdata
pertaintoaninvestment:
Costoftheinvestment........$18,955
Lifeoftheproject...........5years
Annualcostsavings...........$5,000
Estimatedsalvagevalue.......$1,000
Discountrate.................10%
Thenetpresentvalueoftheproposedinvestmentis:
a.$3,355.
b.($3,430).
c.$0.
d.$621.

53.
D
Medium

(Ignoreincometaxesinthisproblem.)Thefollowingdata
pertaintoaninvestmentproposal:
Costoftheinvestment..........$20,000
Annualcostsavings.............$5,000
Estimatedsalvagevalue.........$1,000
Lifeoftheproject.............8years
Discountrate...................16%
Thenetpresentvalueoftheproposedinvestmentis:
a.$1,720.
b.$6,064.
c.$2,154.
d.$2,025.

54.
C
Hard

(Ignoreincometaxesinthisproblem.)StratfordCompany
purchasedamachinewithanestimatedusefullifeofseven
years.Themachinewillgeneratecashinflowsof$90,000each
yearoverthenextsevenyears.Ifthemachinehasnosalvage
valueattheendofsevenyears,andassumingthecompany's
discountrateis10%,whatisthepurchasepriceofthemachine
ifthenetpresentvalueoftheinvestmentis$170,000?
a.$221,950.
b.$170,000.
c.$268,120.
d.$438,120.

55.
C
Medium

(Ignoreincometaxesinthisproblem.)SamWelleristhinking
ofinvesting$70,000tostartabookstore.Samplansto
withdraw$15,000fromthebusinessattheendofeachyearfor
thenextfiveyears.Attheendofthefifthyear,Samplansto
sellthebusinessfor$110,000cash.Ata12%discountrate,
whatisthenetpresentvalueoftheinvestment?
a.$54,075.
b.$62,370.
c.$46,445.
d.$70,000.

ManagerialAccounting,9/e

15

56.
D
Hard

(Ignoreincometaxesinthisproblem.)Arthuroperatesapart
timeautorepairservice.Heestimatesthatanewdiagnostic
computersystemwillresultinincreasedcashinflowsof$2,100
inYear1,$3,200inYear2,and$4,000inYear3.IfArthur's
discountrateis10%,thenthemosthewouldbewillingtopay
forthenewcomputersystemwouldbe:
a.$6,652.
b.$6,984.
c.$7,747.
d.$7,556.

57.
C
Medium

(Ignoreincometaxesinthisproblem.)Thefollowingdata
pertaintoaninvestmentproposal:
Presentinvestmentrequired........$26,500
Annualcostsavings................$5,000
Projectedlifeoftheinvestment...10years
Projectedsalvagevalue............$0
Theinternalrateofreturn,interpolatedtothenearesttenth
ofapercent,wouldbe:
a.11.6%.
b.12.8%.
c.13.6%.
d.12.4%.

58.
A
Medium

(Ignoreincometaxesinthisproblem.)Thefollowingdataare
availableonaproposedinvestmentproject:
Initialinvestment.........$142,500
Annualcashinflows........$30,000
Lifeoftheinvestment.....8years
Requiredrateofreturn....10%
Theinternalrateofreturn,interpolatedtothenearesttenth
ofapercent,wouldbe:
a.13.3%.
b.12.1%.
c.15.3%.
d.12.7%.

16 ManagerialAccounting,9/e

59.
C
Medium

(Ignoreincometaxesinthisproblem.)Thefollowingdata
pertaintoaninvestmentproposal:
Presentinvestmentrequired........$14,000
Annualcostsavings................$2,500
Projectedlifeoftheinvestment...8years
Projectedsalvagevalue............$0
Requiredrateofreturn............6%
Theinternalrateofreturn,interpolatedtothenearesttenth
ofapercent,wouldbe:
a.6.7%.
b.9.3%.
c.8.7%.
d.7.3%.

60.
A
Hard

(Ignoreincometaxesinthisproblem.)OverlandCompanyhas
gatheredthefollowingdataonaproposedinvestmentproject:
Investmentindepreciableequipment....$150,000
Annualcashflows......................$40,000
Lifeoftheequipment..................10years
Salvagevalue..........................0
Discountrate..........................10%
Theinternalrateofreturnonthisinvestmentisclosestto:
a.23.4%.
b.25.4%.
c.22.7%
d.22.1%

61.
A
Medium

(Ignoreincometaxesinthisproblem.)Thefollowing
informationconcernsaproposedinvestment:
Investmentrequired........$14,150
Annualsavings.............$2,500
Lifeoftheproject........12years
Theinternalrateofreturnis(donotinterpolate):
a.14%.
b.12%.
c.10%.
d.5%.

ManagerialAccounting,9/e

17

62.
A
Medium

(Ignoreincometaxesinthisproblem.)JarveyCompanyis
studyingaprojectthatwouldhaveatenyearlifeandwould
requirea$450,000investmentinequipmentthathasnosalvage
value.Theprojectwouldprovidenetincomeeachyearas
followsforthelifeoftheproject:
Sales............................$500,000
Lesscashvariableexpenses......200,000
Contributionmargin..............300,000
Lessfixedexpenses:
Fixedcashexpenses............$150,000
Depreciationexpenses..........45,000195,000
Netincome.......................$105,000
Thecompany'srequiredrateofreturnis12%.Whatisthe
paybackperiodforthisproject?
a.3years
b.2years
c.4.28years
d.9years

63.
A
Medium

(Ignoreincometaxesinthisproblem.)BuyRitePharmacyhas
purchasedasmallautofordeliveringprescriptions.Theauto
waspurchasedfor$9,000andwillhavea6yearusefullifeand
a$3,000salvagevalue.Deliveringprescriptions(whichthe
pharmacyhasneverdonebefore)shouldincreasegrossrevenues
byatleast$5,000peryear.Thecostoftheseprescriptionsto
thepharmacywillbeabout$2,000peryear.Thepharmacy
depreciatesallassetsusingthestraightlinemethod.The
paybackperiodfortheautois:
a.3.0years.
b.1.8years.
c.2.0years.
d.1.2years.

64.
C
Easy

(Ignoreincometaxesinthisproblem.)Acompanywith$800,000
inoperatingassetsisconsideringthepurchaseofamachine
thatcosts$75,000andwhichisexpectedtoreduceoperating
costsby$20,000eachyear.Thepaybackperiodforthismachine
inyearsisclosestto:
a.0.27years.
b.10.7years.
c.3.75years.
d.40years.

18 ManagerialAccounting,9/e

65.
B
Easy

(Ignoreincometaxesinthisproblem.)TheHigginsCompanyhas
justpurchasedapieceofequipmentatacostof$120,000.This
equipmentwillreduceoperatingcostsby$40,000eachyearfor
thenexteightyears.Thisequipmentreplacesoldequipment
thatwassoldfor$8,000cash.Thenewequipmenthasapayback
periodof:
a.8.0years.
b.2.8years.
c.10.0years.
d.3.0years.

66.
D
Medium
CMA
adapted

(Ignoreincometaxesinthisproblem.)TheKeegoCompanyis
planninga$200,000equipmentinvestmentthathasanestimated
fiveyearlifewithnoestimatedsalvagevalue.Thecompanyhas
projectedthefollowingannualcashflowsfortheinvestment.
YearCashInflows
1$120,000
260,000
340,000
440,000
540,000
Total$300,000
Assumingthatthecashinflowsoccurevenlyovertheyear,the
paybackperiodfortheinvestmentis:
a.0.75years.
b.1.67years.
c.4.91years.
d.2.50years.

67.
A
Hard

(Ignoreincometaxesinthisproblem.)DennyCorporationis
consideringreplacingatechnologicallyobsoletemachinewitha
newstateoftheartnumericallycontrolledmachine.Thenew
machinewouldcost$450,000andwouldhaveatenyearuseful
life.Unfortunately,thenewmachinewouldhavenosalvage
value.Thenewmachinewouldcost$20,000peryeartooperate
andmaintain,butwouldsave$100,000peryearinlaborand
othercosts.Theoldmachinecanbesoldnowforscrapfor
$50,000.Thesimplerateofreturnonthenewmachineis
closestto:
a.8.75%.
b.20.00%.
c.7.78%.
d.22.22%.

ManagerialAccounting,9/e

19

68.
A
Medium

(Ignoreincometaxesinthisproblem.)TheJasonCompanyis
consideringthepurchaseofamachinethatwillincrease
revenuesby$32,000eachyear.Cashoutflowsforoperatingthis
machinewillbe$6,000eachyear.Thecostofthemachineis
$65,000.Itisexpectedtohaveausefullifeoffiveyears
withnosalvagevalue.Forthismachine,thesimplerateof
returnis:
a.20%.
b.40%.
c.49.2%.
d.9.2%.

69.
A
Easy

PerkinsCompanyisconsideringseveralinvestmentproposals,as
shownbelow:

InvestmentProposalo
ABCD
Investmentrequired...$80,000$100,000$60,000$75,000
Presentvalueoffuture
netcashflows......96,000150,00084,000120,000
Ranktheproposalsintermsofpreferenceusingthe
profitabilityindex:
a.D,B,C,A.
b.B,D,C,A.
c.B,D,A,C.
d.A,C,B,D.

70.
C
Easy

Informationonfourinvestmentproposalsisgivenbelow:
ProposalInvestmentNetPresentValue
1$50,000$30,000
260,00024,000
330,00015,000
445,0009,000
Ranktheproposalsintermsofpreferenceaccordingtothe
profitabilityindex:
a.3,4,1,2.
b.1,2,3,4.
c.1,3,2,4.
d.2,1,4,3.

Reference:141
(Ignoreincometaxesinthisproblem.)ShieldsCompanyhasgatheredthe
followingdataonaproposedinvestmentproject:
Investmentrequiredinequipment.....$400,000
Annualcashinflows..................$80,000
Salvagevalue........................$0
Lifeoftheinvestment...............10years
Discountrate........................10%
20 ManagerialAccounting,9/e

71.
D
Easy
ReferTo:
141

Thepaybackperiodfortheinvestmentisclosestto:
a.0.2years.
b.1.0years.
c.3.0years.
d.5.0years.

72.
B
Medium
ReferTo:
141

Thesimplerateofreturnontheinvestmentisclosestto:
a.5%.
b.10%.
c.15%.
d.20%.

73.
C
Medium
ReferTo:
141

Thenetpresentvalueonthisinvestmentisclosestto:
a.$400,000.
b.$80,000.
c.$91,600.
d.$76,750.

74.
C
Medium
ReferTo:
141

Theinternalrateofreturnontheinvestmentisclosestto:
a.11%.
b.13%.
c.15%.
d.17%.

Reference:142
(Ignoreincometaxesinthisproblem.)Bugle'sBagelBakeryisinvestigating
thepurchaseofanewbagelmakingmachine.Thismachinewouldprovidean
annualoperatingcostsavingsof$3,650foreachofthenext4years.In
addition,thisnewmachinewouldallowtheproductionofonenewtypeof
bagelthatwouldresultinselling1,500dozenmorebagelseachyear.The
companyearnsacontributionmarginof$0.90oneachdozenbagelssold.The
purchasepriceofthismachineis$13,450anditwillhavea4yearuseful
life.Bugle'sdiscountrateis14%.
75.
D
Medium
ReferTo:
142

Thetotalannualcashinflowfromthismachineforcapital
budgetingpurposesis:
a.$3,650.
b.$5,150.
c.$4,750.
d.$5,000.

76.
C
Medium
ReferTo:
142

Theinternalrateofreturnforthisinvestmentisclosestto:
a.14%.
b.16%.
c.18%.
d.20%.

ManagerialAccounting,9/e

21

77.
A
Medium
ReferTo:
142

Thenetpresentvalueofthisinvestmentisclosestto:
a.$1,120.
b.$6,550.
c.$13,450.
d.$20,000.

Reference:143
(Ignoreincometaxesinthisproblem.)TreadsCorporationisconsideringthe
replacementofanoldmachinethatiscurrentlybeingused.Theoldmachine
isfullydepreciatedbutcanbeusedbythecorporationforfivemoreyears.
IfTreadsdecidestoreplacetheoldmachine,PiccoCompanyhasofferedto
purchasetheoldmachinefor$60,000.Theoldmachinewouldhavenosalvage
valueinfiveyears.
ThenewmachinewouldbeacquiredfromHillcrestIndustriesfor$1,000,000
incash.Thenewmachinehasanexpectedusefullifeoffiveyearswithno
salvagevalue.Duetotheincreasedefficiencyofthenewmachine,estimated
annualcashsavingsof$300,000wouldbegenerated.
TreadsCorporationusesadiscountrateof12%.
78.
C
Medium
ReferTo:
143

Thenetpresentvalueoftheprojectisclosestto:
a.$171,000.
b.$136,400.
c.$141,500.
d.$560,000.

79.
C
Medium
ReferTo:
143

Theinternalrateofreturnoftheprojectisclosestto:
a.14%.
b.16%.
c.18%.
d.20%.

Reference:144
(Ignoreincometaxesinthisproblem.)OrientalCompanyhasgatheredthe
followingdataonaproposedinvestmentproject:
Investmentindepreciableequipment.....$200,000
Annualnetcashflows...................$50,000
Lifeoftheequipment...................10years
Salvagevalue...........................0
Discountrate...........................10%
Thecompanyusesstraightlinedepreciationonallequipment.
80.
D
Medium
ReferTo:
144

Thepaybackperiodfortheinvestmentwouldbe:
a.2.41years.
b.0.25years.
c.10years.
d.4years.

22 ManagerialAccounting,9/e

81.
C
Medium
ReferTo:
144

Thesimplerateofreturnontheinvestmentwouldbe:
a.10%.
b.35%.
c.15%.
d.25%.

82.
B
Medium
ReferTo:
144

Thenetpresentvalueofthisinvestmentwouldbe:
a.($14,350).
b.$107,250.
c.$77,200.
d.$200,000.

Reference:145
(Ignoreincometaxesinthisproblem.)ApexCorp.isplanningtobuy
productionmachinerycosting$100,000.Thismachinery'sexpectedusefullife
isfiveyears,withnoresidualvalue.Apexusesadiscountrateof10%and
hascalculatedthefollowingdatapertainingtothepurchaseandoperation
ofthismachinery:
Estimated
annualnet
Yearcashinflow
1$60,000
230,000
320,000
420,000
520,000
83.
A
Medium
CPA
adapted
ReferTo:
145

Thepaybackperiodis:
a.2.50years.
b.2.75years.
c.3.00years.
d.5.00years.

84.
A
Medium
CPA
adapted
ReferTo:
145

Thenetpresentvalueisclosestto:
a.$20,400.
b.$28,400.
c.$80,000.
d.$50,000.

ManagerialAccounting,9/e

23

Reference:146
(Ignoreincometaxesinthisproblem.)TheFinneyCompanyisreviewingthe
possibilityofremodelingoneofitsshowroomsandbuyingsomenewequipment
toimprovesalesoperations.Theremodelingwouldcost$120,000nowandthe
usefullifeoftheprojectis10years.Additionalworkingcapitalneeded
immediatelyforthisprojectwouldbe$30,000;theworkingcapitalwouldbe
releasedforuseelsewhereattheendofthe10yearperiod.Theequipment
andothermaterialsusedintheprojectwouldhaveasalvagevalueof
$10,000in10years.Finney'sdiscountrateis16%.
85.
B
Easy
ReferTo:
146

Theimmediatecashoutflowrequiredforthisprojectwouldbe:
a.$(120,000).
b.$(150,000).
c.$(90,000).
d.$(130,000).

86.
D
Hard
ReferTo:
146

Whatwouldtheannualnetcashinflowsfromthisprojecthave
tobeinordertojustifyinvestinginremodeling?
a.$14,495
b.$35,842
c.$16,147
d.$29,158

Reference:147
(Ignoreincometaxesinthisproblem.)TheSawyerCompanyhas$80,000to
investandisconsideringtwodifferentprojects,XandY.Thefollowing
dataareavailableontheprojects:
ProjectXProjectY
Costofequipmentneedednow...$80,000
Workingcapitalrequirement....$80,000
Annualcashoperatinginflows..$23,000$18,000
Salvagevaluein5years.......$6,000
Bothprojectswillhaveausefullifeof5years;attheendof5years,the
workingcapitalwillbereleasedforuseelsewhere.Sawyer'sdiscountrate
is12%.
87.
D
Medium
ReferTo:
147

ThenetpresentvalueofprojectXis:
a.$2,915.
b.$(11,708).
c.$5,283.
d.$6,317.

88.
B
Medium
ReferTo:
147

ThenetpresentvalueofprojectYisclosestto:
a.$15,110.
b.$30,250.
c.$11,708.
d.$(11,708).

24 ManagerialAccounting,9/e

Reference:148
(Ignoreincometaxesinthisproblem.)TheBeckerCompanyisinterestedin
buyingapieceofequipmentthatitneeds.Thefollowingdatahavebeen
assembledconcerningthisequipment:
Costofrequiredequipment..........$250,000
Workingcapitalrequired............$100,000
Annualoperatingcashinflows........$80,000
Cashrepairatendof4years.......$40,000
Salvagevalueatendof6years.....$90,000
Thisequipmentisexpectedtohaveausefullifeof6years.Attheendof
thesixthyeartheworkingcapitalwouldbereleasedforuseelsewhere.The
company'sdiscountrateis10%.
89.
C
Easy
ReferTo:
148

Thepresentvalueofallfutureoperatingcashinflowsis
closestto:
a.$480,000.
b.$452,300.
c.$348,400.
d.$278,700.

90.
B
Easy
ReferTo:
148

Thepresentvalueofthenetcashflows(allcashinflowsless
allcashoutflows)occurringduringyear4is:
a.$40,000.
b.$27,320.
c.$54,640.
d.$42,790.

91.
D
Medium
ReferTo:
148

Thepresentvalueofthenetcashflows(allcashinflowsless
allcashoutflows)occurringduringyear6isclosestto:
a.$270,000.
b.$195,900.
c.$107,200.
d.$152,300.

Reference:149
(Ignoreincometaxesinthisproblem.)URCompanyisconsideringrebuilding
andsellingusedalternatorsforautomobiles.Thecompanyestimatesthatthe
netoperatingcashflows(saleslesscashoperatingexpenses)arisingfrom
therebuildingandsaleoftheusedalternatorswouldbeasfollows(numbers
inparenthesesindicateanoutflow):
Years110...$90,000
Year11........(20,000)
Year12........100,000
Inadditiontotheabovenetoperatingcashflows,URCompanywouldpurchase
productionequipmentcosting$200,000nowtouseintherebuildingofthe
alternators.Theequipmentwouldhavea12yearlifeanda$15,000salvage
value.Thecompany'sdiscountrateis10%.

ManagerialAccounting,9/e

25

92.
C
Medium
ReferTo:
149

Thepresentvalueofthenetoperatingcashflows(salesless
cashoperatingexpenses)arisingfromtherebuildingandsale
ofthealternators(roundedtothenearestdollar)is:
a.$582,735.
b.$596,735.
c.$577,950.
d.$591,950.

93.
B
Medium
ReferTo:
149

Thenetpresentvalueofallcashflowsassociatedwiththis
investment(roundedtothenearestdollar)is:
a.$377,950.
b.$382,735.
c.$392,950.
d.$362,950.

Reference:1410
(Ignoreincometaxesinthisproblem.)WestlandCollegehasatelephone
systemthatisinpoorcondition.Thesystemeithercanbeoverhauledor
replacedwithanewsystem.Thefollowingdatahavebeengatheredconcerning
thesetwoalternatives:
PresentProposedNew

SystemSystem

Purchasecostnew.......................$250,000$300,000
Accumulateddepreciation................$240,000
Overhaulcostsneedednow...............$230,000
Annualcashoperatingcosts.............$180,000$170,000
Salvagevaluenow.......................$160,000
Salvagevalueattheendof8years.....$152,000$165,000
Workingcapitalrequired................$200,000
WestlandCollegeusesa10%discountrateandthetotalcostapproachto
capitalbudgetinganalysis.Bothalternativesareexpectedtohaveauseful
lifeofeightyears.
94.
B
Hard
ReferTo:
1410

Thenetpresentvalueofthealternativeofoverhaulingthe
presentsystemis:
a.$(1,279,316).
b.$(1,119,316).
c.$801,284.
d.$(1,194,036).

95.
A
Hard
ReferTo:
1410

Thenetpresentvalueofthealternativeofpurchasingthenew
systemis:
a.$(1,076,495).
b.$(1,236,495).
c.$(1,169,895).
d.$(969,895).

26 ManagerialAccounting,9/e

Reference:1411
(Ignoreincometaxesinthisproblem.)LambertManufacturinghas$60,000to
investineitherProjectAorProjectB.Thefollowingdataareavailableon
theseprojects:
ProjectAProjectB
Costofequipmentneedednow..............$120,000$70,000
Workingcapitalinvestmentneedednow.....$50,000
Annualnetoperatingcashinflows.........$50,000$45,000
Salvagevalueofequipmentin6years.....$15,000
Bothprojectshaveausefullifeof6years.Attheendof6years,the
workingcapitalinvestmentwillbereleasedforuseelsewhere.Lambert's
discountrateis14%.
96.
D
Medium
ReferTo:
1411

ThenetpresentvalueofProjectAisclosestto:
a.$82,241.
b.$67,610.
c.$74,450.
d.$81,290.

97.
A
Medium
ReferTo:
1411

ThenetpresentvalueofProjectBisclosestto:
a.$77,805.
b.$127,805.
c.$55,005.
d.$105,005.

98.
C
Medium
ReferTo:
1411

Whichofthefollowingstatementsis(are)correct?
I.ProjectAisacceptableaccordingtothenetpresentvalue
method.
II.ProjectAhasaninternalrateofreturngreaterthan14%.
a.OnlyI.
b.OnlyII.
c.BothIandII.
d.NeitherInorII.

Reference:1412
(Ignoreincometaxesinthisproblem.)FastFood,Inc.,haspurchasedanew
donutmaker.Itcost$16,000andhasanestimatedlifeof10years.The
followingannualdonutsalesandexpensesareprojected:
Sales.....................$22,000
Expenses:
Flour,etc.,required
inmakingdonuts...$10,000
Salaries...............6,000
Depreciation...........1,60017,600
Netincome................$4,400

ManagerialAccounting,9/e

27

99.
B
Medium
ReferTo:
1412

Thepaybackperiodonthenewmachineisclosestto:
a.5years.
b.2.7years.
c.3.6years.
d.1.4years.

100.
C
Easy
ReferTo:
1412

Thesimplerateofreturnforthenewmachineisclosestto:
a.20%.
b.37.5%.
c.27.5%.
d.80.0%.

Reference:1413
(Ignoreincometaxesinthisproblem.)PurvellCompanyhasjustacquireda
newmachine.Dataonthemachinefollow:
Purchasecost............$50,000
Annualcostsavings......15,000
Lifeofthemachine......8years
Thecompanyusesstraightlinedepreciationanda$5,000salvagevalue.(The
companyconsiderssalvagevalueinmakingdepreciationdeductions.)Assume
cashflowsoccuruniformlythroughoutayear.
101.
A
Easy
ReferTo:
1413

Thepaybackperiodwouldbeclosestto:
a.3.33years.
b.3.0years.
c.8.0years.
d.2.9years.

102.
C
Medium
ReferTo:
1413

Thesimplerateofreturnwouldbeclosestto:
a.30.0%.
b.17.5%.
c.18.75%.
d.12.5%.

Reference:1414
(Ignoreincometaxesinthisproblem.)HanleyCompanypurchasedamachine
for$125,000thatwillbedepreciatedonthestraightlinebasisovera
fiveyearperiodwithnosalvagevalue.Therelatedcashflowfrom
operationsisexpectedtobe$45,000ayear.Thesecashflowsfrom
operationsoccuruniformlythroughouttheyear.
103.
C
Easy
CPA
adapted
ReferTo:
1414

Whatisthepaybackperiod?
a.2.1years.
b.2.3years.
c.2.8years.
d.4.2years.

28 ManagerialAccounting,9/e

104.
A
Easy
CPA
adapted
ReferTo:
1414

Whatisthesimplerateofreturnontheinitialinvestment?
a.16%.
b.24%.
c.28%.
d.36%.

Essay
105.
Medium

(Ignoreincometaxesinthisproblem.)PrinceCompanys
requiredrateofreturnis10%.Thecompanyisconsideringthe
purchaseofthreemachines,asindicatedbelow.Considereach
machineindependently.
Required:
a.MachineAwillcost$25,00andhavealifeof15years.Its
salvagevaluewillbe$1,000,andcostsavingsareprojected
at$3,500peryear.Computethemachinesnetpresentvalue.
b.HowmuchwillPrinceCompanybewillingtopayforMachineB
ifthemachinepromisesannualcashinflowsof$5,000per
yearfor8years?
c.MachineChasaprojectedlifeof10years.Whatisthe
machine'sinternalrateofreturnifitcosts$30,000and
willsave$6,000annuallyincashoperatingcosts?
Interpolatetothenearesttenthofapercent.Wouldyou
recommendpurchase?Explain.
Answer:
a.10%Present
YearAmountFactorValue
Investmentrequirednow($25,000)1.000($25,000)
Annualcostsavings1153,5007.60626,621
Salvagevalue.....151,0000.239239
Netpresentvalue$1,860
b.10%Present
YearAmountFactorValue
Annualcashinflows18$5,0005.335$26,675
Sincethepresentvalueofthecashinflowsis$26,675,the
companyshouldbewillingtopayuptothisamounttoacquire
themachine.

ManagerialAccounting,9/e

29

c.InvestmentrequiredNetannualcashflow=Factorofthe
internalrateofreturn
$30,000%6,000=5.000
14%factor............5.2165.216
Truefactor...........5.000
16%factor............4.833
0.2160.383
14%+2%(0.2160.383)=15.1%
Themachineshouldbepurchased,sincetheinternalrateof
returnisgreaterthantherequiredrateofreturn.
106.
Medium

Ignoreincometaxesinthisproblem.)Ursus,Inc.,is
consideringaprojectthatwouldhaveatenyearlifeandwould
requirea$1,000,000investmentinequipment.Attheendoften
years,theprojectwouldterminateandtheequipmentwouldhave
nosalvagevalue.Theprojectwouldprovidenetincomeeach
yearasfollows:
Sales................................$2,000,000
Lessvariableexpenses...............1,400,000
Contributionmargin..................600,000
Lessfixedexpenses..................400,000
Netincome...........................$200,000
Alloftheaboveitems,exceptfordepreciationof$100,000a
year,representcashflows.Thedepreciationisincludedinthe
fixedexpenses.Thecompany'srequiredrateofreturnis12%.
Required:
a.Computetheproject'snetpresentvalue.
b.Computetheproject'sinternalrateofreturn,interpolating
tothenearesttenthofapercent.
c.Computetheproject'spaybackperiod.
d.Computetheproject'ssimplerateofreturn.
Answer:
a.Sincedepreciationistheonlynoncashitemontheincome
statement,thenetannualcashflowcanbecomputedbyadding
backdepreciationtonetincome.
Netincome.............$200,000
Depreciation...........100,000
Netannualcashflow...$300,000
12%Present
YearsAmountFactorValue
Initialinvestment..Now$(1,000,000)1.000$(1,000,000)
Netannualcash
flows.............110300,0005.6501,695,000

30 ManagerialAccounting,9/e

Netpresentvalue$695,000

ManagerialAccounting,9/e

31

b.Theformulaforcomputingthefactoroftheinternalrateof
return(IRR)is:
InvestmentrequiredNetannualcashinflow=Factorofthe
IRR
$1,000,000$300,000=3.333
26%factor........3.4653.465
Truefactor.......3.333
28%factor........3.269
0.1320.196
26%+2%(0.1320.196)=27.3%
c.Theformulaforthepaybackperiodis:
InvestmentrequiredNetannualcashinflow=Payback
period
$1,000,000$300,000=3.33years
d.Theformulaforthesimplerateofreturnis:
NetincomeInitialinvestment=Simplerateofreturn
$200,000$1,000,000=20.0%
107.
Medium

(Ignoreincometaxesinthisproblem.)Thefollowingdata
concernaninvestmentproject:
Investmentinequipment...........$16,000
Netannualcashinflows...........$3,600
Workingcapitalrequired..........$4,500
Salvagevalueoftheequipment....$2,000
Lifeoftheproject...............12years
Discountrate.....................14%
Theworkingcapitalwillbereleasedforuseelsewhereatthe
conclusionoftheproject.
Required:
Computetheproject'snetpresentvalue.
Answer:
14%Present
ItemYearsAmountFactorValue
Investmentnow($16,000)1.000($16,000)
Annualcash
inflows...............1123,6005.66020,376
Workingcapital
required..............now(4,500)1.000(4,500)
Workingcapital
released..............124,5000.208936
Salvagevalue
equipment.............122,0000.208416
Netpresentvalue.......$1,228

32 ManagerialAccounting,9/e

ManagerialAccounting,9/e

33

108.
Medium

(Ignoreincometaxesinthisproblem.)BradleyCompany's
requiredrateofreturnis14%.Thecompanyhasanopportunity
tobetheexclusivedistributorofaverypopularconsumer
item.Nonewequipmentwouldbeneeded,butthecompanywould
havetouseonefourthofthespaceinawarehouseitowns.The
warehousecost$200,000new.Thewarehouseiscurrentlyhalf
emptyandtherearenootherplanstousetheemptyspace.In
addition,thecompanywouldhavetoinvest$100,000inworking
capitaltocarryinventoriesandaccountsreceivableforthe
newproductline.Thecompanywouldhavethedistributorship
foronly5years.Thedistributorshipwouldgeneratea$17,000
netannualcashinflow.
Required:
Whatisthenetpresentvalueoftheprojectatadiscountrate
of14%?Shouldtheprojectbeaccepted?
Answer:
14%Present
YearsAmountFactorValue
WorkingcapitalinvestmentNow$(100,000)1.000$(100,000)
Annualcashinflows......1517,0003.43358,361
Workingcapitalreleased5100,0000.51951,900
Netpresentvalue........$10,261
Yes,thedistributorshipshouldbeacceptedsincetheproject
hasapositivenetpresentvalue.

109.
Medium

(Ignoreincometaxesinthisproblem.)MonsonCompanyis
consideringthreeinvestmentopportunitieswithcashflowsas
describedbelow:
ProjectA:Cashinvestmentnow.....................$15,000
Cashinflowattheendof5years.......$21,000
Cashinflowattheendof8years.......$21,000
ProjectB:Cashinvestmentnow.....................$11,000
Annualcashoutflowfor5years.........$3,000
Additionalcashinflowattheend
of5years............................$21,000
ProjectC:Cashinvestmentnow.....................$21,000
Annualcashinflowfor4years..........$11,000
Cashoutflowattheendof3years......$5,000
Additionalcashinflowattheend
of4years............................$15,000
Required:
ComputethenetpresentvalueofeachprojectassumingMonson
Companyusesa12%discountrate.

34 ManagerialAccounting,9/e

Answer:
ProjectA:
12%Present
AmountFactorValue
Cashinvestmentnow..............($15,000)1.000($15,000)
Cashinflowattheendof5years$21,0000.567$11,907
Cashinflowattheendof8years$21,0000.404$8,484
Netpresentvalue................$5,391
ProjectB:
12%Present
AmountFactorValue
Cashinvestmentnow..............($11,000)1.000($11,000)
Annualcashoutflowfor5years..($3,000)3.605($10,815)
Additionalcashinflowatthe
endof5years...............$21,0000.567$11,907
Netpresentvalue................($9,908)
ProjectC:
12%Present
AmountFactorValue
Cashinvestmentnow..............($21,000)1.000($21,000)
Annualcashinflowfor4years...$11,0003.037$33,407
Cashoutflowattheendof
3years........................($5,000)0.712($3,560)
Additionalcashinflowatthe
endof4years.................$15,0000.636$9,540
Netpresentvalue................$18,387
110.
Medium

(Ignoreincometaxesinthisproblem.)JimBinghamis
consideringstartingasmallcateringbusiness.Hewouldneed
topurchaseadeliveryvanandvariousequipmentcosting
$125,000toequipthebusinessandanother$60,000for
inventoriesandotherworkingcapitalneeds.Rentforthe
buildingusedbythebusinesswillbe$35,000peryear.Jim's
marketingstudiesindicatethattheannualcashinflowfromthe
businesswillamountto$120,000.Inadditiontothebuilding
rent,annualcashoutflowforoperatingcostswillamountto
$40,000.Jimwantstooperatethecateringbusinessforonly
sixyears.Heestimatesthattheequipmentcouldbesoldat
thattimefor4%ofitsoriginalcost.Jimusesa16%discount
rate.
Required:
WouldyouadviseJimtomakethisinvestment?

ManagerialAccounting,9/e

35

Answer:
16%Present

DescriptionYearsAmountFactorValue
Van&equipment.....0($125,000)1.000($125,000)
Workingcapital.....0($60,000)1.000($60,000)
Buildingrent.......16($35,000)3.685($128,975)
Netannualcash
inflow............16$80,0003.685$294,800
Salvagevalue,
equipment.........6$5,0000.410$2,050
Releaseofworking
capital...........6$60,0000.410$24,600
Netpresentvalue$7,475
111.
Medium

(Ignoreincometaxesinthisproblem.)GeneralManufacturing
Companyconsistsofseveraldivisions,oneofwhichisthe
TransportationDivision.Thecompanyhasdecidedtodisposeof
thisdivisionsinceitnolongerfitsthecompany'slongterm
strategy.Anofferof$9,000,000hasbeenreceivedfroma
prospectivebuyer.IfGeneralretainedthedivision,the
companywouldoperatethedivisionforonlynineyears,after
whichthedivisionwouldnolongerbeneededandwouldbesold
for$600,000.Ifthecompanyretainsthedivision,animmediate
investmentof$500,000wouldneedtobemadetoupdate
equipmenttocurrentstandards.Annualnetoperatingcashflows
wouldbe$1,805,000ifthedivisionisretained.Thecompanys
discountrateis12%.
Required:
Usingthenetpresentvaluemethod,determinewhetherGeneral
Manufacturingshouldacceptorrejecttheoffermadebythe
potentialbuyer.
Answer:
12%Present
YearExplanationAmountFactorValue

o
0Investmenttoupdateassets$(500,000)1.000$(500,000)
19Annualcashinflows.......1,805,0005.3289,617,040
9Sellingpricefor
thedivision............600,0000.361216,600
Netpresentvalue.........$9,333,640
Thesalespriceof$9,000,000islessthanthepresentvalueof
thecashflowsresultingfromretainingthedivision.General
thusshouldnotaccepttheoffer.

36 ManagerialAccounting,9/e

112.
Medium

(Ignoreincometaxesinthisproblem.)MarkStevensis
consideringopeningahobbyandcraftstore.Hewouldneed
$100,000toequipthebusinessandanother$40,000for
inventoriesandotherworkingcapitalneeds.Rentonthe
buildingusedbythebusinesswillbe$24,000peryear.Mark
estimatesthattheannualcashinflowfromthebusinesswill
amountto$90,000.Inadditiontobuildingrent,annualcash
outflowforoperatingcostswillamountto$30,000.Markplans
tooperatethebusinessforonlysixyears.Heestimatesthat
theequipmentandfurnishingscouldbesoldatthattimefor
10%oftheiroriginalcost.Markusesadiscountrateof16%.
Required:
WouldyouadviseMarktomakethisinvestment?Usethenet
presentvaluemethod.
Answer:
16%Present

DescriptionYearsAmountFactorValue

o
Equipment...........0($100,000)1.000($100,000)
Workingcapital.....0($40,000)1.000($40,000)
Buildingrent.......16($24,000)3.685($88,440)
Netannualcash
inflow............16$60,0003.685$221,100
Salvagevalue,
equipment.........6$10,0000.410$4,100
Releaseofworking
capital...........6$40,0000.410$16,400
Netpresentvalue$13,160

113.
Medium

(Ignoreincometaxesinthisproblem.)VernonCompanyhasbeen
offereda7yearcontracttosupplyapartforthemilitary.
Aftercarefulstudy,thecompanyhasdevelopedthefollowing
estimateddatarelatingtothecontract:
Costofequipmentneeded.............................$300,000
Workingcapitalneeded...............................$50,000
Annualcashreceiptsfromthedeliveryofparts,
lesscashoperatingcosts..........................$70,000
Salvagevalueofequipmentatterminationof
thecontract.......................................$5,000
Itisnotexpectedthatthecontractwouldbeextendedbeyond
theinitialcontractperiod.Thecompany'sdiscountrateis
10%.
Required:
Usethenetpresentvaluemethodtodetermineifthecontract
shouldbeaccepted.Roundallcomputationstothenearest
dollar.

ManagerialAccounting,9/e

37

Answer:
10%Present

DescriptionYearsAmountFactorValue

o
Equipment...........0($300,000)1.000($300,000)
Workingcapital.....0($50,000)1.000($50,000)
Netannualcash
inflow............17$70,0004.868$340,760
Salvagevalue,
equipment.........7$5,0000.513$2,565
Releaseofworking
capital...........7$50,0000.513$25,650
Netpresentvalue$18,975
114.
Hard

(Ignoreincometaxesinthisproblem.)ABCompanyis
consideringthepurchaseofamachinethatpromisestoreduce
operatingcostsbythesameamountforeveryyearofits6year
usefullife.Themachinewillcost$83,150andhasnosalvage
value.Themachinehasa20%internalrateofreturn.
Required:
Whatistheannualcostsavingspromisedbythemachine?
Answer:
InvestmentrequiredNetannualcashinflow=
Factoroftheinternalrateofreturn
$83,150Netannualcashinflow=3.326
$83,1503.326=Netannualcashinflow
=$25,000

115.
Easy

(Ignoreincometaxesinthisproblem.)FerrisCompanyhasan
oldmachinethatisfullydepreciatedbuthasacurrentsalvage
valueof$5,000.Thecompanywantstopurchaseanewmachine
thatwouldcost$60,000andhavea5yearusefullifeandzero
salvagevalue.Expectedchangesinannualrevenuesandexpenses
ifthenewmachineispurchasedare:
Increasedrevenues...............$63,000
Increasedexpenses:
Salaryofadditionaloperator..$20,000
Supplies.......................9,000
Depreciation...................12,000
Maintenance....................4,00045,000
Increasednetincome..............$18,000
Required:
a.Computethepaybackperiodonthenewequipment.
b.Computethesimplerateofreturnonthenewequipment.
Answer:
a.InvestmentrequiredNetannualcashinflow=Paybackperiod
$60,000$5,000)($18,000+$12,000)=1.83years(rounded)
b.IncrementalnetincomeInvestment=Simplerateofreturn

38 ManagerialAccounting,9/e

$18,000$55,000=32.7%(rounded)

ManagerialAccounting,9/e

39