Exam 12: Strategy and the Analysis of Capital Investments

On January 1, 2018 Crane Company will acquire a new asset that costs $400,000 and that is anticipated to have a salvage value of $30,000 at the end of four years. The new asset: ? qualifies as three-year property under the Modified Accelerated Cost Recovery System (MACRS) ? will replace an old asset that currently has a tax basis of $80,000 and that can be sold on this date for $60,000 (net of selling costs) ? will continue to generate the same operating revenues as the old asset ($200,000 per year). However, it is predicted that savings in cash operating costs will be experienced as follows: a total of $120,000 in each of the first three years, and $90,000 in the fourth year. Crane is subject to a combined income tax rate, t, of 40% and rounds all computations to the nearest dollar. Crane's fiscal year coincides with the calendar year. Assume that any gain or loss affects the taxes paid at the end of the year in which the gain or loss occurs. The company uses the net present value (NPV) method to analyze projects using the factors and rates presented below (based on a discount rate of 14%): Year PV of \ 1 at 14\% PV of \ 1 Annuity at 14\% MACRS 2018 0.877 0.877 33\% 2019 0.769 1.647 45\% 2020 0.675 2.321 15\% 2021 0.592 2.914 7\% The discounted net-of-tax amount that should be factored into Crane Company's analysis for the disposal of the old asset (rounded to the nearest whole dollar) is:

The time value of money is explicitly considered in which one of the following capital budgeting method(s)?

Olsen Inc. purchased a $600,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high demand and Olsen can sell all that it could manufacture for the next 10 years. To encourage capital investments, the government exempts taxes on profits from new investments in this type of machinery. This legislation most likely will remain in effect in the foreseeable future. The equipment is expected to have 10 years of useful life and no salvage value at the end of this 10-year period. The firm uses straight-line depreciation. The net cash inflow is expected to be $144,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments. Assume that after-tax cash inflows occur evenly throughout the year. The estimated payback period for this proposed investment, in years, is (rounded to two decimal places):

Which of the following statements regarding real options is not true?

Jason Kirby is the leader of the capital budget group charged with reviewing capital investment opportunities for Archer Construction Corporation. Jason is an advocate of a short payback period requirement for accepted capital investments, since "cash flow is the bottom line in this company." Required: Do you agree or not? Why?

Omaha Plating Corporation is considering purchasing a machine for $1,500,000. The machine is expected to generate a constant after-tax income of $100,000 per year for 15 years. The firm will use straight-line (SL) depreciation for the new machine over 10 years with no residual value. What is the payback period for the new machine?

The internal rate of return (IRR) for an investment:

Which of the following methods can be used to deal formally with uncertainty in the capital-budgeting process?

Which of the following is not true regarding the appropriate discount rate to be used in conjunction with discounted cash flow (DCF) decision models?

Flex Corporation is studying a capital investment proposal in which newly acquired assets will be depreciated using the straight-line (SL) method with no salvage value. Which one of the following statements about the proposal would be incorrect if, instead of SL, the Modified Accelerated Cost Recovery System (MACRS) is used for determining depreciation expense for income tax purposes? (Assume that income tax rates are constant over the life of the assets involved.)

Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 10% on all investments. What is the payback period for the new machine (rounded to nearest one-tenth of a year)? (Assume that the cash inflows occur evenly throughout the year.)

Which of the following statements regarding capital investment analysis is false?

On January 1, 2018 Crane Company will acquire a new asset that costs $400,000 and that is anticipated to have a salvage value of $30,000 at the end of four years. The new asset: ? qualifies as three-year property under the Modified Accelerated Cost Recovery System (MACRS) ? will replace an old asset that currently has a tax basis of $80,000 and that can be sold on this date for $60,000 (net of selling costs) ? will continue to generate the same operating revenues as the old asset ($200,000 per year). However, it is predicted that savings in cash operating costs will be experienced as follows: a total of $120,000 in each of the first three years, and $90,000 in the fourth year. Crane is subject to a combined income tax rate, t, of 40% and rounds all computations to the nearest dollar. Crane's fiscal year coincides with the calendar year. Assume that any gain or loss affects the taxes paid at the end of the year in which the gain or loss occurs. The company uses the net present value (NPV) method to analyze projects using the factors and rates presented below (based on a discount rate of 14%): Year PV of \ 1 at 14\% PV of \ 1 Annuity at 14\% MACRS 2018 0.877 0.877 33\% 2019 0.769 1.647 45\% 2020 0.675 2.321 15\% 2021 0.592 2.914 7\% The relevant discounted operating cash flows (cost savings) that should be factored into Crane Company's analysis are:

In making sound capital budgeting decisions, the principal focus is on:

Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 10% on all investments. What is the present value payback period, rounded to one-tenth of a year? (Note: PV factors for 10% are as follows: year 1 = 0.909; year 2 = 0.826; year 3 = 0.751; year 4 = 0.683; year 5 = 0.621; the PV annuity factor for 10%, 5 years = 3.791. Assume that annual after-tax cash inflows occur at year-end.)

All of the following capital budgeting models incorporate the time value of money except:

In applying the Capital Asset Pricing Model (CAPM) to estimate a firm's cost of equity capital, the beta coefficient (β) in the model represents

Which of the following is not a characteristic of capital budgeting post-audits?

If a company is in the situation of having unlimited capital funds, the best decision rule, considering only financial factors, is for the company to invest in all projects in which:

When we assume in our calculations for capital budgeting decisions that all cash flows occur 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, which of the following statements is true?