Test Bank - Chapter15 Capital Budgeting2

7/23/2019 Test Bank - Chapter15 Capital Budgeting2

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Chapter 15

Income Taxes in Capital Budgeting Decisions

True/False

1.FMedium

The present value of the tax savings under the optionalstraightline method !ill ordinaril" #e greater than thepresent value of the tax savings under the M$C%& ta#le method.

'.FMedium

Depreciation expenses ta(en on financial reports is relevantfor capital #udgeting decisions since it affects the compan")snet income.

*.T

Medium

The reduction in taxes made possi#le #" a depreciation taxshield e+uals the depreciation deduction multiplied #" the tax

rate.

,.F-ard

If a compan" is operating at a profit all cash inflo!sassociated !ith an investment proect should #e multiplied #"one minus the tax rate to #e placed on an aftertax #asis.

5.T0as"

Depreciation deductions shield revenues from taxation andthere#" lo!er the amount of taxes that a compan" must pa".

.FMedium

The release of !or(ing capital at the end of an investmentproect is a taxa#le cash inflo!.

2.TMedium

3ot all cash inflo!s are taxa#le.

4.T0as"

If a compan" operates at a profit the aftertax cost of a taxdeducti#le cash expense is determined #" multipl"ing the cashexpense #" one minus the tax rate.

.FMedium

The !or(ing capital re+uired at the start of an investment is ataxa#le cash outflo!.

16.

F-ard

To determine the effect of income taxes on a proect multipl"

the net present value of the proect #" one minus the tax rate.

Managerial Accounting, 9/e 40


2/29

11.TMedium

Due to the half"ear convention assets in the *"ear propert"class are depreciated over four "ears.

1'.F0as"

7hen a compan" invests in e+uipment it gets to immediatel"expense the cost of the e+uipment on the compan")s tax reports.

1*.FMedium

If an asset is in the M$C%& *"ear propert" class #ut has anestimated useful life of six "ears it should #e depreciatedover six "ears on tax reports.

1,.TMedium

$n asset that is in the M$C%& 5"ear propert" class !ould #edepreciated over six "ears.

15.T-ard

8nder the M$C%& s"stem an" salvage value reali9ed !hen anasset is sold is taxed if the asset has exceeded the usefullife assumed in its propert" class.

Multiple Choice

1.B0as"CM$adapted

Depreciation expense reduces income taxes #" an amount e+ualto:a. one minus the tax rate times the amount of deprecation.#. the tax rate times the amount of depreciation.c. the amount of the depreciation.d. one minus the amount of depreciation.

12.CMedium

The calculation of the net present value of an investmentproect re+uires that the depreciation tax shield #e includedat:a. the amount of the depreciation !ith no adustment for taxes.#. the amount of the depreciation times one minus the tax rate.c. the amount of the depreciation times the tax rate.d. 9ero since depreciation is not relevant to the calculation

of net present value.

14.$MediumCM$adapted

In a capital #udgeting decision the use of M$C%& ta#les ascompared to the optional straightline method !ill result in:a. e+ual total depreciation for #oth methods.#. more total depreciation for the M$C%& ta#les method.c. more total depreciation for the optional straightline

method.d. less depreciation for the M$C%& ta#les method in the earl"

"ears of asset life.

Managerial Accounting, 9/e41


3/29

1.CMediumCM$adapted

The use of the M$C%& ta#les instead of the optional straightline method of depreciation has the effect of:a. raising the hurdle rate necessar" to ustif" the proect.#. decreasing the net present value of the proect.c. increasing the present value of the depreciation tax shield.d. increasing the cash outflo!s at the #eginning of the

proect.

'6.BMedium

7hich of the follo!ing is correct;a. 8se of the M$C%& ta#les re+uires that salvage value #e

deducted in computing depreciation deductions.#. 8se of the optional straightline method re+uires that

salvage value not #e considered in computing depreciationdeductions.

c. The use of #oth M$C%& ta#les and the optional straightlinemethod re+uires that salvage value #e deducted in computingdepreciation deductions.

d. 3one of the a#ove are true.

'1.CMedium

7hen computing depreciation deductions under the M$C%& s"stemtaxpa"ers must:a. use the half"ear convention under !hich taxpa"ers are

allo!ed to ta(e onl" a half "ear)s depreciation in the first"ear of an asset)s life.

#. use the half"ear convention under !hich taxpa"ers areallo!ed to ta(e onl" a half "ear)s depreciation in the last"ear of an asset)s life.

c. use the half"ear convention under !hich taxpa"ers areallo!ed to ta(e onl" a half "ear)s depreciation in the firstand last "ears of an asset)s life.

d. calculate depreciation for partial periods using the exactnum#er of da"s if the asset is ac+uired at some time otherthan the #eginning or end of the fiscal "ear.

''.D-ardCM$adapted

7hich of the follo!ing !ould decrease the net present value ofa proect;a. $ decrease in the income tax rate.#. $ decrease in the initial investment.c. $n increase in the useful life of the proect.d. $n increase in the discount rate.

'*.D-ard

$ piece of e+uipment is in the M$C%& 5"ear propert" class andis #eing depreciated using the M$C%& ta#les. The tax rate is*5,566 then the original cost of the e+uipment !as:

a. >*654.#. >'*.c. >1'452.d. >,.



4/29

',.$Medium

$ compan" anticipates a taxa#le cash receipt of >56666 in "ear, of a proect. The compan")s tax rate is *6< and its discountrate is 1'''',*.#. >*5666.c. >5**.d. >15666.

'5.DMedium

$ compan" anticipates a taxa#le cash receipt of >'6666 in "ear* of a proect. The compan")s tax rate is *6< and its discountrate is 4666.#. >,2*.c. >1,666.d. >1111,.

'.

CMedium

$ compan" anticipates a taxa#le cash receipt of >56666 in "ear

* of a proect. The compan")s tax rate is *6< and its discountrate is 1,161'5.#. >*5666.c. >'*',.d. >15666.

'2.DMedium

$ compan" anticipates a taxa#le cash expense of >16666 in "ear' of a proect. The compan")s tax rate is *6< and its discountrate is 4*666@.#. ?>'52'@.c. ?>[email protected]. ?>661@.

'4.$Medium

$ compan" anticipates a taxa#le cash expense of >,6666 in "ear' of a proect. The compan")s tax rate is *6< and its discountrate is 16'*1,6@.#. ?>[email protected]. ?>1'[email protected]. ?>'4666@.



5/29

'.CMedium

$ compan" anticipates a taxa#le cash expense of >6666 in "ear' of a proect. The compan")s tax rate is *6< and its discountrate is 1,1*456@.#. ?>,'[email protected]. ?>*'*[email protected]. ?>14666@.

*6.DMedium

$ compan" anticipates a depreciation deduction of >'6666 in"ear ' of a proect. The compan")s tax rate is *6< and itsdiscount rate is 1'1111.#. >1,666.c. >666.d. >,24*.

*1.

CMedium

$ compan" anticipates a depreciation deduction of >*6666 in

"ear * of a proect. The compan")s tax rate is *6< and itsdiscount rate is 1''1666.#. >1,,2.c. >,6.d. >666.

*'.$Medium

$ compan" anticipates a depreciation deduction of >26666 in"ear ' of a proect. The compan")s tax rate is *6< and itsdiscount rate is 1,115.#. >,666.c. >'1666.d. >*226,.

**.BMedium

$ compan" needs an increase in !or(ing capital of >'6666 inproect that !ill last , "ears. The compan")s tax rate is *61*6.c. >5'.d. >1,666.



6/29

*,.$Medium

$ compan" needs an increase in !or(ing capital of >56666 inproect that !ill last , "ears. The compan")s tax rate is *615666.c. >'52'.d. >*5666.

*5.DMedium

$ compan" needs an increase in !or(ing capital of >26666 inproect that !ill last * "ears. The compan")s tax rate is *6'1666.c. >*444.d. >5554.

*.

B-ard

0"ring Industries has a truc( purchased seven "ears ago at a

cost of >666. $t the time of purchase the ultimate salvagevalue !as estimated at >566 #ut salvage value !as ignored indepreciation deductions. The truc( is no! full" depreciated.$ssuming a tax rate of ,6566 theaftertax cash inflo! for capital #udgeting purposes !ill #e:a. >566.#. >*66.c. >'66.d. >166.

*2.B0as"

&uppose a machine costs >'6666 no! has an expected life ofeight "ears and !ill re+uire a >2666 overhaul at the end ofthe third "ear. If the tax rate is ,61'666.#. >,'66.c. >4666.d. >'466.

*4.B0as"

&uppose a machine that costs >46666 has a useful life of 16"ears. $lso suppose that depreciation on the machine is >4666for tax purposes in "ear ,. The tax rate is ,6


7/29

*.$-ard

Consider a machine !hich costs >115666 no! and !hich has auseful life of seven "ears. This machine !ill re+uire a maoroverhaul at the end of the fourth "ear !hich !ill cost AAdollars. If the tax rate is ,6*66 then the amount of AA indollars is:a. >666.#. >666.c. >'16.d. >1,,6.

,6.D0as"

ast "ear the sales at erse" Compan" !ere >'66666 and !ereall cash sales. The expenses at erse" !ere >1'5666 and !ereall cash expenses. The tax rate !as *6*2566.#. >6666.c. >''566.d. >5'566.

,1.C0as"

ast "ear a firm had taxa#le cash receipts of >466666 and thetax rate !as *6466666.#. >,6666.c. >56666.d. >',6666.

,'.B0as"

$ compan" had taxdeducti#le cash expenses of >56666 last"ear and the tax rate !as *615666.#. >,55666.c. >56666.d. >*6666.

,*.DMedium

$t the Bartholome! Compan" last "ear all sales !ere for cashand all expenses !ere paid in cash. The tax rate !as *6


8/29

,,.BMediumCM$adapted

&uperstrut is considering replacing an old press that cost>46666 six "ears ago !ith a ne! one that !ould cost >',5666.The old press has a net #oo( value of >15666 and could #e soldfor >5666. The increased production of the ne! press !ouldre+uire an investment in additional !or(ing capital of >666.The compan")s tax rate is ,6'5666.#. >','666.c. >'56666.d. >',5666.

,5.$Medium

Eane Compan" is in the process of purchasing a ne! machine forits production line. It is near the end of the "ear and themachine is #eing offered at a special discount if purchased#efore the end of the "ear. Eane has determined that thedepreciation deduction for tax purposes on the ne! machine forthe "ear of purchase !ould #e >1*666. The tax rate is *6*66.#. >166.c. >1*666.d. >6.

,.C0as"

ast "ear the sales at &eidelman Compan" !ere >266666 and !ereall cash sales. The compan")s expenses !ere >,56666 and !ereall cash expenses. The tax rate !as *5


9/29

%eference: 151The oren9 Compan" is deciding !hether or not it should replace an old pieceof e+uipment !ith ne! e+uipment that is more efficient. The follo!ing datarelate to this investment decision:

Cost of the ne! e+uipment no! .............. >1'6666 $nnual cash operating costs of the ne! e+uipment ........................ > 56666 8seful life of the ne! e+uipment............ 2 "ears &alvage value of the ne! e+uipment in seven "ears ........................... > 4666 Boo( value of the old e+uipment no! ........ > ,6666 &alvage value of the old e+uipment no! ..... > *6666 &alvage value of the old e+uipment in seven "ears .............................. > ,666 riginal cost of the old e+uipment three "ears ago ................................ > 46666 $nnual cash operating costs of the old e+uipment ............................ > 26666

verhaul of the old e+uipment needed at the end of four "ears .................... >15666

The old e+uipment is in the M$C%& 5"ear propert" class and is #eingdepreciated #" the optional straightline method #ut this e+uipment !illlast for seven more "ears. The ne! e+uipment is also in the M$C%& 5"earpropert" class and !ill #e depreciated using M$C%& ta#les. The tax rate is*6< and the compan")s aftertax cost of capital is 1'15666.#. >24.c. >16566.d. >5,6.

,.DMedium%efer To:151

The present value of the tax savings at the end of one "earfrom the loss on the sale of the old e+uipment is closest to:a. >16666.#. >*666.c. >2666.d. >'2.



10/29

56.C-ard%efer To:151

The present value of the difference in tax savings #et!een thet!o pieces of e+uipment ?for all "ears@ arising from thedepreciation tax shield in favor of the ne! e+uipment isclosest to:a. >',666.#. >'521.c. >1251.d. >1'1'.

%eference: 15'The Moon Compan" is contemplating the purchase of a ne! machine to replacean old machine. The follo!ing data are availa#le concerning this investmentpossi#ilit":

3e! machine: Gurchase price no! ............................. >56666 $nnual cash operating costs .................... >'6666 8seful life .................................... 2 "ears

&alvage value at the end of seven "ears ........ > *666 ld machine: riginal purchase price three "ears ago ........ >,6666 Boo( value no! ................................. >'6666 $nnual cash operating costs .................... >*6666 &alvage value at the end of seven "ears ........ > '666 verhaul needed four "ears from no! ............ > 2666 &alvage value of the machine no! ............... >'6666

The machine is in the M$C%& 5"ear propert" class and !ould #e depreciatedusing the M$C%& ta#les. The old machine is also in the 5"ear propert" classand is #eing depreciated #" the optional straightline method. -o!ever thisold machine could last seven more "ears if overhauled in four "ears. Thecompan" re+uires a 1'< aftertax return on all e+uipment purchases and thetax rate is *61*5.d. >*666.

5'.D

0as"%efer To:15'

From the point of vie! of #u"ing the ne! machine the presentvalue of the annual cash operating costs ?for all "ears@ is

closest to:a. >2',*5.#. >?2',*[email protected]. >?54,,@.d. >?*4@.



11/29

5*.C-ard%efer To:15'

From the point of vie! of #u"ing the ne! machine the presentvalue of the tax savings ?for all "ears@ arising from thedepreciation tax shield@ is closest to:a. >1514*.#. >1',66.c. >11621.d. >16*6.

5,.D0as"%efer To:15'

From the point of vie! of (eeping the old machine the presentvalue of the overhaul needed at the end of =ear , is closestto:a. >?,66@.#. >[email protected]. >[email protected]. >?*11@.

55.B-ard

%efer To:15'

From the point of vie! of (eeping the old machine the presentvalue of the tax savings ?for all "ears@ arising from thedepreciation tax shield is closest to:

a. >666.#. >,16.c. >15666.d. >1*4.

%eference: 15*Max!ell Compan" purchased a ne! machine anuar" 1 of =ear 1. Data relatingto the machine are as follo!s:

Cost of machine ..... >146666 &alvage value ....... *6666 8seful life ......... 4 "ears

This machine is in the M$C%& 5"ear propert" class. Max!ell uses a 16***6,.d. >1,'2*.

52.$

Medium%efer To:15*

If Max!ell uses the optional straightline method !hat !ill #ethe present value of the depreciation tax shield recorded in

=ear ,;a. >2*2.#. >1,2.c. >1,*,*.d. >12'1'.



12/29

%eference: 15,&hields Compan" is considering the purchase of a ne! computer to replace anold computer. The ne! computer !ill have a useful life of six "ears !ith asalvage value of >,666. The computer !ill #e depreciated using the M$C%&ta#les and it #elongs in the M$C%& 5"ear propert" class. The tax rate is*5,666.The ne! computer re+uires a >*666 cash investment in !or(ing capital !hich!ill #e released at the end of six "ears for use else!here.

54.CMedium%efer To:15,

The present value of the aftertax cash flo! from the salvagereceived on the sale of the old computer !ould #e:a. >,666.#. >1,66.c. >'66.d. >6.

5.

$-ard%efer To:15,

The present value of the tax savings ?for all "ears@ resulting

from the depreciation tax shield is ?rounded to the nearestdollar@:a. >1'12,.#. >''16.c. >*,245.d. >,5666.

6.$Medium%efer To:15,

The present value of the aftertax annual savings in cashoperating costs ?for all "ears@ is:a. >,',1.#. >''4,.c. >5*'5.d. >*'.

1.D-ard%efer To:15,

The present value of the aftertax net cash flo!s occurringduring =ear ' ?to the nearest dollar@ is:a. >1,4.#. >1'*1.c. >4566.d. >1''12.

'.B-ard%efer To:15,

The present value of the aftertax net cash flo!s ?all cashinflo!s less all cash outflo!s@ occurring during =ear ?to thenearest dollar@ is:a. >2,46.#. >12'.c. >226.

d. >452.



13/29

*.$-ard%efer To:15,

$ piece of e+uipment is in the M$C%& 5"ear propert" class andis #eing depreciated #" the optional straightline method. Thetax rate is *5*566 in =ear * then the originalcost of this e+uipment !as:a. >56666.#. >12566.c. >'1666.d. >5'64*.

%eference: 155The Fargo Compan" is considering a ne! machine to replace an old machine.The follo!ing data are availa#le:

$nnual cash operating cost savings from the ne! machine ................................ > 6666 Cost of the ne! machine ....................... 156666 &alvage value of the ne! machine in "ears ... '6666

&alvage value of the old machine no! .......... 15666 8seful life of the ne! machine ................ "ears Income tax rate ............................... ,6< $ftertax cost of capital ..................... 16666.#. >,44.c. >161'5.d. >,6514.

5.$Medium%efer To:155

The present value of the aftertax cash inflo!s ?for all "ears@due to the annual cost savings from the ne! machine is closestto:a. >1545'.#. >'2,'6.c. >1124,.d. >5,6666.

.

CMedium%efer To:155

The present value of the cash flo! arising from the salvage

value of the ne! machine is closest to:a. >521'.#. >'16,.c. >*15.d. >5'6.



14/29

2.DMedium%efer To:155

Consider onl" the cash flo!s !hich !ill occur no!. The presentvalue of these cash flo!s is:a. >156666.#. >1*5666.c. >'61666.d. >1,1666.

%eference: 15The &mith um#er Compan" is considering cutting trees on a plot of land to!hich it has cutting rights. The follo!ing data are availa#le:

Investment re+uired no! in ne! e+uipment ........ >*66666 7or(ing capital investment re+uired ............. ,6666 verhaul of e+uipment needed in ' "ears ......... 26666 3et annual cash inflo! from sale of logs ........ 6666 Cash cost to reseed the land in , "ears ......... 56666 &alvage value of the e+uipment in , "ears ....... '6666 Income tax rate ................................. ,66,'6.#. >'656.c. >1*112.d. >''656*.

26.C-ard%efer To:15

Consider onl" the cash flo!s !hich occur during the fourth"ear. The net present value of the cash flo!s that occur duringthe fourth "ear ?ignoring the depreciation tax shield@ isclosest to:a. >2666.#. >''646.

c. >,15'.d. >1*',4.



15/29

%eference: 152The 0l!ood 0xpress Compan" needs a ne! piece of e+uipment in order to fill acontract that it has ust signed !ith the 8& $rm". This e+uipment !ill havea useful life of seven "ears. It !ill #e depreciated using the M$C%& ta#lesand it #elongs in the M$C%& 5"ear propert" class. The ne! e+uipment has acash purchase cost of >,66666 ho!ever an old full" depreciated piece ofe+uipment !ould #e sold no! for a salvage value of >'5666. $t the end ofseven "ears the ne! e+uipment !ill have a salvage value of >*6666. The netannual cash operating inflo!s from the contract !ill #e >166666. The taxrate is *6,'4466.#. >*6616.c. >1'4,6.d. >'5246.

2'.

$-ard%efer To:152

The present value of the tax savings ?for all "ears@ resulting

from the depreciation tax shield is closest to:a. >4,*5.#. >'4'112.c. >,56666.d. >,'6666.

2*.DMedium%efer To:152

The present value of the net cash flo!s ?all cash inflo!s lessall cash outflo!s@ occurring during "ear 2 is closest to:a. >'1666.#. >4,66.c. >1666.d. >*,66.

2,.CMedium%efer To:152

The present value of the net cash flo!s ?all cash inflo!s lessall cash outflo!s including the depreciation tax shield@occurring during "ear * is closest to:a. >*6,6.#. >'*6,6.c. >'46'.d. >1555'.



16/29

%eference: 154&immons Compan" is considering t!o investment proects $ and B. Thefollo!ing data are availa#le:

Groect $ Groect B Investment in deliver" truc(s no! .............. >1'6666 Investment in !or(ing capital no! ............. >166666 3et annual operating cash inflo!s .................. 14666 1666 ife of the proect ........ 2 "ears 2 "ears

The deliver" truc(s !ill have a total salvage value of >16666 at the end ofseven "ears these truc(s are in the 5"ear M$C%& propert" class and !ill #edepreciated #" the optional straightline method. $t the end of seven "earsthe !or(ing capital !ill #e released for use else!here. The income tax rateis *6< and &immons) aftertax cost of capital is 1'51112.#. >4'15'.c. >5256.d. >2*6',.

2.D-ard%efer To:154

The present value of the tax savings ?for all "ears@ due to thedepreciation tax shield for Groect $ is closest to:a. >45'*2.#. >'522.c. >41444.d. >',5.

%eference: 15ee Compan" is considering replacing an old deliver" van !ith a ne! van. Thefollo!ing data relate to this investment decision:

Cost of the ne! van no! ................................ >'6666 $nnual cash operating costs of the ne! van ............. > 2666 8seful life of the ne! van ............................. "ears &alvage value of the ne! van in six "ears .............. > *566 riginal cost of the old van t!o "ears ago ............. >12666 Boo( value of the old van no! .......................... > 5666 &alvage value of the old van no! ....................... > *'66 &alvage value of the old van in six "ears .............. > 566 $nnual cash operating costs of the old van ............. > 666

verhaul of the old van needed three "ears from no! .... > 566

The old van is in the M$C%& 5"ear propert" class and is #eing depreciated#" the optional straightline method #ut this van !ill last for six more"ears. The ne! van also is in the M$C%& 5"ear propert" class and !ill #edepreciated using the M$C%& ta#les. The tax rate is ,6< and the compan")saftertax cost of capital is 1'


17/29

22.DMedium%efer To:15

The net incremental outla" for the purchase of the ne! van is:a. >'6666.#. >1**66.c. >'*'66.d. >1466.

24.CMedium%efer To:15

The present value of the overhaul of the old van that isavoided is:a. >,'4.#. >566.c. >'222.d. >1451.

2.$Medium%efer To:15

The present value of the aftertax net savings in cashoperating costs ?for all "ears@ is:a. >,**.#. >*'4.c. >12'.d. >4'''.

0ssa"

46.-ard

Jernal Compan" has #een offered a 2"ear contract to suppl" apart for the militar". $fter careful stud" the compan" hasdeveloped the follo!ing estimated data relating to thecontract:

Cost of e+uipment needed ........................ >*66666 7or(ing capital needed to carr" inventories ..... 56666 $nnual net cash inflo! .......................... 6666 &alvage value of e+uipment ...................... 16666

The e+uipment a#ove !ould #e in the M$C%& 5"ear propert"class. It is not expected that the contract !ould #e extended#e"ond the initial contract period. The compan")s aftertaxcost of capital is 16


18/29

$ns!er: 16< Gresent =ears $mount Factor JalueCost of e+uipment needed .... 3o! >?*66666@ 1.666 >?*66666@7or(ing capital needed ...... 3o! ? 56666@ 1.666 ? 56666@3et annual cash inflo!s >6666 x ?16.*6@ ........ 12 *666 ,.44 *64,Depreciation: Income tax savings >*66666 x 6.'66 x .* ..... 1 14666 6.6' 1*' >*66666 x 6.*'6 x .* ..... ' '4466 6.4' '*24 >*66666 x 6.1' x .* ..... * 12'66 6.251 1'22 >*66666 x 6.115 x .* ..... , 16*56 6.4* 26 >*66666 x 6.115 x .* ..... 5 16*56 6.'1 ,'2 >*66666 x 6.654 x .* ..... 5''6 6.5, ',,&alvage value >16666 x ?16.*6@ ........ 2 2666 6.51* *517or(ing capital released .... 2 56666 6.51* '5563et present value ........... > 55,*

The contract should #e accepted since the proect has a positive

net present value.

41.-ard

FM Compan" has #een offered a 2"ear contract to suppl" a partto a maor aircraft manufacturer. $fter careful stud" thecompan" has developed the follo!ing data relating to thecontract:

Cost of e+uipment needed.............................. >,666667or(ing capital needed to carr" inventories........... 6666$nnual #eforetax cash receipts from deliver" of parts less related cash operating costs................... 2666&alvage value of e+uipment at termination of thecontract............................................ 1'666

The e+uipment !ould #e in the M$C%& 5"ear propert" class. Thecontract is not expected to #e extended #e"ond the initialcontract period. The compan")s cost of capital is 16< and thetax rate is *5


19/29

$ns!er:

Tax $ftertax 16< Gresent =ear Cash Flo! 0ffect Cash Flo! Factor KJalueCost of e+uipment .. 6 >?,66666@ >?,66666@ 1.666>?,66666@7or(ing capitalneeded ..... 6 ?6666@ ?6666@ 1.666

?6666@$nnual savings 12 2666 16.*5 *656 ,.44*6'2Depreciation:,66666 x 6.'66 1 46666 6.*5 '4666 6.6'5,5',66666 x 6.*'6 ' 1'4666 6.*5 ,,466 6.4'*2665,66666 x 6.1' * 2466 6.*5 '446 6.251'6142,66666 x 6.115 , ,666 6.*5 1166 6.4*

16,66666 x 6.115 5 ,666 6.*5 1166 6.'14,66666 x 6.654 '*'66 6.*5 41'6 6.5,,546&alvage ....... 2 1'666 16.*5 2466 6.51*,6617or(ing capitalreleased .... 2 6666 6666 6.51*

*62463et present value>?1662,@

The contract should not #e accepted as the proect has a negativenet present value.

4'.-ard

$naconda Mining Compan" o!ns the mining rights to severaltracts of land in !hich copper ore has #een found. The amountof ore on some of the tracts is lo!grade and the compan" isunsure !hether it !ould #e profita#le to extract and sell theore these tracts contain. ne such tract is the 0lton tract on!hich the follo!ing information has #een gathered:

Investment in e+uipment ............................ >66666 7or(ing capital investment ......................... 45666 $nnual cash receipts from sale of ore net of

related cash operating expenses ?#efore taxes@ ... 116666

Cost of restoring land at the completion ofmining activities ................................ 26666

The ore #od" in the 0lton tract !ill #e exhausted after 16"ears of mining. The e+uipment can #e sold for 15< of itsoriginal cost !hen extraction is completed. The compan" usesthe M$C%& ta#les in computing depreciation deductions. Thee+uipment related to this proect is in the M$C%& 2"earpropert" class. The tax rate is *5


20/29

%e+uired:

Compute the net present value of the 0lton tract ?round all dollaramounts to the nearest !hole dollar@ and ma(e a recommendationregarding the via#ilit" of this investment.

$ns!er:

Tax $ftertax 16< Gresent =ear Cash Flo! 0ffect Cash Flo! Factor KJalue

Cost of e+uipment ... 6 >?66666@ >?66666@ 1.666

>?66666@7or(ing capitalneeded ...... 6 ?45666@ ?45666@ 1.666

?45666@3et annual cash receipts .... 116 116666 16.*5 21566 .1,5,**4Depreciation:66666 x 6.1,* 1 45466 6.*5 *66*6 6.6'2'266666 x 6.',5 ' 1,2666 6.*5 51,56 6.4',',266666 x 6.125 * 165666 6.*5 *256 6.251'2566666 x 6.1'5 , 25666 6.*5 ''56 6.4*12'66666 x 6.64 5 5*,66 6.*5 146 6.'1116266666 x 6.64 5*,66 6.*5 146 6.5,165,166666 x 6.64 2 5*,66 6.*5 146 6.51*54466666 x 6.6,5 4 '2666 6.*5 ,56 6.,2,,1*Cost of restoring land ........ 16 ?26666@ 16.*5 ,5566 6.*4?125*@

&alvage ?15< of >66666@ ... 16 6666 16.*5 54566 6.*4''5417or(ing capitalreleased .... 16 45666 45666 6.*4

*'4163et present value >?5***@

The proect should not #e underta(en as the net present value is



21/29

negative.

4*.-ard

%o" Compan" is tr"ing to decide !hether to invest in one of t!oproects or L. $ssociated data for each investment proectfollo!:

Groect L Cost of e+uipment ..... >6666 >1,6666 8seful life ........... "ears "ears $nnual net cash inflo! >'5666 > *6666 &alvage value ......... > 4666 > 1'666

The e+uipment for each proect is in the M$C%& 5"ear propert"class. %o" uses the optional straightline method forcalculating depreciation for tax purposes. The tax rate is *66666 x 6.1 1 666 .*6 '266 6.4* ',11>6666 x 6.' ' 14666 .*6 5,66 6.22 ,*6,>6666 x 6.' * 14666 .*6 5,66 6.21' *4,5>6666 x 6.' , 14666 .*6 5,66 6.* *,*,>6666 x 6.' 5 14666 .*6 5,66 6.52 *6'>6666 x 6.1 666 .*6 '266 6.562 1*&alvage ...... 4666 1.*6 566 6.562 '4*

3et present value >*'62

Groect L:Cost of e+uipment .. 6 >?1,6666@ >?1,6666@ 1.666 >?1,6666@$nnual savings 1 *6666 1.*6 '1666 5.*'4 111444Depreciation:>1,6666 x 6.1 1 1,666 .*6 ,'66 6.4* *251>1,6666 x 6.' ' '4666 .*6 4,66 6.22 5>1,6666 x 6.' * '4666 .*6 4,66 6.21' 541



22/29

>1,6666 x 6.' , '4666 .*6 4,66 6.* 5*,'>1,6666 x 6.' 5 '4666 .*6 4,66 6.52 ,2*>1,6666 x 6.1 1,666 .*6 ,'66 6.562 '1'&alvage ...... 1'666 1.*6 4,66 6.*1 *6*'3et present value >*541

Groect L !ould #e prefera#le to Groect using the net presentvalue measure.

#. Grofita#ilit" index Gresent value of cash inflo!s N Investment

For Groect : Grofita#ilit" index >*'62 N >6666 1.6*5

For Groect L : Grofita#ilit" index >1,*541 N >1,6666 1.6'5

Thus Groect is preferred using the profita#ilit" index.



23/29

4,.-ard

&n"der Compan" is tr"ing to decide !hether to invest in one oft!o proects $ or B. Data for each investment proect follo!:

Groect$ B

Cost of e+uipment........................ >166666 >1566668seful life.............................. "ears "ears0stimated net annual cash inflo!......... > *6666 > ,,666&alvage value at the end of useful life.. > 666 > 1,666

The e+uipment for each proect is in the M$C%& 5"ear propert"class. &n"der Compan" uses the optional straightline methodfor calculating depreciation. The tax rate is *5261



24/29

Groect B:

Tax $ftertax 1'< Gresent =ear Cash Flo! 0ffect Cash Flo! Factor KJalueCost of e+uipment 6 >?156666@ >?156666@ 1.666>?156666@$nnual savings ... 1 ,,666 16.*5 '466 ,.111112525Depreciation:156666 x 6.1 1 15666 6.*5 5'56 6.4*,44156666 x 6.' ' *6666 6.*5 16566 6.224*156666 x 6.' * *6666 6.*5 16566 6.21'2,2156666 x 6.' , *6666 6.*5 16566 6.*24

156666 x 6.' 5 *6666 6.*5 16566 6.5255,156666 x 6.1 15666 6.*5 5'56 6.562'''&alvage ..... 1,666 16.*5 166 6.562,1,3et present value >2'5

Groect B !ould #e prefera#le to Groect $ using the net presentvalue method.

#. Grofita#ilit" index present value of cash inflo!s/investment

For Groect $: profita#ilit" index 16261/166666 1.626. For Groect B: profita#ilit" index 152'5/156666 1.6,4.

Groect $ is preferred using the profita#ilit" index.

45.-ard

%o" Compan" is tr"ing to decide !hether to invest in one of t!oproects and L. Data for each investment proect follo!:

Groect L

Cost of e+uipment ..................... > 6666 >1,6666 8seful life ........................... "ears "ears

0stimated net annual cash inflo! ...... > '5666 > *6666 &alvage value at the end of useful life > 4666 > 1'666

The e+uipment for each proect is in the M$C%& 5"ear propert"class. %o" uses the optional straightline method forcalculating depreciation. The tax rate is *5


25/29

a. Compute the net present value of each proect and indicate!hich appears prefera#le in terms of net present value.%ound all computations to the nearest dollar.

#. Compute the profita#ilit" index for each proect andindicate !hich proect !ould #e prefera#le using thisinvestment criterion.



26/29

$ns!er:

a.Groect : Tax $ftertax 1'< Gresent =ear Cash Flo! 0ffect Cash Flo! Factor KJalueCost of e+uipment 6 >?6666@ >?6666@ 1.666 >?6666@$nnual savings ... 1 '5666 16.*5 1'56 ,.111 46,Depreciation:6666 x 6.1 1 666 6.*5 *156 6.4* '41*6666 x 6.' ' 14666 6.*5 *66 6.22 56'16666 x 6.' * 14666 6.*5 *66 6.21' ,,46666 x 6.' , 14666 6.*5 *66 6.* ,666666 x 6.' 5 14666 6.*5 *66 6.52 *52'6666 x 6.1 666 6.*5 *156 6.562 152&alvage ..... 4666 16.*5 5'66 6.562 '*3et present value > *5

Groect L:

Tax $ftertax 1'< Gresent =ear Cash Flo! 0ffect Cash Flo! Factor KJalueCost of e+uipment 6 >?1,6666@ >?1,6666@ 1.666 >?1,6666@$nnual savings ... 1 *6666 16.*5 1566 ,.111 4615Depreciation:1,6666 x 6.1 1 1,666 6.*5 ,66 6.4* ,*21,6666 x 6.' ' '4666 6.*5 466 6.22 24111,6666 x 6.' * '4666 6.*5 466 6.21' 241,6666 x 6.' , '4666 6.*5 466 6.* '**1,6666 x 6.' 5 '4666 6.*5 466 6.52 55521,6666 x 6.1 1,666 6.*5 ,66 6.562 ',4,&alvage ..... 1'666 16.*5 2466 6.562 *553et present value >?'',,1@

Groect !ould #e prefera#le to Groect L using the net presentvalue method.

#.Grofita#ilit" index present value of cash inflo!s/investment

For Groect : profita#ilit" index 6*5/6666 1.616. For Groect L: profita#ilit" index 11255/1,6666 6.4,6.

Groect is preferred using the profita#ilit" index.



27/29

4.-ard

Jas+ue9 Compan" has #een offered a 2"ear contract to suppl" apart to a maor aircraft manufacturer. $fter careful stud" thecompan" has developed the follo!ing data relating to thecontract:

Cost of e+uipment needed ........................... >*66666 7or(ing capital needed to carr" inventories ........ 56666 $nnual #eforetax cash receipts from deliver"

of parts less related cash operating costs ..... 6666 &alvage value of e+uipment at

termination of the contract ............. ....... 16666

The e+uipment a#ove !ould #e in the M$C%& 5"ear propert"class. The contract is not expected to #e extended #e"ond theinitial contract period. The compan")s cost of capital is 16'6666throughout its useful life. There !ould #e a need for anincrease in !or(ing capital of >'666 !hich !ould #e releasedat the end of the proect. The asset)s salvage value !ould #e>5666. The compan")s tax rate is ,6< and its discount rate is16?56666@ 1.666 >?56666@

7or(ing capital needed .... 3o! > ?'666@ 1.666 > ?'666@3et annual cash inflo!s ... 1, > 1'666 *.126 > *46,6Depreciation tax shield: 1 > **** 6.6 > *6*6 ' > 2 6.4' > 5562 * > 2 6.251 > 5662 , > **** 6.4* > ''22 > 154'1

&alvage value ............. , > *666 6.4* > '6,7or(ing capital released .. , > '666 6.4* > 1*3et present value ......... > 5'2

44.Medium

$ compan" is considering purchasing an asset for >6666 !hich!ould have a useful life of 5 "ears. The asset #elongs to theM$C%& * "ear propert" class and !ould #e depreciated for taxpurposes using the M$C%& ta#les. The asset !ould generateannual net cash inflo!s of >'666 throughout its useful life.There !ould #e a need for an increase in !or(ing capital of>666 !hich !ould #e released at the end of the proect. Theasset)s salvage value !ould #e >4666. The compan")s tax rateis ,6< and its discount rate is 1'


29/29

1'< Gresent =ears $mount Factor JalueCost of asset ........... 3o! >?6666@ 1.666 >?6666@7or(ing capital needed .. 3o! > ?666@ 1.666 > ?666@3et annual cash inflo!s 15 > 1566 *.65 > 5'*4Depreciation tax shield: 1 > 2' 6.4* > 21*2 ' > 1646 6.22 > 451' * > *55' 6.21' > '5' , > 122 6.* > 11*6 > 1*64

&alvage value ........... 5 > ,466 6.52 > '2''7or(ing capital released 5 > 666 6.52 > *,6'3et present value ....... > 1526

Documents

Test Bank - Chapter15 Capital Budgeting2