Connect - Managerial Accounting Chapter 11

1.

Beyer Company is considering the purchase of an asset for $180,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year.

	Year 1				Year 2				Year 3				Year 4				Year 5				Total
Net cash flows		$	60,000			$	40,000			$	70,000			$	125,000			$	35,000			$	330,000

Compute the payback period for this investment. (Cumulative net cash outflows must be entered with a minus sign. Round your Payback Period answer to 2 decimal places.)

	Year Cash Inflow (Outflow) Cumulative Net Cash Inflow (Outflow) 0 $(180,000) $(180,000) 1 60,000 (120,000) 2 40,000 (80,000) 3 70,000 (10,000) 4 125,000 115,000 5 35,000 150,000 $150,000 Payback period = 3.08 years

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2.

Compute the payback period for each of these two separate investments:

a.	A new operating system for an existing machine is expected to cost $520,000 and have a useful life of six years. The system yields an incremental after-tax income of $150,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10,000.
b.	A machine costs $380,000, has a $20,000 salvage value, is expected to last eight years, and will generate an after-tax income of $60,000 per year after straight-line depreciation.

	Payback Period Choose Numerator: / Choose Denominator: = Payback Period Cost of investment / Annual net cash flow = Payback period a. $520,000 / $235,000 = 2.21 years b. $380,000 / $105,000 = 3.62 years

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3.

A machine costs $700,000 and is expected to yield an after-tax net income of $52,000 each year. Management predicts this machine has a 10-year service life and a $100,000 salvage value, and it uses straight-line depreciation. Compute this machine’s accounting rate of return.

	Accounting Rate of Return Choose Numerator: / Choose Denominator: = Accounting Rate of Return Annual after-tax net income / Annual average investment = Accounting rate of return $52,000 / $400,000 = 13.00 %

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4.

B2B Co. is considering the purchase of equipment that would allow the company to add a new product to its line. The equipment is expected to cost $360,000 with a 12-year life and no salvage value. It will be depreciated on a straight-line basis. The company expects to sell 144,000 units of the equipment’s product each year. The expected annual income related to this equipment follows.

Sales	$	225,000
Costs
Materials, labor, and overhead (except depreciation on new equipment)		120,000
Depreciation on new equipment		30,000
Selling and administrative expenses		22,500
Total costs and expenses		172,500
Pretax income		52,500
Income taxes (30%)		15,750
Net income	$	36,750

1.	Compute the payback period.

	Payback Period Choose Numerator: / Choose Denominator: = Payback Period Cost of investment / Annual net cash flow = Payback period $360,000 / $66,750 = 5.39 years

2.	Compute the accounting rate of return for this equipment.

	Accounting Rate of Return Choose Numerator: / Choose Denominator: = Accounting Rate of Return Annual after-tax net income / Annual average investment = Accounting rate of return $36,750 / $180,000 = 20.42 %

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5.

B2B Co. is considering the purchase of equipment that would allow the company to add a new product to its line. The equipment is expected to cost $360,000 with a 12-year life and no salvage value. It will be depreciated on a straight-line basis. The company expects to sell 144,000 units of the equipment’s product each year. The expected annual income related to this equipment follows. If at least an 8% return on this investment must be earned, compute the net present value. (FV of $1, PV of $1, FVA of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Sales	$	225,000
Costs
Materials, labor, and overhead (except depreciation)		120,000
Depreciation on new equipment		30,000
Selling and administrative expenses		22,500
Total costs and expenses		172,500
Pretax income		52,500
Income taxes (30%)		15,750
Net income	$	36,750

Compute the net present value of this investment.

	Chart Values are Based on: n = 12 i = 8% Select Chart Amount x PV Factor = Present Value Present Value of an Annuity of 1 $66,750 x 7.5361 = $503,035 Present value of cash inflows $503,035 Present value of cash outflows (360,000) Net present value $143,035

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6.

Phoenix Company can invest in each of three cheese-making projects: C1, C2, and C3. Each project requires an initial investment of $228,000 and would yield the following annual cash flows. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

	C1				C2				C3
Year 1		$	12,000			$	96,000			$	180,000
Year 2			108,000				96,000				60,000
Year 3			168,000				96,000				48,000
Totals		$	288,000			$	288,000			$	288,000

(1)	Assuming that the company requires a 12% return from its investments, use net present value to determine which projects, if any, should be acquired. (Round your answers to the nearest whole dollar. Negative amounts should be indicated by a minus sign.)

Project C1 Initial Investment $228,000 Chart Values are Based on: i = 12% Year Cash Inflow x PV Factor = Present Value 1 12,000 x 0.8929 = 10,715 2 108,000 x 0.7972 = 86,098 3 168,000 x 0.7118 = 119,582 $216,395 Present value of cash inflows $216,395 Present value of cash outflows 228,000 Net present value $(11,605) Should the company acquire this investment? No Project C2 Initial Investment $228,000 Year Cash Inflow x PV Factor = Present Value 1 96,000 x 0.8929 = 85,718 2 96,000 x 0.7972 = 76,531 3 96,000 x 0.7118 = 68,333 $230,582 Present value of cash inflows $230,582 Present value of cash outflows 228,000 Net present value $2,582 Should the company acquire this investment? Yes Project C3 Initial Investment $228,000 Year Cash Inflow x PV Factor = Present Value 1 180,000 x 0.8929 = 160,722 2 60,000 x 0.7972 = 47,832 3 48,000 x 0.7118 = 34,166 $242,720 Present value of cash inflows $242,720 Present value of cash outflows 228,000 Net present value $14,720 Should the company acquire this investment? Yes

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Questions 7-10

[The following information applies to the questions displayed below.]

Manning Corporation is considering a new project requiring a $90,000 investment in test equipment with no salvage value. The project would produce $66,000 of pretax income before depreciation at the end of each of the next six years. The company’s income tax rate is 40%. In compiling its tax return and computing its income tax payments, the company can choose between the two alternative depreciation schedules shown in the table. (FV of $1, PV of $1, FVA of $1 and PVA of $1) (Use MACRS) (Use appropriate factor(s) from the tables provided.)

	Straight-Line Depreciation				MACRS Depreciation
Year 1		$	9,000			$	18,000
Year 2			18,000				28,800
Year 3			18,000				17,280
Year 4			18,000				10,368
Year 5			18,000				10,368
Year 6			9,000				5,184
Totals		$	90,000			$	90,000

7.

Required:
1.	Complete the following table assuming use of straight-line depreciation. Net cash flow equals the amount of income before depreciation minus the income taxes.

	Income Before Depreciation Straight-Line Depreciation Taxable Income Income Taxes Net Cash Flows Year 1 $66,000 $9,000 $57,000 $22,800 $43,200 Year 2 66,000 18,000 48,000 19,200 46,800 Year 3 66,000 18,000 48,000 19,200 46,800 Year 4 66,000 18,000 48,000 19,200 46,800 Year 5 66,000 18,000 48,000 19,200 46,800 Year 6 66,000 9,000 57,000 22,800 43,200

8.

2.	Complete the following table assuming use of MACRS depreciation. Net cash flow equals the amount of income before depreciation minus the income taxes.

	Income Before Depreciation MACRS Depreciation Taxable Income Income Taxes Net Cash Flows Year 1 $66,000 $18,000 $48,000 $19,200 $46,800 Year 2 66,000 28,800 37,200 14,880 51,120 Year 3 66,000 17,280 48,720 19,488 46,512 Year 4 66,000 10,368 55,632 22,253 43,747 Year 5 66,000 10,368 55,632 22,253 43,747 Year 6 66,000 5,184 60,816 24,326 41,674

9.

3.	Compute the net present value of the investment if straight-line depreciation is used. Use 10% as the discount rate.

	Chart Values are Based on: i = 10% Year Net Cash Inflow x PV Factor = Present Value 1 43,200 x 0.9091 = 39,273 2 46,800 x 0.8264 = 38,676 3 46,800 x 0.7513 = 35,161 4 46,800 x 0.6830 = 31,964 5 46,800 x 0.6209 = 29,058 6 43,200 x 0.5645 = 24,386 Present value of cash inflows $198,518 Present value of cash outflows (90,000) Net present value $108,518

10.

4.	Compute the net present value of the investment if MACRS depreciation is used. Use 10% as the discount rate.

	Chart Values are Based on: i = 10% Year Net cash Inflow x PV Factor = Present Value 1 46,800 x 0.9091 = 42,546 2 51,120 x 0.8264 = 42,246 3 46,512 x 0.7513 = 34,944 4 43,747 x 0.6830 = 29,879 5 43,747 x 0.6209 = 27,163 6 41,674 x 0.5645 = 23,525 Present value of cash inflows $200,303 Present value of cash outflows (90,000) Net present value $110,303

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11.

Sentinel Company is considering an investment in technology to improve its operations. The investment will require an initial outlay of $250,000 and will yield the following expected cash flows. Management requires investments to have a payback period of three years, and it requires a 10% return on investments. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

Period	Cash Flow
1		$	47,000
2			52,000
3			75,000
4			94,000
5			125,000

Required:
1.	Determine the payback period for this investment. (Enter cash outflows with a minus sign. Round your Payback Period answer to 1 decimal place.)

Year Cash inflow (outflow) Cumulative Net Cash Inflow (outflow) 0 $(250,000) $(250,000) 1 47,000 (203,000) 2 52,000 (151,000) 3 75,000 (76,000) 4 94,000 18,000 5 125,000 143,000 $143,000 Calculate the payback period: Payback occurs between year: 3 and year: 4 Calculate the portion of the year: Numerator for partial year $76,000 0.8 years Denominator for partial year $94,000 Payback period = 3.8 years

2.	Determine the break-even time for this investment.(Enter cash outflows with a minus sign. Round your break-even time answer to 1 decimal place.)

Year Cash inflow (outflow) Table factor Present Value of Cash Flows Cumulative Present Value of Cash Flows 0 $(250,000) 1.0000 $(250,000) $(250,000) 1 47,000 0.9091 $42,728 (207,272) 2 52,000 0.8264 $42,973 (164,299) 3 75,000 0.7513 $56,348 (107,951) 4 94,000 0.6830 $64,202 (43,749) 5 125,000 0.6209 $77,613 33,864 $143,000 Calculate the break even time: Break-even time occurs between year: 4 and year: 5 Calculate the portion of the year: Numerator for partial year $43,749 0.6 years Denominator for partial year $77,613 Break-even time = 4.6 years

3.	Determine the net present value for this investment.

	Net present value $33,864

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Neither the payback period nor the accounting rate of return methods of evaluating investments considers the time value of money.
True

The expected amount of time to recover the initial amount of an investment is called the:
Payback period.

A company buys a machine for $60,000 that has an expected life of 9 years and no salvage value. The company anticipates a yearly net income of $2,850 after taxes of 30%, with the cash flows to be received evenly throughout each year. What is the accounting rate of return?
9.50%.

The accounting rate of return uses cash flows in its calculation.
False

Capital budgeting decisions usually involve analysis of:
Long-term investments only.

In ranking choices with the break-even time (BET) method, the investment with the highest BET measure gets the highest rank.
False

The net present value capital budgeting method considers all estimated cash flows for the project's expected life.
True

A disadvantage of using the payback period to compare investment alternatives is that:
It ignores cash flows beyond the payback period.

Which one of the following methods considers the time value of money in evaluating alternative capital expenditures?
Net present value.

Capital budgeting decisions are not affected by return on investment considerations.
False

The internal rate of return method of evaluating capital investments cannot be used with uneven cash flows.
False

The calculation of the payback period for an investment when net cash flow is even (equal) is:
(Cost of investment)/(Annual net cash flow)

The payback method of evaluating an investment fails to consider how long the investment will generate cash inflows beyond the payback period.
True

The break-even time (BET) method is a variation of the:
Payback method.

A limitation of the internal rate of return method is that it:
Ignores varying risks over the life of a project.

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A company is considering a 5-year project. The company plans to invest $60,000 now and it forecasts cash flows for each year of $16,200. The company requires a hurdle rate of 12%. Calculate the internal rate of return to determine whether it should accept this project. Selected factors for a present value of an annuity of 1 for five years are shown below:

Interest rate	Present value of an annuity of $1 factor for year 5
10%	3.7908
12%	3.6048
14%	3.4331

The project earns more than 10% but less than 12%. At a hurdle rate of 12%, the project should be rejected.

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Poe Company is considering the purchase of new equipment costing $80,000. The projected net cash flows are $35,000 for the first two years and $30,000 for years three and four. The revenue is to be received at the end of each year. The machine has a useful life of 4 years and no salvage value. Poe requires a 10% return on its investments. The present value of an annuity of 1 and present value of an annuity for different periods is presented below. Compute the net present value of the machine.

Periods	Present Value of 1 at 10%	Present Value of an Annuity of 1 at 10%
1	0.9091	0.9091
2	0.8264	1.7355
3	0.7513	2.4869
4	0.6830	3.1699

$23,775

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A given project requires a $28,000 investment and is expected to generate end-of-period annual cash inflows as follows:

Year 1	Year 2	Year 3
$12,000	$13,000	$12,000

Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below.

i = 10% n = 1	i = 10% n = 2	i = 10% n = 3
.9091	.8264	.7513

$2,668.00

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Alfarsi Industries uses the net present value method to make investment decisions and requires a 15% annual return on all investments. The company is considering two different investments. Each require an initial investment of $15,000 and will produce cash flows as follows:

End of Year	Investment
	A	B
1	$8,000	$0
2	8,000	0
3	8,000	24,000

The present value factors of $1 each year at 15% are:

1	0.8696
2	0.7561
3	0.6575

The present value of an annuity of $1 for 3 years at 15% is 2.2832

The net present value of Investment A is:

$3,266.