Strategic Business Analysis

Concept of Investment Recovery

1. Kore Industries is analyzing a capital investment proposal for new equipment to produce a product over
the next 8 years. The analyst is attempting to determine the appropriate "end-of-life" cash flows for the
analysis. At the end of 8 years, the equipment must be removed from the plant and will have a net book
value of zero, a tax basis of $75,000, a cost to remove of $40,000, and scrap salvage value of $10,000.
Kore's effective tax rate is 40%. What is the appropriate "end-of-life" cash flow related to these items
that should be used in the analysis? 
$12,000 

2. Lor Industries is analyzing capital investment proposals for new machinery to produce a new product
over the next 10 years. At the end of 10 years, the machinery must be disposed of with a net zero
carrying value but with a residual value of P20,000. It will require some P30,000 to remove the
machinery. The applicable tax rate is 35%. The appropriate “end-of-life” cash flow based on the
foregoing information is:
Outflow of P6,500

3. The following selected data pertain to a 4-year project being considered by Metro Industries:
 
 ｷ  A depreciable asset that costs $1,200,000 will be acquired on January 1.  The asset, which is
expected to have a $200,000salvage value at the end of 4 years, qualifies as 3-year property under the
Modified Accelerated Cost Recovery System (MACRS).
ｷ The new asset will replace an existing asset that has a tax basis of $150,000 and can be sold on the
same January 1 for $180,00
ｷ  The project is expected to provide added annual sales of 30,000 units at $20.  Additional cash
operating costs are: variable, $12 per unit; fixed, $90,000 per year.
ｷ  A $50,000 working capital investment that is fully recoverable at the end of the fourth year is
required Metro is subject to a 40% income tax rate and rounds all computations to the nearest dollar.
Assume that any gain or loss affects the taxes paid at the end of the year in which it occurred. The
company uses the net present value method to analyze investments and will employ the following
factors and rates.
 
  Present Present  
Value Value of
Period of $1 at $1 Annuity MACRS
12% at 12%
1 0.89 0.89 33%
2 0.80 1.69 45
3 0.71 2.40 15
4 0.64 3.04 7
 The expected incremental sales will provide a discounted, net-of-tax contribution margin over 4 years
of
$437,760

4. Which one of the following statements concerning cash flow determination for capital budgeting
purposes is not correct? 
Book depreciation is relevant because it affects net income. 

5. Arlene Inc. currently has annual cash revenues of P2,400,000 and annual operating costs of P1,850,000
(all cash items except depreciation of P350,000). The company is considering the purchase of a new
machine costing P1,200,000 that would increase cash revenues to P2,900,000 and operating costs
(including depreciation) to P2,050,000.  The new machine would increase depreciation to P500,000 per
year.  Revenues are expected to increase to 2,900,000 and assuming a 35% income tax rate, Arlene’s
incremental after tax cash flows from the machine would be:
P345,000

6. In order to increase production capacity, Gunning Industries is considering replacing an

existing production machine with a new technologically improved machine effective January 1.
The following information is being considered by Gunning Industries:
ｷ  The new machine would be purchased for $160,000 in cash.  Shipping, installation, and
testing would cost an additional $30,000.
ｷ  The new machine is expected to increase annual sales by  20,000 units at a sales price of
$40 per unit.  Incremental operating costs include $30 per unit in variable costs and total fixed
costs of $40,000 per year.
ｷ The investment in the new machine will require an immediate increase in working capital of
$35,000.  This cash outflow will be recovered at the end of year 5.ｷ Gunning uses straight-line
depreciation for financial reporting and tax reporting purposes.  The new machine has  an
estimated useful life of 5 years and zero salvage value.ｷ Gunning is subject to a 40% corporate
income tax rate.
Gunning uses the net present value method to analyze investments and will employ the
following factors and rates: 
 
Present Present Value of an
Value Ordinary
Period of $1 at Annuity of $1 at 10%
10%
1 .909 .909
2 .826 1.736
3 .751 2.487
4 .683 3.170
5 .621 3.791
Gunning Industries' discounted annual depreciation tax shield for the year of replacement is
$13,817 

7. If income tax considerations are ignored, how is depreciation used in the following capital budgeting
techniques?
`Internal Rate of Return, Excluded; Accounting Rate of Return, Included.

8. Whatney Co. is considering the acquisition of a new, more efficient press. The cost of the press is
$360,000, and the press has an estimated 6-year life with zero salvage value. Whatney uses straight-
line depreciation for both financial reporting and income tax reporting purposes and has a 40%
corporate income tax rate. In evaluating equipment acquisitions of this type, Whatney uses a goal of a
4-year payback period. To meet Whatney's desired payback period, the press must produce a minimum
annual before-tax operating cash savings of
$110,000 

9. A company considers a project that will generate cash sales of $50,000 per year. Fixed costs will be
$10,000 per year, variable costs will be 40% of sales, and depreciation of the equipment in the project
will be $5,000 per year. Taxes are 40%. The expected annual cash flow to the company resulting from
the project is? 
$14,000 

10. The Dickins Corporation is considering the acquisition of a new machine at a cost of $180,000.
Transporting the machine to Dickins' plant will cost $12,000. Installing the machine will cost an
additional $18,000. It has a 10-year life and is expected to have a salvage value of $10,000.
Furthermore, the machine is expected to produce 4,000 units per year with a selling price of
$500 and combined direct materials and direct labor costs of $450 per unit. Federal tax
regulations permit machines of this type to be depreciated using the straight-line method over
5 years with no estimated salvage value. Dickins has a marginal tax rate of 40%.
What is the net cash outflow at the beginning of the first year that Dickins should use in a
capital budgeting analysis? 
$(210,000) 

11. In order to increase production capacity, Rovic Industries is considering replacing an existing
production machine with a new technologically improved machine effective January 1, 2014.
The following information is being considered by Gunning Industries:
·         The new machine would be purchased for P160,000 in cash.  Shipping and
installation would cost an additional P30,000.
·         The new machine is expected to increase annual sales by 20,000 units at a sales
price of P40 per unit. Incremental operating costs include P30 per unit in variable cost and
total fixed costs of P40,000 per year.
 ·         The investments in the new machine will require an immediate increase in working
capital of P35,000. This cash outflow will be recovered at the end of year 5.
·         Rovic uses straight-line depreciation for financial reporting and tax reporting
purposes. The new machine has an estimated useful life of five years and zero residual
value.
·         Rovic is subject to a 40% corporate income tax rate.
Rovic uses the net present value method to analyze investments and will employ the
following factors and rates:

 
  Present Value of an
Ordinary
Period Present Annuity of
Value of P1 P1 at 10%
at 10%
1 .909 .909 
2 .826 1.736
3 .751 2.487
4 .683 3.170
5 .621 3.791
 
Rovic Industries’ net cash outflow in a capital budgeting decision is?
P225.000

12. Garfield, Inc. is considering a 10-year capital investment project with forecasted revenues of P40,000
per year and forecasted cash operating expenses of P29,000 per year. The initial cost of the equipment
for the project is P23,000, and Garfield expects to sell the equipment for P9,000 at the end of the tenth
year. The equipment will be depreciated over 7 years. The project requires working capital investments
of P7,000 at its inception and another P5,000 at the end of year 5. Assuming a 40% marginal tax rate,
the expected net cash flows from the project in the tenth year is?
P24,000

13. Waltz Co. is considering the acquisition of a new, more efficient press. The cost of the press is
P360,000, and the press has an estimated 6-year life with zero residual value.  Waltz uses straight-line
depreciation for both financial reporting and income tax reporting purposes and has a 40% corporate
income tax rate. In evaluating equipment acquisitions of this type, Waltz uses a goal of a 4-year
payback period. To meet Waltz desired payback period, the press must produce a minimum annual
before-tax operating cash savings of 
P110,000
 14. Yipann Corporation is reviewing an investment proposal. The initial cost as well as other
related data for each year are presented in the schedule below. All cash flows are assumed to
take place at the end of the year. The salvage value of the investment at the end of each year is
equal to its net book value, and there will be no salvage value at the end of the investment's
life.
 
Investment Proposal
 
Annual    
  Initial Net After- Annual
Cost Tax
Year and Book Cash Net
Value Flows Income
0 $105,000 0 $0
1 70,000

Yipann uses a 24% after-tax target rate of return for new investment proposals. The discount figures
for a 24% rate of return are given. 

   
Present Value
of
  Present Value an Annuity of
of $1.00
  $1.00 Received at
Received at the End
Year the End of of Each Period
Period
1 .81 .81
2 .65 1.46
3 .52 1.98
4 .42 2.40
5 .34 2.74
6 .28 3.02
7 .22 3.24

 The average annual cash inflow at which Yipann would be indifferent to the investment (rounded to
the nearest dollar) is?
$38,321

15. The Dickins Corporation is considering the acquisition of a new machine at a cost of $180,000.
Transporting the machine to Dickins' plant will cost $12,000. Installing the machine will cost an
 additional $18,000. It has a 10-year life and is expected to have a salvage value of $10,000.
Furthermore, the machine is expected to produce 4,000 units per year with a selling price of
$500 and combined direct materials and direct labor costs of $450 per unit. Federal tax
regulations permit machines of this type to be depreciated using the straight-line method over
5 years with no estimated salvage value. Dickins has a marginal tax rate of 40%.
What is the net cash flow for the tenth year of the project that Dickins should use in a capital
budgeting analysis?
$126,000 

16. The Moore Corporation is considering the acquisition of a new machine. The machine can be
purchased for $90,000; it will cost $6,000 to transport to Moore's plant and $9,000 to install. It
is estimated that the machine will last 10 years, and it is expected to have an estimated
salvage value of $5,000. Over its 10-year life, the machine is expected to produce 2,000 units
per year with a selling price of $500 and combined material and labor costs of $450 per unit.
Federal tax regulations permit machines of this type to be depreciated using the straight-line
method over 5 years with no estimated salvage value. Moore has a marginal tax rate of 40%.
What is the net cash flow for the third year that Moore Corporation should use in a capital
budgeting analysis?
$68,400

17. In order to increase production capacity, Gunning Industries is considering replacing an

existing production machine with a new technologically improved machine effective January 1.
The following information is being considered by Gunning Industries:
ｷ  The new machine would be purchased for $160,000 in cash.  Shipping, installation, and
testing would cost an additional $30,000.
ｷ  The new machine is expected to increase annual sales by  20,000 units at a sales price of
$40 per unit.  Incremental operating costs include $30 per unit in variable costs and total fixed
costs of $40,000 per year.
ｷ The investment in the new machine will require an immediate increase in working capital of
$35,000.  This cash outflow will be recovered at the end of year 5.ｷ Gunning uses straight-line
depreciation for financial  reporting and tax reporting purposes.  The new machine has  an
estimated useful life of 5 years and zero salvage value.ｷ Gunning is subject to a 40% corporate
income tax rate.
Gunning uses the net present value method to analyze investments and will employ the
following factors and rates: 
 
Present Present Value of an
Value Ordinary
Period of $1 at Annuity of $1 at 10%
10%
1 .909 .909
2 .826 1.736
3 .751 2.487
4 .683 3.170
5 .621 3.791
 
The acquisition of the new production machine by Gunning Industries will contribute a
discounted net-of-tax contribution margin of 
$454,920 

18. The Moore Corporation is considering the acquisition of a new machine. The machine can be
purchased for $90,000; it will cost $6,000 to transport to Moore's plant and $9,000 to install. It
is estimated that the machine will last 10 years, and it is expected to have an estimated
salvage value of $5,000. Over its 10-year life, the machine is expected to produce 2,000 units
per year with a selling price of $500 and combined material and labor costs of $450 per unit.
Federal tax regulations permit machines of this type to be depreciated using the straight-line
method over 5 years with no estimated salvage value. Moore has a marginal tax rate of 40%.
What is the net cash flow for the tenth year of the project that Moore Corporation should use in
a capital budgeting analysis?
$63,000 

19. The following selected data pertain to a 4-year project being considered by Metro Industries:
 
 ｷ  A depreciable asset that costs $1,200,000 will be acquired on January 1.  The asset, which is
expected to have a $200,000salvage value at the end of 4 years, qualifies as 3-year property under the
Modified Accelerated Cost Recovery System (MACRS).
ｷ The new asset will replace an existing asset that has a tax basis of $150,000 and can be sold on the
same January 1 for $180,00
ｷ  The project is expected to provide added annual sales of 30,000 units at $20.  Additional cash
operating costs are: variable, $12 per unit; fixed, $90,000 per year.
ｷ  A $50,000 working capital investment that is fully recoverable at the end of the fourth year is
required Metro is subject to a 40% income tax rate and rounds all computations to the nearest dollar.
Assume that any gain or loss affects the taxes paid at the end of the year in which it occurred. The
company uses the net present value method to analyze investments and will employ the following
factors and rates.
 
  Present Present  
Value Value of
Period of $1 at $1 Annuity MACRS
12% at 12%
1 0.89 0.89 33%
2 0.80 1.69 45
3 0.71 2.40 15
4 0.64 3.04 7
 
The overall discounted-cash-flow impact of the working capital investment on Metro's project is?
$(18,000)
20. Metrejean Industries is analyzing a capital investment proposal for new equipment to produce a
product over the next 8 years. At the end of 8 years, the equipment must be removed from the plant and
will have a net book value of $0, a tax basis of $150,000, a cost to remove of $80,000, and scrap
salvage value of $20,000. Metrejean's effective tax rate is 40%. What is the appropriate "end-of-life"
cash flow related to these items that should be used in the analysis? 
$24,000 

21. The Moore Corporation is considering the acquisition of a new machine. The machine can be
purchased for $90,000; it will cost $6,000 to transport to Moore's plant and $9,000 to install. It
is estimated that the machine will last 10 years, and it is expected to have an estimated
salvage value of $5,000. Over its 10-year life, the machine is expected to produce 2,000 units
per year with a selling price of $500 and combined material and labor costs of $450 per unit.
Federal tax regulations permit machines of this type to be depreciated using the straight-line
method over 5 years with no estimated salvage value. Moore has a marginal tax rate of 40%.
What is the initial cost of investment?
$(105,000)

22.