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Exam 25: Capital Budgeting and Managerial Decisions

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Question 41

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A company must decide between scrapping or rebuilding units that do not pass inspection. The company has 15,000 such units that cost $6 per unit to manufacture. The units were built to satisfy a special order, which must still be satisfied if the defective units are scrapped. The units can be sold as scrap for $2.50 each or they can be reworked for $4.50 each and sold for the full price of $9.00 each. If the units are sold as scrap, the company will have to build 15,000 replacement units and sell them at the full price. Required: (1) What is the net return from selling the units as scrap? (2) What is the net return from reworking and selling the units? (3) Should the company sell the units as scrap or rework them?

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Question 42

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A company is considering purchasing a machine for $75,000. The machine is expected to generate a net after-tax income of $11,250 per year. Depreciation expense would be $7,500. What is the payback period for this machine?

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An opportunity cost is the potential benefit that is lost by taking a specific action when two or more alternative choices are available.

The payback method, unlike the net present value method, does not ignore cash flows after the point of cost recovery.

A company is considering purchasing a machine for $21,000. The machine will generate an after-tax net income of $2,000 per year. Annual depreciation expense would be $1,500. What is the payback period for the new machine?

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and be depreciated over a three-year period with no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the accounting rate of return for this machine?

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

An ______________________________ is the potential benefit lost by taking a specific action when two or more alternative choices are available.

What is one advantage and one disadvantage of using the accounting rate of return to evaluate investment alternatives?

A limitation of the internal rate of return method is:

Eagle Company is considering the purchase of an asset for $100,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year. Compute the payback period for this investment. (Round to two decimal places.)

Marsden manufactures a cat food product called Special Export. Marsden currently has 10,000 bags of Special Export on hand. The variable production costs per bag are $1.80 and total fixed costs are $10,000. The cat food can be sold as it is for $9.00 per bag or be processed further into Prime Cat Food and Feline Surprise at an additional $2,000 cost. The additional processing will yield 10,000 bags of Prime Cat Food and 3,000 bags of Feline Surprise, which can be sold for $8 and $6 per bag, respectively. The net advantage (incremental income) of processing Special Export further into Prime and Feline Surprise would be:

Coffer Co. is analyzing two projects for the future. Assume that only one project can be selected. If the company is using the payback period method and it requires a payback of three years or less, which project should be selected?

Saxon Manufacturing is considering purchasing two machines. Each machine costs $9,000 and will produce cash flows as follows: Saxon Manufacturing uses the net present value method to make the decision, and it requires a 15% annual return on its investments. The present value factors of 1 at 15% are: 1 year, 0.8696; 2 years, 0.7561; 3 years, 0.6575. Which machine should Saxon purchase?

Monterey Corporation is considering the purchase of a machine costing $36,000 with a 6-year useful life and no salvage value. Monterey uses straight-line depreciation and assumes that the annual cash inflow from the machine will be received uniformly throughout each year. In calculating the accounting rate of return, what is Monterey's average investment?

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

Marsden manufactures a cat food product called Special Export. Marsden currently has 10,000 bags of Special Export on hand. The variable production costs per bag are $1.80 and total fixed costs are $10,000. The cat food can be sold as it is for $9.00 per bag or be processed further into Prime Cat Food and Feline Surprise at an additional $2,000 cost. The additional processing will yield 10,000 bags of Prime Cat Food and 3,000 bags of Feline Surprise, which can be sold for $8 and $6 per bag, respectively. If Special Export is processed further into Prime Cat Food and Feline Surprise, the total gross profit would be:

Textel is thinking about having one of its products manufactured by a subcontractor. Currently, the cost of manufacturing 1,000 units follows: If Textel can buy 1,000 units from a subcontractor for $100,000, it should:

Incremental costs should be considered in a make or buy decision.

How does the calculation of break-even time (BET) differ from the calculation of payback period (PBP)?