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Exam 26: Incremental Analysis and Capital Budgeting

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Question 51

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The technique which identifies the time period required to recover the cost of the investment is called the ________________ method.

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Question 52

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You are the general accountant for Unlimited Words Inc. a typing service based in San Francisco California. The company has decided to upgrade its equipment. It currently has a widely used version of a word processing program. The company wishes to invest in more up-to-date software and to improve its printing capabilities. Two options have emerged. Option #1 is for the company to keep its existing computer system and upgrade its word processing program. The memory of each individual work station would be enhanced and a larger more efficient printer would be used. Better telecommunications equipment would allow for the electronic transmission of some documents as well. Option #2 would be for the company to invest in an entirely different computer system. The software for this system is extremely impressive and it comes with individual laser printers. However the company is not well known and the software does not connect well with well-known software. The net present value information for these options follows: $\begin{array}{llcc}&&\text { Option \#1 }&\text { Option \#2 }\\\text { Initial Investment } && \$(95,000) & \$(240,000) \\\text { Returns } & \text { Year 1 } & 55,000 & 80,000 \\& \text { Year 2 } & 30,000 & 80,000 \\& \text { Year 3 } & 10,000 & 80,000 \\& \text { Net Present Value } & 0 & 0\end{array}$ Required: Prepare a brief report for management in which you make a recommendation for one system or the other using the information given.

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I recommend that the company accept Opti...

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Question 53

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The decision rule on whether to sell or process further

Good Cabin Company manufactures cappuccino makers. For the first ten months of 2016 the company reported the following operating results while operating at 80% of plant capacity: $\begin{array}{lr}\text { Sales (500,000 units) } & \$ 90,000,000 \\\text { Cost of goods sold } & \$ 4,000,000 \\\text { Gross profit } & 36,000,000 \\\text { Operating expenses } & 24,000,000 \\\text { Net income } & \$ 12,000,000\end{array}$ An analysis of costs and expenses reveals that variable cost of goods sold is $85 per unit and variable operating expenses are $35 per unit. In November Good Cabin Company receives a special order for 30000 machines at $135 each from a major coffee shop franchise. Acceptance of the order would result in $10000 of shipping costs but no increase in fixed expenses. Instructions (a) Prepare an incremental analysis for the special order. (b) Should Good Cabin Company accept the special order? Justify your answer.

Mezzita Inc. is considering purchasing equipment costing $12000 with a 6-year useful life. The equipment will provide cost savings of $3100 and will be depreciated straight-line over its useful life with no salvage value. Mezzita requires a 10% rate of return. $\quad$ $\quad$ $\quad$ $\quad$ $\quad$$\text { Present Value of an Annuity of } 1$ $\begin{array}{lllllll}\text { Period }&8\%&9\%&10\%&11\%&12\%&15\%\\6 & 4.623 & 4.486 & 4.355 & 4.231 & 4.111 & 3.784\end{array}$ What is the approximate net present value of this investment?

The process used to identify the financial data that change under alternative courses of action is called allocation of limited resources.

Decision-making involves choosing among alternative courses of action.

If an asset cost $270000 and is expected to have a $60000 salvage value at the end of its twelve-year life and generates annual net cash inflows of $40000 each year the cash payback period is

The appropriate table to use when an investment promises to return unequal cash flows is the

If a company has excess capacity and present markets will not be affected it would be profitable to accept an order at a special unit price even though the price is less than the unit variable cost to manufacture the item.

In a decision concerning replacing old equipment with new equipment the book value of the old equipment can be considered a sunk cost.

Define the term "opportunity cost." How may this cost be relevant in a make-or-buy decision?

Karpentry Company is unsure of whether to sell its product assembled or unassembled. The unit cost of the unassembled product is $30 and Karpentry would sell it for $66. The cost to assemble the product is estimated at $21 per unit and the company believes the market would support a price of $85 on the assembled unit. What decision should Karpentry make?

Multi-Cities Inc. has three divisions: Buck Leonard and Hickory. The results of August 2016 are presented below. $\begin{array}{lcccc}&\text { Buck }&\text {Leonard }&\text {Hickory } & \text { Total }\\ \text { Units sold } & 3,000 & 5,000 & 2,000 & 10,000 \\\text { Revenue } & \$ 70,000 & \$ 50,000 & \$ 40,000 & \$ 160,000 \\ \text { Less variable costs } & 32,000 & 26,000 & 16,000 & 74,000 \\ \text {Less direct fixed costs } & 14,000 & 19,000 & 12,000 & 45,000 \\\text { Less allocated fixed costs } & 6,000 & 10,000 & 4,000 & 20,000 \\\text { Net income } & \$ 18,000 & \$(5,000) & \$ 8,000 & \$ 21,000 \\\end{array}$ All of the allocated costs will continue even if a division is discontinued. Multi-Cities allocates indirect fixed costs based on the number of units to be sold. Since the Leonard division has a net loss Multi-Cities feels that it should be discontinued. Multi-Cities feels if the division is closed that sales at the Buck division will increase by 10% and that sales at the Hickory division will stay the same. Instructions (a) Prepare an analysis showing the effect of discontinuing the Leonard division. (b) Should Multi-Cities close the Leonard division? Briefly indicate why or why not.

Use the following table $\text { Present Value of an Annuity of } 1$$\begin{array}{rrrr}\text { Period } & 8 \% & 9 \% & 10 \%\\1 & .926 & .917 & .909 \\2 & 1.783 & 1.759 & 1.736 \\3 & 2.577 & 2.531 & 2.487\end{array}$ A company has a minimum required rate of return of 8% and is considering investing in a project that costs $68337 and is expected to generate cash inflows of $27000 each year for three years. The approximate internal rate of return on this project is

The process of making capital expenditure decisions in business is called ___________.

The potential benefit that may be obtained by following an alternative course of action is called an _________________ cost.

The higher the rate of return for a given risk the

The rate of return that management expects to pay on all borrowed and equity funds is the

A negative net present value means that the