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All Textbook Solutions for Survey of Accounting (Accounting I)
1SEQManagement is considering a $100,000 investmentin a project with a five-year life and no residualvalue. If the total income from the project is expected to be $60,000 and recognition is givento the effect of straight-line depreciation on theinvestment, the average rate of return is: A. 12% B. 24% C. 60% D. 75%The expected period of time that will elapse between the date of a capital investment and thecomplete recovery of the amount of cash investedis called: A.The average rate of return period B.The cash payback period C.The net present value period D.The internal rate of return periodA project that will cost $120,000 is estimated to generate cash flows of $25,000 per year for eight years. What is the net present value of the project, assuming a 1O% required rate of return? (Use thepresent value tables in this chapter.) A. $11,675 B. $13,375 C. $75,000 D. $95,0005SEQWhat are the principal objections to the use 01the average rate of return method in evaluatingcapital investment proposals?Discuss the principal limitations of the cash payback method for evaluating capital investmentproposals.3CDQ4CDQ5CDQ6CDQ7CDQ8CDQ9CDQ10CDQ11CDQ12CDQ13CDQ14CDQ15CDQMonsanto Company, a large chemical and fiberscompany, invested $37 million in state-of-the-artsystems to improve process control, laboratoryautomation, and local area network (LAN) communications. The investment was not justifiedmerely on cost savings but was also justified onthe basis of qualitative considerations. Monsantomanagement viewed the investment as a criticalelement toward achieving its vision of the future.What qualitative and quantitative considerationsdo you believe Monsanto would have consideredin its strategic evaluation of these investments?Average rate of return The following data are accumulated by McDermott Motors Inc. evaluating two competingcapital investment proposals: Determine the expected average rate of return for each proposal.15.2EAverage rate of return—new product Arrowhead Inc. is considering an investment in new equipment that will be used to manufacture a mobile communications product. The product is expected to generate additionalannual sales of 24,000 units at $400 per unit. 11w equipment has a cost of $27,000.000,residual value of $1.800,000, and a 10-year life. The equipment only can be used to manufacture the product. The cost to manufacture the product is shown below. Determine the average rate of return on the equipment.Calculate cash flows Daffodil Inc. is planning to invest in manufacturing equipment to make a new garden tool.The new garden tool is expected to generate additional annual sales of 120,000 units at $9each. The new manufacturing equipment will cost $320,000, have a 10-year life, a residualvalue of $20,000, and will be depreciated using the straight-line method. Selling expensesrelated to the new product are expected to be 15% of sales revenue. The cost to manufacture the product includes the following on a per-unit basis a. Determine the net cash flows for the first year of the project, Years 2—9, and for the lastyear of the project. b. Assume that the operating cash flows occur evenly throughout the year and that the equipment is purchased on January 1. 20Y1. Determine when the cash payback will occur byyear, month, and day.15.5ECash payback method Bliss Beauty Products ¡s considering an investment ¡n one of two new product lines. Theinvestment required for either product line is $2,800,000. The net cash flows associatedwith cadi product arc shown below. a. Recommend a product offering to Bliss Beauty Products, based on the cash payback periodfor each product line. b. Why is one product line preferred over the other, even though they both have the sametotal net cash flows? c. Assume thatinstead of $550.000 of cash flows in Year 3 and $450,000 in ‘ar 4, the Shampoo/Conditioner had cash flows of $600,000 in Year 3 and $550,000 in Year 4. What would be thecash payback period assuming that the cash flows occur uniformly throughout the year?15.7E15.8ENet present value method—annuity Model 99 Hotels is considering the construction of a new hotel for $80 million. The expected life of the hotel is 20 years with no residual value. The hotel is expected to earnrevenues of $15 million per year. Total expenses.including straight-line depreciation. Areexpected to he $6 million per year. Model 99 management has set a minimum acceptablerate of return of 10%. a. Determine the equal annual net cash flows from operating the hotel. b. Calculate the net present value of the new hotel, using the present value factor of an annuity of $1 at 10% for 20 periods of 8.5136. Round to the nearest million dollars. c. Does your analysis support construction of the new hotel?15.10E15.11E15.12E15.13EAverage rate of return, cash payback period, net present value method Southwest Transportation Inc. is considering a distribution facility at a cost of $10,000.000.The facility has an estimated life of 10 years and a $2,000.000 residual value. It is expectedto provide yearly net cash flows of $2,500,000. The company’s minimum desired rate ofreturn for net present value analysis is 15%. Compute the following: a. The average rate of return, giving effect to straight-tine depreciation on the investment.Round to one decimal place. b. The cash payback period. c. The net present value. Use the table of the present value of an annuity of $1 appearing inExhibit 5,15.15EInternal rate of return method The internal rate of return method is used by Leach Construction Co. in analyzing a capitalexpenditure proposal that involves an investment of $400.125 and annual net cash flows of$75,000 for each of the eight years of its useful life. a. Determine a present value factor for an annuity of $1 which can be used in determiningthe internal rate of return. b. Using the factor determined in part (a) and the present value of an annuity of $1 tableappearing Exhibit 5, determine the internal rate of return for the proposal.15.17EInternal rate of return method—two projects Strahn Foods Inc. is considering two possible investments: a delivery truck or a baggingmachine. The delivery truck would cost $65,970 and could be used to deliver an additional 90,000 bags of taquitos chips per year. Each hag of chips can be sold for a contribution margin of $0.35. The delivery truck operating expenses, excluding depreciation,are $0.55 per mile for 24,000 miles per year. The bagging machine would replace an oldbagging machine, and its net investment cost would he $35,890. The new machine wouldrequire 2.5 fewer hours of direct labor per day. Direct labor is $20 per hour. There are240 operating days in the year. Both the truck and the bagging machine are estimated tohave five-year lives. The minimum rate of return is 14%. However, Strahn Foods has funds to invest in only one of the projects. a. Compute the internal rate of return for each investment. Use the table of present valuesof an annuity of $1 in the chapter. b. Provide a memo to management with a recommendation.15.19E15.20E15.21E15.22EAverage rate of return method, net present value method, and analysis The capital investment committee of Overnight Express Inc. is considering two investmentprojects. The estimated income from operations and net cash flows from each investmentare as follows: Each project requires an investment of $800.000. Straight-line depreciation will beused, and no residual value is expected. The committee has selected a r.ne of 15% forpurposes of the net present value analysis. Instructions 1. Compute the following: a. The average rate of return for each investment. b. The net present value for each investment. Use the present value of Si table appearingin this chapter.Average rate of return method, net present value method, and analysis The capital investment committee of Overnight Express Inc. is considering two investmentprojects. The estimated income from operations and net cash flows from each investmentare as follows: Each project requires an investment of $800.000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a r.ne of 15% for purposes of the net present value analysis. Instructions Prepare a brief report for the capital investment committee, advising it on the relative meritsof the two projects.15.2.1PCash payback period, net present value method, and analysis McMorris Publications Inc. is considering two new magazine products. The estimated netcash flows from each product arc as follows: Each product requires an investment of $400000. A rate of 10% has been selected forthe net present value analysis. Instructions Prepare a brief report advising management on the relative merits of each of the twoproducts.15.3.1P15.3.2P15.3.3P15.4.1P15.4.2P15.4.3P15.5.1P15.5.2P15.5.3P15.6.1P15.6.2P15.6.3P15.6.4PCapital rationing decision involving four proposals Kopecky Industries Inc. is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated income from operations, and net cash flow for each proposal are as follows: The company’s capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average rate of return of 12% is required on allprojects. 1f the preceding standards are met, the net present value method and presentvalue indexes are used to rank the remaining proposals. Instructions Compute the present value index for each oldie proposals in part (4). Round to two decimal places.15.6.6P15.6.7P15.6.8P15.1.1MBA15.1.2MBAFinancial leverage MicrosoCortrepotied (MSFT) reported the following data (in millions) for a tern year Compute the profit margin, asset turnover, and financial leverage metrics using the expandedDuPont formula. Round profit margin, asset turnover, and financial leverage to two decimalplaces.Round return on stockholders’ equity to one decimal place.15.1.4MBA15.2.1MBA15.2.2MBA15.2.3MBA15.3.1MBA15.3.2MBA15.3.3MBA15.4MBA15.5.1MBAFinancial leverage Costco Wholesale Corporation (COST) and Wel-Mart Stroes Inc. (WMT)reported the following data (in milllions) for a recent year: Compute the return on stockholders equity. Round to one decimal place.15.5.3MBA15.5.4MBAEthics and professional conduct in business Erin Haywood was recently hired as a cost analyst by Wind River Medical Supplies Inc. Oneof Erin’s first assignments was to perform a net present value analysis for a new warehouse.Et-in performed the analysis and calculated a present value index of 0.8. The plant manager.ZuhairBarbat, is very intent on purchasing the warehouse because he believes that more storage space is needed. Zuhair asks Erín into his office and the following conversation takes place: ZubairErín, you’re new here, aren’t you? EHii: Yes, sir. Zubair: V.dl, Erin, let me tell you something. ¡m not at all pleased with the capital investment analysis that you performed on this new warehouse. T need that warehouse for my production. If I dont get it, where am I going to place our output? Erín: Hopefully with the customer, sir. Zithair: Now don’t get smart with me. Erín: No, really. I was being serious. My analysis does not support constructing a new ware- house. The numbers don’t lie: the warehouse does not meet our investment return targets. In fact, it seems to me that purchasing a warehouse dots not add much value to the business. We need to be producing product to satisfy customer orders, not to fill a warehouse. Zubair Listen, you need to understand sonwthing. The headquarters people will not allow mv to build the warehouse if the numbers dont add up. You know as well as I that many assump tions go into your net present value analysis. Why don’t you relax some of your assumptions so that the f́nancial savings will offset the cost? Erín: I’m willing to discuss my assumptions with you. Maybe I overlooked something. Zubafr Good. Here’s what I want you to do. 1 see in your analysis tha you don’t project greater sales as a result of the warehouse. It seems to me, if we can store more goxLs, then will have more to sell. Thus, logically, a larger warehouse translates into more sales. If you incorporate this into your analysis, I think you’ll see that the numbers will work out. Why don’t you work it through and come back with a new analysis? I’m really counting on you on this one. Let’s get off to a good start together and see if we can get this project accepted. What is your advice to Erin?15.2.1C15.2.2C15.2.3C15.3.1C15.3.2CQualitative issues in investment analysis The following an some selected quotes from senior executives CEO, Worthington Industries (a high technology steel company): We try to find the best technology, stay ahead of the corn petition, and serve the customer.... We’ll make any investment that will pay back quickly... but ¡fit is something that we really see as a must down the road, payback is not going to be that important. Chairman of Arnjen Inc. (a biotech company): “You cannot really run the numbers, do net present value cakulations, because the uncertainties are really gigantic.... You decide on a project you want to run, and then you run the numbers ¡as a reality check on your assump tionsi. Success in a business like this is much more dependent on tracking rather than on predicting, much more dependent on seeing resufts over time, tracking and adjusting and read justing, much more dynamic much more flexible. Chief Financial Officer of Mcr c 4 & Co., Inc. (a pharmaceutical company): . . . at the indi vidual product level—the development of a successful new product requires on the order of $230 million in R&D, spread over more than a decade—discounted cash flow style analysis does not become a factor until development is near the point of manufacturing scale-up effort. Prior to that point, given the uncertainties associated with new product development, it would be lunacy in our business to decide that we know exactly what’s going to happen to a product once it gets out.” ExpLain the role of capital investment analysis for these companies.15.5.1C15.5.2C15.6C