Chapter 24: Q1DQ (page 1083)
Capital budgeting decisions require careful analysis because they are generally the most and decisions that management faces.
Capital budgeting decisions are the most difficult and risky.
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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.
A company is considering investing in a new machine that requires a cash payment of \(47,947 today. The machine will generate annual cash flows of \)21,000 for the next three years. What is the internal rate of return if the company buys this machine?
Archer Foods has a freezer that is in need of repair and is considering whether to replace the old freezer with a new freezer or have the old freezer extensively repaired. Information about the two alternatives follows. Management requires a 10% rate of return on its investments.
Alternative 1: Keep the old freezer and have it repaired. If the old freezer is repaired, it will be kept for another eight years and then sold for its salvage value.
Cost of old freezer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \(75,000
Cost of repair . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Annual expected revenues generated . . . . . . . . . . . . . . . 63,000
Annual cash operating costs after repair . . . . . . . . . . . . . 55,000
Salvage value of old freezer in 8 years . . . . . . . . . . . . . . 3,000
Alternative 2: Sell the old freezer and buy a new one. The new freezer is larger than the old one and will allow the company to expand its product offerings, thereby generating more revenues. Also, it is more energy efficient and will yield substantial operating cost savings.
Cost of new freezer............................. \)150,000
Salvage value of old freezer now.................. 5,000
Annual expected revenues generated . . . . . . . . . . . . . . 68,000
Annual cash operating costs . . . . . . . . . . . . . . . . . . . . . . 30,000
Salvage value of new freezer in 8 years . . . . . . . . . . . . . 8,000
Required
1. Determine the net present value of alternative 1.
2. Determine the net present value of alternative 2.
3. Which alternative do you recommend that management select? Explain.
After evaluating the risk of the investment described in Exercise 24-8, B2B Co. concludes that it must earn at least an 8% return on this investment. Compute the net present value of this investment. (Round the net present value to the nearest dollar.)
Refer to the information in QS 24-11 and instead assume the investment has a salvage value of $20,000. Compute the investment’s net present value.
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