Chapter 24: Q5DQ (page 1083)
Why is an investment more attractive to management if it has a shorter payback period?
Investments are more attractive when it has a shorter payback period because the initial outlay of risk is for a shorter period.
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If Quail Company invests \(50,000 today, it can expect to receive \)10,000 at the end of each year for the next seven years, plus an extra $6,000 at the end of the seventh year. What is the net present value of this investment assuming a required 10% return on investments? (Round present value calculations to the nearest dollar.)
Manning Corporation is considering a new project requiring a \(90,000 investment in test equipment with no salvage value. The project would produce \)66,000 of pretax income before depreciation at the end of each of the next six years. The company’s income tax rate is 40%. In compiling its tax return and computing its income tax payments, the company can choose between the two alternative depreciation schedules shown in the table.
Straight-Line MACRS
Depreciation Depreciation*
Year 1 . . . . . . . . . . \( 9,000 \)18,000
Year 2 . . . . . . . . . . 18,000 28,800
Year 3 . . . . . . . . . . 18,000 17,280
Year 4 . . . . . . . . . . 18,000 10,368
Year 5 . . . . . . . . . . 18,000 10,368
Year 6 . . . . . . . . . . 9,000 5,184
Totals . . . . . . . . . . . \(90,000 \)90,000
Required
1. Prepare a five-column table that reports amounts (assuming use of straight-line depreciation) for each of the following for each of the six years: (a) pretax income before depreciation, (b) straight-line depreciation expense, (c) taxable income, (d) income taxes, and (e) net cash flow. Net cash flow equals the amount of income before depreciation minus the income taxes. (Round answers to the nearest dollar.)
2. Prepare a five-column table that reports amounts (assuming use of MACRS depreciation) for each of the following for each of the six years: (a) pretax income before depreciation, (b) MACRS depreciation expense, (c) taxable income, (d) income taxes, and (e) net cash flow. Net cash flow equals the income amount before depreciation minus the income taxes. (Round answers to the nearest dollar.)
3. Compute the net present value of the investment if straight-line depreciation is used. Use 10% as the discount rate. (Round the net present value to the nearest dollar.)
4. Compute the net present value of the investment if MACRS depreciation is used. Use 10% as the discount rate. (Round the net present value to the nearest dollar.)
Analysis Component
5. Explain why the MACRS depreciation method increases this project’s net present value.
What is capital budgeting?
Retsa Company is considering an investment in technology to improve its operations. The investment will require an initial outlay of \(800,000 and will yield the following expected cash flows. Management requires investments to have a payback period of two years, and it requires a 10% return on its investments.
Period Cash Flow
1 . . . . . . . . . . . . \)450,000
2 . . . . . . . . . . . . 400,000
3 . . . . . . . . . . . . 350,000
4 . . . . . . . . . . . . 300,000
Required
1. Determine the payback period for this investment. (Round the answer to one decimal.)
2. Determine the break-even time for this investment. (Round the answer to one decimal.)
3. Determine the net present value for this investment.
Analysis Component
4. Should management invest in this project? Explain.
5. Compare your answers for parts 1 through 4 with those for Problem 24-5B. What are the causes of the differences in results and your conclusions?
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. Assume the company uses an 8% discount rate. Compute the net present value of this investment. (Round your answer to the nearest dollar.)
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