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DISCUSSION QUESTIONS
22-1
22-2
Chapter 22
Chapter 22
22-3
EXERCISES
E22-1
Estimated
Unit
Unit
Unit
Demand
Sales
Variable
Contribution
Year
in Units
Price
Cost
Margin
1
12,000
$25
$15
$10
2
12,000
25
15
10
3
12,000
25
15
10
4
12,000
25
15
10
5
12,000
25
15
10
Total net pretax cash inflows from sales .......................................
Initial cash outflow (cost of asset) .............................. $500,000
Less pretax estimated salvage value ........................... (100,000)
Excess of net pretax cash inflows over cost ................................
Net Pretax
Cash Inflows
From Sales
$120,000
120,000
120,000
120,000
120,000
$600,000
400,000
$200,000
E22-2
Estimated
Unit
Unit
Unit
Demand
Sales
Variable
Contribution
Year
in Units
Price
Cost
Margin
1
6,000
$12
$9
$3
2
8,000
12
9
3
3
10,000
12
9
3
4
10,000
12
9
3
5
10,000
12
9
3
6
10,000
12
9
3
7
10,000
12
9
3
8
8,000
12
9
3
9
6,000
12
9
3
10
4,000
12
9
3
Total net pretax cash inflows from sales .......................................
Initial cash outflow (cost of machine) .......................... $150,000
Less pretax estimated salvage value ...........................
(20,000)
Excess of net pretax cash inflows over cost ................................
Net Pretax
Cash Inflows
From Sales
$ 18,000
24,000
30,000
30,000
30,000
30,000
30,000
24,000
18,000
12,000
$246,000
130,000
$116,000
22-4
Chapter 22
E22-3
Estimated
6% Annual
Net Pretax
Price-level
Year
Cash Inflows
Adjustment
1
$15,000
(1 + .06)1 = 1.060
2
20,000
(1 + .06)2 = 1.124
3
20,000
(1 + .06)3 = 1.191
4
20,000
(1 + .06)4 = 1.262
5
15,000
(1 + .06)5 = 1.338
6
10,000
(1 + .06)6 = 1.419
Total price-level adjusted net pretax cash
inflows from operations ...........................................
Plus cash inflow from salvage ........................... $5,000
Price-level adjustment ........................................ 1,419
Total price-level adjusted
net pretax cash inflows ............................................
Less initial cash outflow ...................................................
Excess of net pretax cash inflows over
initial cash outflow....................................................
Price-level
Adjusted Net
Cash Inflows
$15,900
22,480
23,820
25,240
20,070
14,190
Estimated
9% Annual
Net Pretax
Price-level
Year
Cash Inflows
Adjustment
1
$20,000
(1 + .09)1 = 1.090
2
30,000
(1 + .09)2 = 1.188
3
40,000
(1 + .09)3 = 1.295
4
60,000
(1 + .09)4 = 1.412
5
60,000
(1 + .09)5 = 1.539
6
60,000
(1 + .09)6 = 1.677
7
60,000
(1 + .09)7 = 1.828
8
60,000
(1 + .09)8 = 1.993
9
40,000
(1 + .09)9 = 2.172
10
20,000
(1 + .09)10 = 2.367
Total price-level adjusted net pretax cash
inflows from operations...............................................
Plus cash inflow from salvage ........................... $10,000
Price-level adjustment ........................................
2.357
Total price-level adjusted
net pretax cash inflows ...............................................
Less initial cash outflow.......................................................
Excess of net pretax cash inflows over
initial cash outflow ......................................................
Price-level
Adjusted Net
Cash Inflows
$ 21,800
35,640
51,800
84,720
92,340
100,620
109,680
119,580
86,880
47,340
$121,700
7,095
$128,795
75,000
$53,795
E22-4
$750,400
23,670
$774,070
250,000
$524,070
**
Year
1
2
3
4
5
6
MACRS 5-year
Recovery Rate
.200
.320
.192
.115
.115
.058
1.000
Depreciable
Basis
$600,000
600,000
600,000
600,000
600,000
600,000
Tax
Depreciation
$120,000
192,000
115,200
69,000
69,000
34,800
$600,000
20,000
$20
$400,000
(1)
(2)
(3)
(4)
(5)
Annual
Additional
Tax Liability
Operating
Maintenance
Tax
Taxable
With 40%
Savings
Cost
DepreIncome
Tax Rate
Year
With CIM*
With CIM
ciation**
(1) (2) (3)
40% (4)
1
$400,000
$200,000
$120,000
$ 80,000
$32,000
2
400,000
200,000
192,000
8,000
3,200
3
400,000
200,000
115,200
84,800
33,920
4
400,000
200,000
69,000
131,000
52,400
5
400,000
200,000
69,000
131,000
52,400
6
400,000
200,000
34,800
165,200
66,080
Total net after-tax cash inflows ..................................................................................................
Less initial cash outflow to purchase system..........................................................................
Excess of net after-tax cash inflows over initial cash outflow ...............................................
E22-5
(6)
Net
After-tax
Cash Inflows
(1) (2) (5)
$168,000
196,800
166,080
147,600
147,600
133,920
$960,000
600,000
$360,000
Chapter 22
22-5
22-6
Chapter 22
E22-6
(1)
(2)
(3)
(4)
Estimated
Taxable
Tax Liability
InflationTax
Income
With 40%
Adjusted Net
Depre(Loss)
Tax Rate
Year
Cash Inflows
ciation*
(1) (2)
40% (3)
1
$30,000
$40,000
$(10,000)
$(4,000)
2
40,000
64,000
(24,000)
(9,600)
3
50,000
38,400
11,600
4,640
4
60,000
23,000
37,000
14,800
5
70,000
23,000
47,000
18,800
6
80,000
11,600
68,400
27,360
7
60,000
0
60,000
24,000
Total net after-tax cash inflows........................................................
Less initial cash outflow to purchase system ...............................
Excess of net after-tax cash inflows over initial cash outflow .....
*
Year
1
2
3
4
5
6
MACRS 5-year
Recovery Rate
.200
.320
.192
.115
.115
.058
1.000
Depreciable
Basis
$200,000
200,000
200,000
200,000
200,000
200,000
(5)
Net
After-tax
Cash Inflows
(1) (4)
$ 34,000
49,600
45,360
45,200
51,200
52,640
36,000
$314,000
200,000
$114,000
Tax
Depreciation
$ 40,000
64,000
38,400
23,000
23,000
11,600
$200,000
Chapter 22
22-7
E22-7
(1)
(2)
(3)
(4)
(5)
Estimated
Taxable
Tax Liability
Net
Periodic
Tax
Income
With 40%
After-tax
Net Cash
Depre(Loss)
Tax Rate
Cash Inflows
Year
Inflows
ciation*
(1) (2)
40% (3)
(1) (4)
1
$10,000
$14,300
$(4,300)
$(1,720)
$ 11,720
2
15,000
24,500
(9,500)
(3,800)
18,800
3
20,000
17,500
2,500
1,000
19,000
4
25,000
12,500
12,500
5,000
20,000
5
25,000
8,900
16,100
6,440
18,560
6
25,000
8,900
16,100
6,440
18,560
7
25,000
8,900
16,100
6,440
18,560
8
20,000
4,500
15,500
6,200
13,800
9
15,000
0
15,000
6,000
9,000
10
10,000
0
10,000
4,000
6,000
Total net after-tax cash inflows ................................................................ $154,000
After-tax cash inflow from salvage at end of economic life:
Pretax cash inflow from salvage................................. $10,000
Less tax payable on sale at 40% tax rate...................
4,000
6,000
Total net after-tax cash inflows ................................................................ $160,000
Less initial cash outflow to purchase system .........................................
100,000
Excess of net after-tax cash inflows over initial cash outflow .............. $ 60,000
*
Year
1
2
3
4
5
6
7
8
MACRS 7-year
Recovery Rate
.143
.245
.175
.125
.089
.089
.089
.045
1.000
Depreciable
Basis
$100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
Tax
Depreciation
$ 14,300
24,500
17,500
12,500
8,900
8,900
8,900
4,500
$100,000
22-8
Chapter 22
Problems
P22-1
(1)
Year
1
2
3
4
5
6
Year
1
2
3
4
5
6
Periodic
Cash
Inflows
$19,000
22,000
24,000
18,000
15,000
10,000
$109,000
(1)
Depreciable
Basis of
Property
$60,000
60,000
60,000
60,000
60,000
60,000
(2)
8% Price-Level Adjustment
(1 + .08) = 1.080
(1 + .08)2 = 1.166
(1 + .08)3 = 1.260
(1 + .08)4 = 1.360
(1 + .08)5 = 1.469
(1 + .08)6 = 1.587
(2)
5-Year
Property
Recovery
Percentage
.200
.320
.192
.115
.115
.058
(3)
InflationAdjusted
Estimated
Cash
Inflows
(1) (2)
$ 20,520
25,652
30,240
24,480
22,035
15,870
$138,797
(3)
Tax
Depreciation
(1) (2)
$12,000
19,200
11,520
6,900
6,900
3,480
$60,000
(1)
(2)
(3)
(4)
(5)
Federal
Adjusted
Taxable
and
Estimate of
Tax
Income
State
Income
Net Cash
Depre(Loss)
Income
Tax
Year
Inflows
ciation
(1) (2)
Tax Rate
(3) (4)
1
$20,520
$12,000
$ 8,520
40%
$3,408
2
25,652
19,200
6,452
40%
2,581
3
30,240
11,520
18,720
40%
7,488
4
24,480
6,900
17,580
40%
7,032
5
22,035
6,900
15,135
40%
6,064
6
15,870
3,480
12,390
40%
4,956
Total estimated net after-tax cash inflows from project ..........................................................
Less initial cash outlay for machinery ......................................................................................
Excess of after-tax cash inflows from project over Initial cash outflow ...............................
P22-1 (Concluded)
(6)
Net
After-tax
Cash
Inflows
(1) (5)
$ 17,112
23,071
22,752
17,448
15,981
10,914
$107,278
60,000
$ 47,278
Chapter 22
22-9
22-10
Chapter 22
P22-2
Cost of new machine .......................................................................................
Trade-in allowance for old machine................................................................
Net cash outflow at beginning of project.......................................................
Tax basis of old machine traded in ................................................................
Tax basis of new machine ...............................................................................
$18,000
9,000
$ 9,000
8,000
$17,000
$20,000
16,400
$ 3,600
Year
1
2
3
4
5
Year
1
2
3
4
5
6
(1)
(2)
Original
Tax
Basis
of Old
Machine
$10,000
10,000
10,000
10,000
10,000
5-Year
Property
Recovery
Rate
.320
.192
.115
.115
.058
(1)
(2)
Original
Tax
Basis
of New
Machine
$17,000
17,000
17,000
17,000
17,000
17,000
5-Year
Property
Recovery
Rate
.200
.320
.192
.115
.115
.058
(3)
Tax
Depreciation
on Old
Machine
(1) (2)
$3,200
1,920
1,150
1,150
580
$8,000
(3)
Tax
Depreciation
on New
Machine
(1) (2)
$3,400
5,440
3,264
1,955
1,955
986
$17,000
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Additional
Annual
Tax
Cost
Increase
Increase
Allowable
Depreciation Savings
(Decrease)
(Decrease)
Net
Tax Depreciation
with New
With
in Taxable
Income
in Income
Cash
New
Old
Machine
New
Income
Tax
Tax
Inflow
Year Machine
Machine
(1) (2)
Machine
(4) (3)
Rate
(5) (6)
(4) (7)
1
$3,400
$3,200
$ 200
$3,600
$3,400
40%
$1,360
$ 2,240
2
5,440
1,920
3,520
3,600
80
40%
32
3,568
3
3,264
1,150
2,114
3,600
1,486
40%
594
3,006
4
1,955
1,150
805
3,600
2,795
40%
1,118
2,482
5
1,955
580
1,375
3,600
2,225
40%
890
2,710
6
986
0
986
3,600
2,614
40%
1,046
2,554
Total increase in periodic cash inflows ..................................................................................................
$16,560
Less initial cash outlay for new machine ...............................................................................................
9,000
Increase in cash inflows over initial cash outlay for new machine .....................................................
$ 7,560
(1)
P22-2 (Concluded)
Chapter 22
22-11
22-12
Chapter 22
P22-3
(1)
Year
1
2
3
4
(1)
(2)
Tax
Basis
of New
Tools
$2,500,000
2,500,000
2,500,000
2,500,000
3-Year
Property
Recovery
Rate
.333
.444
.148
.075
(3)
Tax
Depreciation
on New
Tools
(1) (2)
$ 832,500
1,110,000
370,000
187,500
$2,500,000
$1,600,000
$ 360,000
232,000
72,000
$ 664,000
$ 936,000
$3,868,000
2,500,000
$1,368,000
(6)
Net
After-tax
Cash
Inflows
(1) (5)
$ 894,600
1,005,600
709,600
636,600
561,600
$3,808,000
(2) Total after-tax cash inflows from making product (from part (1) above) ..........................
Initial cash outlay to purchase tools.....................................................................................
Excess of total net after-tax cash inflows over initial cost of capital project ..................
(2)
60,000
$3,868,000
(1)
(3)
(4)
(5)
Increase
Increase
Tax
(Decrease)
(Decrease)
Depreciation
in Taxable
Income
in Income
Cost
on New
Income
Tax
Taxes
Year
Savings
Tools
(1) (2)
Rate
(3) (4)
1
$936,000
$ 832,500
$ 103,500
40%
$ 41,400
2
936,000
1,110,000
(174,000)
40%
(69,600)
3
936,000
370,000
566,000
40%
226,400
4
936,000
187,500
748,500
40%
299,400
5
936,000
0
936,000
40%
374,400
Total periodic cash inflows from annual cost savings .......................................................
After-tax disposal value of specialized tools:
Cash inflow from salvage of tools ................................................................. $100,000
Less tax on salvage of tools ..........................................................................
40,000
Total after-tax cash inflows from making product...............................................................
P22-3 (Concluded)
Chapter 22
22-13
(1)
(2)
Year
1
2
3
4
5
6
7
8
(1)
Tax Basis
for
Depreciable
Property
$200,000
200,000
200,000
200,000
200,000
200,000
200,000
200,000
Estimated Estimated
Annual
Operating
Year Revenues Expenses
1 $100,000
$40,000
2
120,000
50,000
3
140,000
60,000
4
140,000
60,000
5
140,000
60,000
6
140,000
60,000
7
140,000
60,000
8
140,000
60,000
9
120,000
60,000
10 100,000
60,000
P22-4
(3)
Tax
Depreciation
Available
(1) (2)
$ 28,600
49,000
35,000
25,000
17,800
17,800
17,800
9,000
$200,000
Annual 6%
Inflation
Adjustment
(1 + .06) = 1.060
(1 + .06)2 = 1.124
(1 + .06)3 = 1.191
(1 + .06)4 = 1.262
(1 + .06)5 = 1.338
(1 + .06)6 = 1.419
(1 + .06)7 = 1.504
(1 + .06)8 = 1.594
(1 + .06)9 = 1.689
(1 + .06)10 = 1.791
Unadjusted
Cash
Inflows
(1) (2)
$60,000
70,000
80,000
80,000
80,000
80,000
80,000
80,000
60,000
40,000
(2)
7-Year
Property
Recovery
Rate
.143
.245
.175
.125
.089
.089
.089
.045
(4)
(3)
(5)
InflationAdjusted
Cash
Inflows
(3) (4)
$ 63,600
78,680
95,280
100,960
107,040
113,520
120,320
127,520
101,340
71,640
Annual
Fixed
Lease
Rentals
$20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
(6)
(7)
Pretax
Annual
Cash
Inflows
(5) (6)
$ 43,600
58,680
75,280
80,960
87,040
93,520
100,320
107,520
81,340
51,640
$779,900
22-14
Chapter 22
(1)
(2)
(3)
(4)
(5)
Increase
Increase
Pretax
(Decrease)
(Decrease)
Annual
Tax
in Taxable
Income
in Income
Cash
Depreciation
Income
Tax
Taxes
Year
Inflows
Available
(1) (2)
Rate
(3) (4)
1
$ 43,600
$28,600
$15,000
40%
$ 6,000
2
58,680
49,000
9,680
40%
3,872
3
75,280
35,000
40,280
40%
16,112
4
80,960
25,000
55,960
40%
22,384
5
87,040
17,800
69,240
40%
27,696
6
93,520
17,800
75,720
40%
30,288
7
100,320
17,800
82,520
40%
33,008
8
107,520
9,000
98,520
40%
39,408
9
81,340
0
81,340
40%
32,536
10
51,640
0
51,640
40%
20,656
Total after-tax cash inflows from proposed investment ..........................................................
Less initial investment cash outflow .........................................................................................
Excess of total after-tax cash inflows over initial cash outflow.............................................
P22-4 (Concluded)
After-tax
Cash
Inflows
(1) (5)
$ 37,600
54,808
59,168
58,576
59,344
63,232
67,312
68,112
48,804
30,984
$547,940
200,000
$347,940
(6)
Chapter 22
22-15
(1)
(2)
(3)
(4)
Contribution
Unit
Unit
Margin
Estimated
Sales
Variable
Per Unit
Year
Demand
Price
Cost
(2) (3)
1
1,000
$11
$5
$6
2
1,000
11
5
6
3
1,000
11
5
6
4
1,000
11
5
6
5
1,000
11
5
6
6
1,000
11
5
6
7
1,000
11
5
6
Total periodic cash inflows .....................................................
(1)
P22-5
(5)
Net Cash
Inflow
From
Sales
(1) (4)
$ 6,000
6,000
6,000
6,000
6,000
6,000
6,000
$42,000
(6)
Cost
Savings
From
Reduced
Maintenance
$1,500
1,200
900
600
300
0
0
$4,500
Periodic
Net Cash
Inflows
(5) + (6)
$ 7,500
7,200
6,900
6,600
6,300
6,000
6,000
$46,500
(7)
22-16
Chapter 22
Chapter 22
22-17
P22-5 (Continued)
Year
1
2
3
4
5
6
7
Recovery
Year
1
2
3
4
5
6
(1)
(2)
Periodic
Net Cash
Inflows
$ 7,500
7,200
6,900
6,600
6,300
6,000
6,000
$46,500
Annual 10%
Price-Level
Adjustment
(1 + .10) = 1.100
(1 + .10)2 = 1.210
(1 + .10)3 = 1.331
(1 + .10)4 = 1.464
(1 + .10)5 = 1.611
(1 + .10)6 = 1.772
(1 + .10)7 = 1.949
(1)
Depreciable
Basis of
Machine
$40,000
40,000
40,000
40,000
40,000
40,000
(2)
5-Year
Property
Recovery
Percentage
.200
.320
.192
.115
.115
.058
(3)
Tax
Depreciation
(1) (2)
$ 8,000
12,800
7,680
4,600
4,600
2,320
$40,000
(3)
Adjusted
Estimate of
Net Cash
Inflows
(1) (2)
$ 8,250
8,712
9,184
9,662
10,149
10,632
11,694
$68,283
(1)
(2)
(3)
7,016
$63,984
(6)
Net
After-tax
Cash
Inflows
(1) (5)
$ 8,150
10,347
8,582
7,637
7,929
7,307
7,016
$56,968
(2) Total after-tax cash inflows from the capital expenditure ..................................................
Less original investment cash outflow.................................................................................
Excess of total after-tax cash inflows over initial investment............................................
$63,984
40,000
$23,984
**The cash inflow from the salvage sale at the end of the project would be fully taxable because the tax
basis of the machine would be zero (i.e., the machine was fully depreciated). Thus, the tax on the cash
inflow from salvage would be $4,678 ($11,694 40%).
*$6,000 estimated salvage value 1.949 inflation adjustment (10% for 7 years)
(4)
(5)
Federal
Income
Adjusted
Taxable
and
Tax
Estimate of
Income
State
Payment
Net Cash
Tax
(Loss)
Income
(Reduction)
Year
Inflows
Depreciation
(1) (2)
Tax Rate
(3) (4)
1
$ 8,250
$ 8,000
$ 250
40%
$ 100
2
8,712
12,800
(4,088)
40%
(1,635)
3
9,184
7,680
1,504
40%
602
4
9,662
4,600
5,062
40%
2,025
5
10,149
4,600
5,549
40%
2,220
6
10,632
2,320
8,312
40%
3,325
7
11,694
0
11,694
40%
4,678
Total after-tax cash inflow from sales and cost savings ....................................................
After-tax cash inflow from salvage at end of economic life:
Cash inflow from salvage (adjusted for expected 10% inflation)* ............. $11,694
Tax payable on salvage sale**........................................................................
4,678
Total net after-tax cash inflows from the capital expenditure ............................................
P22-5 (Concluded)
22-18
Chapter 22
Chapter 22
22-19
P22-6
Year
1
2
3
4
5
6
7
8
9
10
Year
1
2
3
4
5
6
7
8
(1)
(2)
Unadjusted
Cash
Inflows
$15,000
20,000
25,000
25,000
25,000
25,000
25,000
20,000
15,000
10,000
Annual 10%
Price-Level
Adjustment
(1 + .10) = 1.100
(1 + .10)2 = 1.210
(1 + .10)3 = 1.331
(1 + .10)4 = 1.464
(1 + .10)5 = 1.611
(1 + .10)6 = 1.772
(1 + .10)7 = 1.949
(1 + .10)8 = 2.144
(1 + .10)9 = 2.358
(1 + .10)10 = 2.594
(1)
Tax
Basis of
Depreciable
Property
$100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
(2)
7-Year
Property
Recovery
Rate
.143
.245
.175
.125
.089
.089
.089
.045
(3)
Tax
Depreciation
Available
(1) (2)
$ 14,300
24,500
17,500
12,500
8,900
8,900
8,900
4,500
$100,000
(3)
InflationAdjusted
Cash
Inflows
(1) (2)
$16,500
24,200
33,275
36,600
40,275
44,300
48,725
42,880
35,370
25,940
(1)
(2)
(3)
(4)
(5)
InflationIncrease
Increase
Adjusted
(Decrease)
(Decrease)
Annual
Tax
in Taxable
Income
in Income
Cash
Depreciation
Income
Tax
Taxes
Year
Inflows
Available
(1) (2)
Rate
(3) (4)
1
$16,500
$14,300
$ 2,200
40%
$ 880
2
24,200
24,500
(300)
40%
(120)
3
33,275
17,500
15,775
40%
6,310
4
36,600
12,500
24,100
40%
9,640
5
40,275
8,900
31,375
40%
12,550
6
44,300
8,900
35,400
40%
14,160
7
48,725
8,900
39,825
40%
15,930
8
42,880
4,500
38,380
40%
15,352
9
35,370
0
35,370
40%
14,148
10
25,940
0
25,940
40%
10,376
Total periodic after-tax cash inflows ............................................................................................
After-tax cash inflow from salvage:
Inflation-adjusted cash inflow from salvage ($2,000 2.594) ...........................
$5,188
Tax payable on salvage ($5,188 40%)...............................................................
2,075
Total after-tax cash inflows from project .....................................................................................
Less initial investment cash outflow............................................................................................
Excess of total after-tax cash inflows over initial investment...................................................
P22-6 (Concluded)
3,113
$251,952
100,000
$151,952
After-tax
Cash
Inflows
(1) (5)
$ 15,620
24,320
26,965
26,960
27,725
30,140
32,795
27,528
21,222
15,564
$248,839
(6)
22-20
Chapter 22
Savings
from
Reduced
Labor
$15,000
25,000
35,000
35,000
35,000
35,000
Year
1
2
3
4
5
6
(1)
$25,000
30,000
35,000
35,000
35,000
35,000
(2)
Savings
from
Reduced
Machine
Setup Time
$20,000
25,000
30,000
30,000
30,000
30,000
Savings
from
Reduced
Inventory
(3)
$ 60,000
80,000
100,000
100,000
100,000
100,000
(4)
Total
Periodic
Savings
from CIM
(1) + (2) + (3)
$10,000
10,000
10,000
10,000
10,000
10,000
(5)
Additional
Maintenance
Cost
with CIM
$50,000
70,000
90,000
90,000
90,000
90,000
(6)
Net
Periodic
Savings
with CIM
(4) (5)
(1 + .06)
(1 + .06)2
(1 + .06)3
(1 + .06)4
(1 + .06)5
(1 + .06)6
=
=
=
=
=
=
(6)
$53,000
78,680
107,190
113,580
120,420
127,710
(8)
InflationAdjusted
Periodic
Savings
(6) (7)
1,200,000
$(359,652)
Periodic Net
After-tax
Cash Inflows
(1) (5)
$ 127,800
191,208
157,114
130,148
134,252
99,826
$ 840,348
1.060
1.124
1.191
1.262
1.338
1.419
Annual 6%
Inflation
Adjustment
(7)
(1)
(2)
(3)
(4)
(5)
InflationAdjusted
Tax
Taxable
Tax
Periodic
Depreciation
Income
Effective
Liability
Savings
and
(Loss)
Tax
(Refund)
Year
with CIM
Amortization*
(1) (2)
Rate
(3) (4)
1
$ 53,000
$240,000
$(187,000)
40%
$ (74,800)
2
78,680
360,000
(281,320)
40%
(112,528)
3
107,190
232,000
(124,810)
40%
(49,924)
4
113,580
155,000
(41,420)
40%
(16,568)
5
120,420
155,000
(34,580)
40%
(13,832)
6
127,710
58,000
69,710
40%
27,884
Total annual after-tax savings from investment in CIM...............................................................
Less initial investment:
Equipment cost...............................................................................................
$1,000,000
Software cost ..................................................................................................
200,000
Excess of cost of CIM system over after-tax savings .................................................................
(1)
P22-7
Chapter 22
22-21
Year
1
2
3
4
5
6
(2)
Rate for
MACRS
5-year
Property
.200
.320
.192
.115
.115
.058
(1)
Recovery
Property
Tax Basis
$1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
Tax
Depreciation
(1) (2)
$ 200,000
320,000
192,000
115,000
115,000
58,000
$1,000,000
(3)
Software
Tax Basis
$200,000
200,000
200,000
200,000
200,000
200,000
(4)
5-year
Straight-line
Amortization
Rate
.200
.200
.200
.200
.200
.000
(5)
Tax
Amortization
(4) (5)
$ 40,000
40,000
40,000
40,000
40,000
0
$200,000
(6))
(7)
Total Tax
Amortization
and
Depreciation
(3) + (6)
$ 240,000
360,000
232,000
155,000
155,000
58,000
$1,200,000
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
InflationInflationTax
Periodic
Adjusted
Adjusted
Net
DepreNet
Periodic
Lost Periodic
Periodic
ciation
Taxable
Tax
After-tax
Savings
Contribution
Savings
and
Income
Effective Liability
Cash
with CIM
Margin Saved
with CIM
Amor(Loss)
Tax
(Refund)
Inflows
Year from Part (1)
with CIM**
(1) + (2)
tization*
(3) (4)
Rate
(5) (6)
(3) (7)
1 $ 53,000
$212,000
$265,000 $240,000
$ 25,000
40%
$ 10,000 $ 255,000
2
78,680
224,800
303,480
360,000
(56,520)
40%
(22,608)
326,088
3
107,190
238,200
345,390
232,000
113,390
40%
45,356
300,034
4
113,580
252,400
365,980
155,000
210,980
40%
84,392
281,588
5
120,420
267,600
388,020
155,000
233,020
40%
93,208
294,812
6
127,710
283,800
411,510
58,000
353,510
40%
141,404
270,106
Total annual after-tax savings from investment in CIM...................................................................... $1,727,628
Less initial investment for equipment and software (from above) ...................................................
1,200,000
Excess of after-tax savings over cost of CIM system with new information................................... $ 527,628
(2)
P22-7 (Continued)
22-22
Chapter 22
Chapter 22
22-23
P22-7 (Concluded)
**
Year
1
2
3
4
5
6
(1)
(2)
Lost Periodic
Contribution
Margin Saved
with CIM
$200,000
200,000
200,000
200,000
200,000
200,000
Annual 6%
Inflation
Adjustment
(1 + .06) = 1.060
(1 + .06)2 = 1.124
(1 + .06)3 = 1.191
(1 + .06)4 = 1.262
(1 + .06)5 = 1.338
(1 + .06)6 = 1.419
(3)
InflationAdjusted
Lost Periodic
Contribution
Margin Saved
with CIM
(1) (2)
$212,000
224,800
238,200
252,400
267,600
283,800
22-24
Chapter 22
CASES
C22-1
Some of the factors that affect the decision of whether or not to delay the investment in new cleaning equipment are given below. Each factor can have two sides
(i.e., delay versus no delay) depending upon the circumstances involved.
(a) Unemployment, inflation rate, and business conditions in general.
Business outlook improvingdo not delay.
Business outlook deterioratingdelay.
All of these factors affect the climate for business and should be considered.
(b) Difficulty associated with acquisition and installation of equipment and
training of operators.
Great difficultydo not delay.
Little difficultydelay.
The greater the lead time involved, the sooner the equipment should be
acquired so that it is ready when needed.
(c) Extent of operating efficiency improvements.
Greatdo not delay.
Littledelay.
The greater the efficiency, the less it should be delayed because costs will
be saved even though volume does not increase.
(d) Inflation rate in cost of equipment.
Cost of equipment not expected to increase drasticallydelay.
Cost of equipment expected to increase drasticallydo not delay.
Company wants to minimize its initial cost outlay.
(e) Dependability of present equipment and likelihood of breakdowns.
Dependability is gooddelay.
Dependability is not gooddo not delay.
Company could defer, or have to go ahead with investment due to condition
of present equipment.
(f) Chance for technological advances in equipment.
Gooddelay.
No chancedo not delay.
If there is a chance that technological advances will develop in the design of
the equipment, the company might want to take advantage of the new
design.
(g) Ability to obtain market advantage by providing better quality service at
same or lower price.
Gooddo not delay.
Poor/neutraldelay.
Better service means more customers or justifies higher rates.
Chapter 22
22-25
C22-1 (Concluded)
(h) Competitors plans for obtaining similar equipment and achieving market
advantage.
High probabilitydo not delay.
Low probabilitydelay.
Company wants to maintain competitive advantage or meet competition.
(i) Ability to predict timing and increased volume of demand from new or existing customers.
Goodbetter quality of decision; could defer switch longer.
Lowless reliable criteria for decision.
The better a company is able to predict new business, the more certain It can
be of its decision and, possibly, the longer it can wait to make a change.
C22-2
Knight is probably correct in her assessment that the proposed capital investment framework grants too much freedom to the divisions. Neoglobes long-run
performance depends on its capital investments. While divisions must have
some responsibility for capital investments for the proposed organization structure to be effective, corporate management must maintain adequate control to
direct the future course of the firm. Under the proposed framework, division
management controls a substantial portion of the capital budget, and in some
years, few funds would be available for investment by corporate management.
The present proposal would reduce corporate managements ability to diminish
a product line, and it also would impair managements ability to have adequate
funds available for investment in new businesses.
Capital investment procedures should involve both division and corporate
managements in such a way that division management still should be able to
influence the future direction of the firm. Such procedures might include classification of capital projects into groups, some of which could be approved by division management without corporate management study.
An alternative to the Neoglobe capital investment program might have the following features:
(a) All proposed investment projects would be classified according to their
naturereplacement, cost savings, expansion.
(b) Replacement and cost savings projects could be adopted by division management alone, without approval of corporate management, provided an
individual project did not exceed a specified dollar limit and the total of such
projects did not exceed another specified dollar limit. The dollar limits would
reflect the nature and size of each divisions operations.
(c) All expansion projects, or other projects that exceed the dollar limit, would
be submitted to corporate management for evaluation and approval.
22-26
Chapter 22
C22-3
The process of planning for and evaluating long-term commitments of resources
is normally referred to as capital expenditure planning, evaluating, and control,
or capital budgeting. The capital budget is distinct in that it focuses on the longterm effect of resources committed. Its primary objectives are to provide management with (1) a formal process to chart its future course, (2) a means of
ranking and selecting among alternative resource commitments to maximize
return on investment, and (3) a program for ongoing evaluation of extant
resource commitments.
Any significant resource commitment is viewed as a project. Hence, the capital budget is composed of projects, some of which are in process and some of
which are proposed. Each project affects significant periods of time in the ongoing life of a company. A project often involves the evaluation of alternatives and
the purchase of such assets as property, plant, and equipment. It should also
consider, however, any proposal or program that requires a significant resource
commitment over an extended period, such as the development of new products,
opening new markets, and the design and development of major computer programs.
Once resources have been committed to a particular project, the project
requires ongoing evaluation; i.e., are the projects objectives being met? If not, it
needs to be evaluated in terms of whether the project should be retained as is,
modified if possible, or abandoned.
McAngus can make significant use of capital expenditure planning, evaluating, and control. At the division level, projects will need to be defined in terms of
those elements of the plant, or operation of the division, over which the manager
has control. On the basis of the facts given, the division manager has authority
to operate his or her plant essentially as if it were an independent company.
Hence, anything affecting operations, which has required or will require significant resource commitment over a significant period of time, should form an integral part of that divisions capital budget. At the top management level, the
president may view each division as a project, particularly for evaluation purposes. The other described activities of top management (investigating and evaluating such things as new markets, etc.) are projects in the capital budgeting
sense. These and other new proposals may be defined, analyzed, and evaluated
using a variety of available techniques.
C22-4
(1)
Arnetts revision of the first proposal described in the case can certainly be considered a violation of the Standards of Ethical Conduct. Arnett discarded the reasonable projections and estimates after being questioned and pressured by
Earle, and used figures that have only a remote chance of occurring. By doing
this, Arnett violated the standard of objectivity (which requires that the management accountant communicate information fairly and objectively and disclose
fully relevant information that could reasonably be expected to influence an
Chapter 22
(2)
(3)
(4)
22-27
22-28
Chapter 22
C22-5
(1)
Referring to the specific standards in the IMAs Standards of Ethical Conduct for
Practitioners of Management Accounting and Financial Management, the conduct of H. Dodge and G. Watson is unethical as discussed below:
(a) H. Dodges first revision of the proposal for the warehouse conversion was
unethical because Dodges actions violate the following standards:
Competence. Although the estimates used in the analysis are based on
managements judgment, Dodges action in changing reasonable estimates
to remote assumptions is unethical. Management accountants have the
responsibility to prepare complete and clear reports and recommendations
after appropriate analyses of relevant and reliable information.
Integrity. Dodge has the responsibility to avoid conflicts of interest, refrain
from subverting the attainment of the organizations legitimate and ethical
objectives (profitability), and refrain from engaging in or supporting any
activity that would discredit the profession.
Objectivity. Dodge has the responsibility to communicate information fairly
and objectively and to disclose fully all relevant information that can influence an intended users understanding.
(b) G. Watsons conduct in giving H. Dodge specific instructions on preparing
the second revision of the proposal is unethical because Watsons conduct
violates the following specific standards:
Competence. Watson has the responsibility to perform his professional
duties in accordance with relevant technical standards, such as using conservatism and realistic estimates in the net present value analysis.
Management accountants should prepare complete and clear reports and
recommendations after appropriate analyses of relevant and reliable information.
Confidentiality. Watson should refrain from using or appearing to use confidential information acquired in the course of his work for unethical advantage for personal gain (saving on commuting time and costs).
Integrity. Watson has the responsibility to advise all parties of any potential
conflict of interest. Watson should refuse any favor (the warehouse reducing
his commuting time) that would appear to influence his actions. Watson
should communicate unfavorable as well as favorable information and professional judgments and opinions.
Objectivity. Watson has the responsibility to disclose fully all relevant information that can influence an intended users understanding of the analysis.
Chapter 22
22-29
C22-5 (Concluded)
(2)
C22-6
(1)
By referring to the IMAs Standards of Ethical Conduct and taking into consideration the specific standards of competence, confidentiality, integrity, and objectivity, L. Forrest should evaluate B. Rollands directives as follows:
Competence. Forrest has a responsibility to present complete and clear reports
and recommendations after appropriate analysis of relevant and reliable information. Rolland does not wish the report to be complete or clear, and has provided some information that is not totally reliable.
Confidentiality. Forrest should not disclose confidential information outside of
the organization; but it also appears that Rolland wants to refrain from disclosing information to the board of directors that it should know about.
Integrity. Rolland is engaging in activities that could prejudice him from carrying
out his duties ethically. In evaluating Rollands directive as it affects Forrest,
Forrest has an obligation to communicate unfavorable as well as favorable information and professional judgments or opinions.
22-30
Chapter 22
By referring to the Standards of Ethical Conduct, L. Forrest should take the following steps to resolve this situation:
(a) Forrest should first investigate and see if IDI has an established policy for
resolution of ethical conflicts and, if so, follow those procedures.
(b) If this policy does not resolve the ethical conflict, the next step would be for
Forrest to discuss the situation with his supervisor, Rolland, and see if he
can obtain resolution. One possible solution may be to present a base
case and sensitivity analysis of the investment. Forrest should make it clear
to Rolland that he has a problem and is seeking guidance.
(c) If Forrest cannot obtain a satisfactory resolution with Rolland, Forrest could
take the situation up to the next layer of management, and inform Rolland
that is being done. If this is not satisfactory, Forrest should progress to the
next level, and eventually to all higher levels of management until the issue
is resolved (i.e., the president, audit committee, or board of directors).
(d) Since Rolland has instructed him not to discuss the situation with anyone
else at IDI, Forrest may want to have a confidential discussion with an objective advisor to clarify relevant concepts and obtain an understanding of possible courses of action. Forrest may want to talk to a close professional
friend or the IMA Ethics Hotline for this purpose.
(e) If Forrest cannot satisfactorily resolve the situation within the organization,
he may resign from the company and submit an informative memo to an
appropriate person in IDI (i.e., the president, audit committee, or board of
directors).
(f) Forrest may consult with personal legal counsel.