Actg411 1st Sem 2016-2017 Long Quiz Long Run Decisions

Problem

1. Each of the following scenarios are independent. Assume that all cash flows are after-tax cash flows.
a. Moore Company is investing $120,000 in a project that will yield a uniform series of cash inflows over the
next 4 years.
b. DVD Plus has decided to invest in some new electronic equipment. The equipment will have a 3-year life
and will produce a uniform series of cash savings. The NPV of the equipment is $1,750, using a discount rate
of 8%. IRR is 12%
c. A new lathe costing $60,096 will produce savings of $12,000 per year
d. The NPV of a project is $3,927. The project has a life of 4 years and produces the following cash flows:

Year Cash flows

1 $10,000
2 $12,000
3 $15,000
4 ?
The cost of the project is two times the cash flow produced in Year 4. The discount rate is 10%

Required:
1. If the internal rate of return is 14% for Moore Company, how much cash inflow per year can be expected?
(5pts)
2. Determine the investment and the amount of cash savings realized each year for DVD Plus (10 pts)
3. For Scenario c, how many years must the lathe last if an IRR of 18% is realized? (5 pts)
4. For Scenario d, find the cost of the project and the cash flow for Year 4. (10 pts)
2. Wayward, Inc. is contemplating the purchase of a new piece of equipment for expansion. This acquisition
would alleviate $8,000 per year in rental costs for the current machine. The following information pertains to
the new equipment:

Initial cost of proposed new equipment $156,000

Estimated useful life 8 years
Estimated disposal value at end of useful life $20,000

Elco estimates the new equipment will cause revenues to increase from the current level of $300,000 to
$360,000 per year. Cash operating expenses related to the increase in revenue are expected to be $24,000 per
year. Elco uses straight-line depreciation. Elcos required rate of return is 10%, and its income tax rate is 30%.
The current machine has a zero book value and a zero salvage value. Calculate the annual incremental after
tax operating cash flows if the new equipment is purchased. (5 pts)
3. Dark Bader is considering investing $20,000 in a project with the following annual cash revenues and
expenses:
Cash Revenues Cash Expenses
Year 1 $ 8,000 $ 8,000
Year 2 $ 12,000 $ 8,000
Year 3 $ 15,000 $ 9,000
Year 4 $ 20,000 $10,000
Year 5 $ 20,000 $10,000
Depreciation will be $4,000 per year.
 a. What is accounting rate of return on the investment? (10 pts)

Essay

4. Which model is better for independent projects - net present value or internal rate of return? For mutually
exclusive projects? Explain your reasoning for each case. (6 pts)
Actg411 1st Sem 2016-2017 Long Quiz Long Run Decisions
Answer Section

PROBLEM

1. ANS:
Refer to Excel File

PTS: 30
2. ANS:
Increase in revenues +$60,000
Increase in cash operating expenses (24,000)
Reduction of rental costs +8,000
Depreciation expense (17,000)
Income before taxes 27,000
Income tax expense (8,100)
Net income 18,900
Add back non-cash items: depreciation +17,000
Cash flows from operations $35,900

PTS: 5
3. ANS:
Refer to Excel File

PTS: 1

ESSAY

4. ANS:
For independent projects, both net present value and internal rate of return will yield the same decision. If the
net present value is positive, then the internal rate of return is above the minimum required amount. However,
for competing (mutually exclusive) projects, the situation is different, since the two models can signal
different results. NPV differs from IRR in two significant ways. First, NPV assumes that each cash inflow
received is reinvested at the required rate of return, while IRR assumes that the cash inflow in reinvested at
the project's own internal rate of return. This may not be realistic. Second, NPV is a dollar measure while IRR
is not. Thus, a "better" project in terms of IRR may yield less profit over the life of the project than one with a
positive NPV but a lower IRR. As a result, for competing projects, it is usually better to use NPV.

PTS: 1