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Exam 25: Capital Budgeting and Managerial Decisions

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Question 71

True/False

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Relevant benefits refer to the additional or incremental revenue generated by selecting a particular course or action over another.

A) True
B) False

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Question 72

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Ahngram Corp. has 1,000 defective units of a product that cost $3 per unit in direct costs and $6.50 per unit in indirect cost when produced last year. The units can be sold as scrap for $4 per unit or reworked at an additional cost of $2.50 and sold at full price of $12. The incremental net income (loss) from the choice of reworking the units, versus selling them as scrap, would be:

A) $2,500 higher if the units are reworked.
B) $5,500 higher if the units are reworked.
C) $4,000 higher if the units are reworked.
D) $2,500 lower if the units are reworked.
E) $12,000 higher if the units are reworked.

F) B) and E)
G) C) and D)

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Question 73

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A company can buy a machine that is expected to have a three-year life and a $30,000 salvage value. The machine will cost $1,800,000 and is expected to produce a $200,000 after-tax net income to be received at the end of each year. If a table of present values of $1 at 12% shows values of 0.8929 for one year, 0.7972 for two years, and 0.7118 for three years, what is the net present value of the cash flows from the investment, discounted at 12%?

If net present values are used to evaluate two investments that have equal costs and equal total cash flows, the one with more cash flows in the early years has the higher net present value.

Listmann Corp. processes four different products that can either be sold as is or processed further. Listed below are sales and additional cost data: $\begin{array}{|l|r|r|r|}\hline & \text { Sales Valus } & \text { Add'tional } & \text { Sales Value ofter further} \\ \text { Prgeduct } & \text { with ne further } & \text { Procesaing } & \text { processing } \\& \text {Processing}& \text {Costs}\\\hline \text { Premier } & \$ .350 & \$ 900 & \$ 2,700 \\\hline \text { Deluxe } & 450 & 225 & 630 \\\hline \text { Super } & 900 & 450 & 1.800 \\\hline \text { Bssic } & 90 & 45 & 180 \\\hline\end{array}$ Which product(s) should not be processed further?

Minor Electric has received a special one-time order for 1,500 light fixtures (units) at $5 per unit. Minor currently produces and sells 7,500 units at $6.00 each. This level represents 75% of its capacity. Production costs for these units are $4.50 per unit, which includes $3.00 variable cost and $1.50 fixed cost. To produce the special order, a new machine needs to be purchased at a cost of $1,000 with a zero salvage value. Management expects no other changes in costs as a result of the additional production. Should the company accept the special order?

If two projects have the same risks, the same payback periods, and the same initial investments, they are equally attractive.

Wheeler Company can produce a product that incurs the following costs per unit: direct materials, $10; direct labor, $24, and overhead, $16. An outside supplier has offered to sell the product to Axle for $45. If Wheeler buys from the supplier, it will still incur 45% of its overhead cost. Compute the net incremental cost or savings of buying.

In using a capital budgeting method that takes the time value of money into consideration, management must consider a hurdle rate in making its decisions. What is a hurdle rate? What factors does management have to consider in selecting a hurdle rate?

Bannister Co. is thinking about having one of its products manufactured by an outside supplier. Currently, the cost of manufacturing 1,000 units follows: $\begin{array} { l r } \text { Direct material } & \$ 45,000 \\\text { Direct labor } & 30,000 \\\text { Factory overhead (30\% is variable) } & 98,000\end{array}$ If Bannister can buy 1,000 units from an outside supplier for $100,000, it should:

Minor Electric has received a special one-time order for 1,500 light fixtures (units) at $5 per unit. Minor currently produces and sells 7,500 units at $6.00 each. This level represents 75% of its capacity. Production costs for these units are $4.50 per unit, which includes $3.00 variable cost and $1.50 fixed cost. To produce the special order, a new machine needs to be purchased at a cost of $1,000 with a zero salvage value. Management expects no other changes in costs as a result of the additional production. Should the company accept the special order?

The following present value factors are provided for use in this problem. $\begin{array} { | l | l | l | } \hline \text { Periods } & \text { Present value of } \mathbf { \$ 1 } \text { at } \mathbf { 8 \% } & \text { Present value of an annuity of } \mathbf { \$ 1 } \text { at } \mathbf { 8 \% } \\\hline 1 & 0.9259 & 0.9259 \\\hline 2 & 0.8573 & 1.7833 \\\hline 3 & 0.7938 & 2.5771 \\\hline 4 & 0.7350 & 3.3121 \\\hline\end{array}$ Cliff Co. wants to purchase a machine for $40,000, but needs to earn an 8% return. The expected year-end net cash flows are $12,000 in each of the first three years, and $16,000 in the fourth year. What is the machine's net present value?

Markson Company had the following results of operations for the past year: $\begin{array} { | l | l | l | } \hline \text { Sales } ( 8,000 \text { units at } \$ 20 ) & \$ 160,000 & \\\hline \text { Variable manufacturing costs } & \$ 86,000 & \\\hline \text { Fixed manufacturing costs } & 15,000 & \\\hline \text { Variable selling and administrative expenses } & 12,000 & \\\hline \text { Fixed selling and administrative expenses } & 20,000 & ( 133,000 ) \\\hline \text { Operating income } & & \$ 27,000 \\\hline\end{array}$ A foreign company whose sales will not affect Markson's market offers to buy 2,000 units at $14 per unit. In addition to existing costs, selling these units would increase fixed overhead by $1,600 for the purchase of special tools. Markson's annual productive capacity is 12,000 units. If Markson accepts this additional business, its profits will:

A company produces three different products that all require processing on the same machines. There are only 27,000 machine hours available in each year. Production information for each product is: $\begin{array} { l | r | l | l } & \underline { \mathrm { A } } & \underline { \mathrm { B } } & \underline { \mathrm { C } } \\\hline \text { Sales price per unit } & \$ 20.00 & \$ 38.00 & \$ 35.00 \\\hline \text { Variable costs per unit } & \$ 12.00 & \$ 26.00 & \$ 17.00 \\\hline \text { Machine hours necessary to produce one unit } & 2.5 & 4.0 & 4.50\end{array}$ Required: (1) Determine the preferred sales mix if there are no market constraints on any of the products. (2) Determine the preferred sales mix if the demand is limited to 5,000 units for each product. (3) Determine the preferred sales mix if the demand is limited to 3,000 units for each product.

A company has the choice of either selling 600 defective units as scrap or rebuilding them. The company could sell the defective units as they are for $2.00 per unit. Alternatively, it could rebuild them with incremental costs of $0.60 per unit for materials, $1.00 per unit for labor, and $0.80 per unit for overhead, and then sell the rebuilt units for $5.00 each. - What is the amount of incremental income (loss) from rebuilding?

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and be depreciated over a six-year period with no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the accounting rate of return for this machine? $\begin{array}{llr} \text { Sales } &&\$90,000\\ \text { Costs:} &\\ \text { Manufacturing } &\$52,000\\ \text { Depreciation on machine } &4,000\\ \text {Selling and administrative expenses } &30,000&(86,000) \\ \text {Income before taxes } &&\$4,000\\ \text {Income tax (50 \%) } &&(2,000) \\ \text {Net income } &&\$2,000\end{array}$

A sunk cost will change with a future course of action.

A company has the choice of either selling 600 defective units as scrap or rebuilding them. The company could sell the defective units as they are for $2.00 per unit. Alternatively, it could rebuild them with incremental costs of $0.60 per unit for materials, $1.00 per unit for labor, and $0.80 per unit for overhead, and then sell the rebuilt units for $5.00 each. - What is the amount of incremental revenue from rebuilding?

A company inadvertently produced 6,000 defective portable radios. The radios cost $10 each to be manufactured. A salvage company will purchase the defective units as they are for $8 each. The production manager reports that the defects can be corrected for $4.50 per unit, enabling the company to sell them at the regular price of $15.00. The repair operations would not affect other production operations. Prepare an analysis that shows which action should be taken.

A company has just received a special, one-time order for 1,000 units. Producing the order will have no effect on the production and sales of other units. The buyer's name will be stamped on each unit, at a cost of $1.50 per unit. Normal cost data, excluding stamping, follows: Direct materials…………………………… $ 10 per unit Direct labor……………………………….. 16 per unit Variable overhead………………………… 4 per unit Allocated fixed overhead…………………. 12 per unit Allocated fixed selling expense…………… 8 per unit Prepare an analysis that indicates the selling price per unit this company will require to earn $3,000 on the order.