Quentin owns a small retail ice cream parlor. He is considering expanding the business and has two alternatives.
1. Involves purchasing a machine that would enable him to offer frozen yogurt to customers. The machine would cost $4,050 and has an expected useful life of three years with no salvage value. Additional annual cash revenues and cash operating expenses associated with selling yogurt are expected to be $2,970 and $450, respectively.
2. Alternatively, he could purchase for $5,040 the equipment necessary to serve cappuccino. That equipment has an expected useful life of four years and no salvage value. Additional annual cash revenues and cash operating expenses associated with selling cappuccino are expected to be $4,140 and $1,215, respectively. Income before taxes earned by the ice cream parlor is taxed at an effective rate of 20%.
a. Determine the payback period and unadjusted rate of return (use average investment) for each alternative.
b. Indicate which investment alternative you would recommend. Explain your choice.
Finance: Payment, NPV, IRR, Max Price, Flexible Budget, Performance
Matching. Select the term from the list provided that bests matches each of the following definitions or descriptions. Put the number of the term in the answer column.
Your Answer Definition or Description Term
A. The concept that recognizes that the present value of an opportunity to receive one dollar in the future is less than one dollar 1. Accumulated conversion factors
B. Annuity with the cash flows occurring at the end of each period 2. Annuity
C. Paid to investors and creditors for the use of their assets 3. Capital investments
D. Review conducted to determine whether a project actually generated the results that were originally expected 4. Cost of capital
E. Factors used to convert a series of future cash inflows into their present value equivalent 5. Internal rate of return
F. The rate that produces a net present value of zero for an investment in a capital project 6. Minimum rate of return
G. Purchase of long term operational assets that involves a long term commitment of funds 7. Net present value method
H. Technique that evaluates investment opportunities by determining the length of time necessary to recover the initial net investment . Ordinary annuity
I. Measure of profitability computed by dividing the average incremental increase in annual net income by the average investment cost . Payback method
J. An equal series of cash flows received over equal intervals of time at a constant rate of return 10. Postaudit
K. Rate of return required to persuade a company to accept an investment opportunity 11. Time value of money
L. Evaluation technique in which future cash flows are discounted back to present value equivalents, from which the cost of the investment is subtracted 12. Unadjusted rate of return
Bigtime Video is considering installing tanning beds in its video rental stores. The beds cost $200,000 and have an estimated six-year useful life. Ignore income taxes. The following pro forma income statement is provided:
Tanning bed revenue $ 86,000
Bulbs, supplies, etc. $20,000
Maintenance 6,000 60,000
Net income $ 26,000
1) Bigtime Video would like to recoup its original investment in less than five years. Compute the payback period for the tanning bed investment. Would you recommend that the beds be purchased? Why or why not?
2) Bigtime Video's cost of capital is 12%. Compute the unadjusted rate of return on the original investment. Would you recommend that the beds be purchased? Why or why not?
Brady Company is considering the purchase of a new high-speed machine for its factory. The machine will cost $150,000 and will save the company $40,000 per year in cash operating costs. The machine has an estimated useful life of five years and no expected salvage value. The company's cost of capital is 14%.
1) Compute the net present value of this investment.
2) What is the maximum amount that Brady should be willing to pay for the machine?
3) What are the minimum annual cash savings that will make the machine acceptable on a net present value basis if the purchase price is $150,000?
Caroline Farr is manager of a production department of Helling Company. Her department makes one product; the following information for her department was accumulated for 2012:
Static Budget Actual Results
Number of units 100,000 97,000
Direct materials cost $800,000 $792,000
Direct labor cost $400,000 $380,000
Variable manufacturing overhead $200,000 $199,000
Fixed manufacturing overhead $290,000 $292,000
Total $1,690,000 $1,663,000
a) Prepare a flexible budget for the department's actual level of activity.
b) Use the flexible budget to evaluate Ms. Farr's performance.
c) Why does the budget not include sales revenue and net income?
Bane Accounting Services planned to charge its customers $120 per hour in 2007. The chief operating officer expected that the company would provide 40,000 hours of service to clients. However, the vice president for marketing argued that the actual number of hours might range from 36,000 to 44,000 hours. Bane's standard variable cost is $65 per hour, and its standard fixed cost is $1,500,000.
Required: Prepare flexible budgets for 36,000, 40,000, and 44,000 hours.
36,000 hours 40,000 hours 44,000 hours
Less fixed costs
Most large organizations establish responsibility centers (sections, departments, divisions, etc.) in order to delegate decision-making authority to the individuals who are best suited to make decisions in those particular centers. Consider the following responsibility centers and classify each as most likely being a cost center, profit center, or investment center.
Responsibility Center Description Type of Responsibility Center
1) Atlanta office of an investment banking services firm
2) Birmingham location of a major retail furniture chain
3) Cadillac division of General Motors
4) Casting department of a small steel mill
5) Customer complaint center at Delta Airlines
6) Check clearing department in a bank operations center
7) Finishing department of a manufacturing plant that makes precision cutting instruments
8) Gulfstream Aerospace unit (maker of business jets) of General Dynamics Corporation
9) Home electronics division of Sony Corporation
10) Maintenance department in an automobile assembly plant
11) Medical diagnostic equipment unit of Hewlett Packard Company
12) Restaurant in a Macy's department store
Choose the correct answer:
1 - The practice of delegating authority and responsibility is referred to as.
management by exception.
centralization of authority
2 - Contribution margin would be one of the most important measurements used in
evaluating the performance of a
3 - A budget prepared at a single volume of activity is referred to as a
4 - All of the following are capital investments except
Purchasing $40,000 of machinery
Buying a $4,000,000 manufacturing plant
Acquiring $400,000 of common stock
Paying $500,000 to renovate a retail store
10 - Which of the following is not a factor in explaining why the present value of a future
dollar is less than one dollar?
Risk of failure to collect