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costaccountingchapter21

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Cost Accounting, 14e (Horngren/Datar/Rajan)

    Chapter 21 Capital Budgeting and Cost Analysis

Objective 21.1

1) Which of the following involves significant financial investments in projects to develop new products,

    expand production capacity, or remodel current production facilities?

    A) capital budgeting

    B) working capital

    C) master budgeting

    D) project-cost budgeting

    Answer: A

    Diff: 1

    Terms: capital budgeting

    Objective: 1

    AACSB: Reflective thinking

2) The accounting system that corresponds to the project dimension in capital budgeting is the:

    A) net present value method

    B) internal rate of return

    C) accrual accounting rate of return

    D) life-cycle costing

    Answer: D

    Diff: 1

    Terms: capital budgeting

    Objective: 1

    AACSB: Reflective thinking

3) Capital budgeting is the process of making long-run planning decisions for investments in projects.

    Answer: TRUE

    Diff: 2

    Terms: capital budgeting

    Objective: 1

    AACSB: Analytical skills

    4) A capital budget spans only a one-year period. Answer: FALSE

    Explanation: A capital budget normally is for a period of time greater than one year.

    Diff: 2

    Terms: capital budgeting

    Objective: 1

    AACSB: Analytical skills

    1

    Copyright ? 2012 Pearson Education, Inc.

    5) The identify projects stage of capital budgeting gathers information from all parts of the value chain to evaluate alternative projects.

    Answer: FALSE

    Explanation: This is the definition of the obtain information stage.

    Diff: 1

    Terms: capital budgeting

    Objective: 1

    AACSB: Analytical skills

    6) The obtain information stage of capital budgeting gathers information from all parts of the value chain to evaluate alternative projects.

    Answer: TRUE

    Diff: 1

    Terms: capital budgeting

    Objective: 1

    AACSB: Analytical skills

    7) The make decisions by choosing among alternatives stage of the capital budgeting process consists of determining which investment yields the greatest benefit and the least cost to the organization. Answer: TRUE

    Diff: 1

    Terms: capital budgeting

    Objective: 1

    AACSB: Analytical skills

    8) The make predictions stage of the capital budgeting process consists of forecasting all potential net income additions that are attributable to the alternative projects.

    Answer: FALSE

    Explanation: The make predictions stage of the capital budgeting process consists of forecasting all potential cash flows attributable to the alternative projects.

    Diff: 1

    Terms: capital budgeting

    Objective: 1

    AACSB: Analytical skills

    9) The final activity in the capital budgeting process is to obtain funding and make the investments identified in the make decisions by choosing among alternatives stage of the process. Answer: FALSE

    Explanation: The implement decision, evaluate performance, and learn stage requires that after the funding is obtained and the investment is made, there is a follow-up wherin the realized cash flows are tracked, compared against the estimates, and plans are revised if necessary.

    Diff: 1

    Terms: capital budgeting

    Objective: 1

    AACSB: Analytical skills

    2

    Copyright ? 2012 Pearson Education, Inc.

    10) Match each one of the examples below with one of the stages of the capital budgeting decision model.

Stages:

    1. Identify Projects

    2. Obtain Information

    3. Make Predictions

    4. Make Decisions by Choosing Among Alternatives

    5. Implement the Decision, Evaluate Performance, and Learn

________ a. Issuing corporate stock for the funds to purchase new equipment

    ________ b. Learning how to effectively operate Machine #8 only takes 15 minutes ________ c. The need to reduce the costs to process the vegetables used in producing goulash ________ d. Monitoring the costs to operate a new machine

    ________ e. Percentage of defective merchandise considered too high

    ________ f. Will introducing the new product substantially upgrade our image as

     a producer of quality products?

    ________ g. Research indicates there are five machines on the market capable of producing

     our product at a competitive cost.

    ________ h. Use of the internal rate of return for each alternative

    Answer:

    a. 5. Implement the Decision, Evaluate Performance, and Learn

    b. 2. Obtain Information

    c. 1. Identify Projects

    d. 5. Implement the Decision, Evaluate Performance, and Learn

    e. 1. Identify Projects

    f. 2. Obtain Information

    g. 2. Obtain Information

    h. 4. Make Decisions by Choosing Among Alternatives

    Diff: 2

    Terms: capital budgeting

    Objective: 1

    AACSB: Reflective thinking

    11) Explain why a corporation's customer base is considered an intangible asset. Answer: A corporation's customer base is considered an intangible asset because if it is handled properly, a corporation's existing customers will be a source of revenues for an indefinite time period. One could make the case that the customer base is like an annuity a steady source of revenues and earnings. Thus

    it is an asset, although an intangible one.

    An existing customer usually will stay with a corporation if he or she is handled properly. Usually there is minimal marginal cost in retaining a customer other than producing a satisfactory product. In contrast, attracting new customers takes time, effort, and most times substantial marketing dollars. Thus, it is much easier to retain a current customer than to obtain a new one. This is why the existing customer base is considered an asset.

    Diff: 2

    Terms: capital budgeting

    Objective: 1

    AACSB: Analytical skills

    12) Explain capital budgeting and then briefly discuss each of the five stages of a capital budgeting

    3

    Copyright ? 2012 Pearson Education, Inc.

project?

    Answer: Capital budgeting is long-run planning for investment projects that usually have a life that is greater than one year.

    Stage 1 of a capital budgeting project is the identify projects stage in which a firm determines which types of capital investments are necessary to accomplish organization objectives and strategies. Stage 2 is the obtain information stage in which a firm gathers information from all parts of the value chain to analyze alternative projects. Stage 3 is the make predictions stage in which the firm forecasts all potential cash flows attributable to the alternative projects. Stage 4 is the make decisions by choosing among alternatives stage in which the firm determines which investment yields the greatest benefit and the least cost to the organization. Stage 5 is the implement the decision, evaluate performance, and learn stage that is further separated into two sub stages: (1) obtain funding and make the investments selected in the stage 4 process, and (2) track the realized cash flows, compare against the forecast numbers, and revise plans if necessary.

    Diff: 2

    Terms: capital budgeting

    Objective: 1

    AACSB: Reflective thinking

    13) Cast Iron Stove Company wants to buy a molding machine that can be integrated into its computerized manufacturing process. It has received three bids for the machine and related manufacturer's specifications. The bids range from $3,500,000 to $3,550,000. The estimated annual savings of the machines range from $260,000 to $270,000. The payback periods are almost identical and the net present values are all within $8,000 of each other. The president just doesn't know what to do about which vendor to choose since all of the selection criteria are so close together.

Required:

    What suggestions do you have for the president?

    Answer: The president needs to consider nonfinancial and qualitative factors between the three vendors. Quality of output units, manufacturing flexibility, and cycle time are all additional factors that can be considered about the machines. Other items might include worker safety, ease of learning and using, and ease of maintenance.

    Diff: 2

    Terms: capital budgeting

    Objective: 1

    AACSB: Reflective thinking

    4

    Copyright ? 2012 Pearson Education, Inc.

Objective 21.2

1) The stage of the capital budgeting process that distinguishes which types of capital expenditure projects

    are necessary to accomplish organization objectives is the: A) identify projects stage

    B) make predictions stage

    C) obtain information stage

    D) make decisions by choosing among alternatives stage Answer: A

    Diff: 1

    Terms: capital budgeting

    Objective: 2

    AACSB: Reflective thinking

2) The stage of the capital budgeting process during which marketing is queried for potential revenue

    numbers is the:

    A) identify projects stage

    B) obtain information stage

    C) make predictions stage

    D) make decisions by choosing among alternatives stage Answer: B

    Diff: 1

    Terms: capital budgeting

    Objective: 2

    AACSB: Reflective thinking

    3) The stage of the capital budgeting process that considers the expected costs and the expected benefits of

    alternative capital investments is the:

    A) identify projects stage

    B) make decisions by choosing among alternatives stage C) obtain information stage

    D) make predictions stage

    Answer: D

    Diff: 1

    Terms: capital budgeting

    Objective: 2

    AACSB: Reflective thinking

4) The stage of the capital budgeting process that chooses projects for implementation is the:

    A) make decisions by choosing among alternatives stage B) make predictions stage

    C) identify projects stage

    D) management-control stage

    Answer: A

    Diff: 1

    Terms: capital budgeting

    Objective: 2

    AACSB: Reflective thinking

    5

    Copyright ? 2012 Pearson Education, Inc.

5) The stage of the capital-budgeting process in which projects get underway and performance is

    monitored is the:

    A) implement the decision, evaluate performance, and learn stage

    B) make predictions stage

    C) identify projects stage

    D) management-control stage

    Answer: A

    Diff: 1

    Terms: capital budgeting

    Objective: 2

    AACSB: Reflective thinking

6) The two factors capital budgeting emphasizes are:

    A) qualitative and nonfinancial B) quantitative and nonfinancial C) quantitative and financial

    D) qualitative and financial

    Answer: C

    Diff: 1

    Terms: capital budgeting

    Objective: 2

    AACSB: Reflective thinking

    7) Which of the following are NOT included in the formal financial analysis of a capital budgeting

    program?

    A) quality of the output

    B) safety of employees

    C) cash flow

    D) Neither A nor B are included. Answer: D

    Diff: 2

    Terms: capital budgeting

    Objective: 2

    AACSB: Reflective thinking

8) The stage of the capital budgeting process in which a firm obtains funding for the project is the:

    A) make decisions by choosing among alternatives stage.

    B) make predictions stage.

    C) obtain information stage.

    D) implement the decision, evaluate performance, and learn stage.

    Answer: D

    Diff: 1

    Terms: net present value (NPV) method Objective: 2

    AACSB: Reflective thinking

    6

    Copyright ? 2012 Pearson Education, Inc.

9) Which capital budgeting technique(s) measure all expected future cash inflows and outflows as if they

    occurred at a single point in time? A) net present value

    B) internal rate of return

    C) payback

    D) Both A and B are correct.

    Answer: D

    Diff: 2

    Terms: capital budgeting, NPV method, IRR method Objective: 2

    AACSB: Reflective thinking

10) Discounted cash flow methods for capital budgeting focus on:

    A) cash inflows

    B) operating income

    C) cash outflows

    D) Both A and C are correct.

    Answer: D

    Diff: 2

    Terms: discounted cash flow (DCF) methods Objective: 2

    AACSB: Reflective thinking

    11) Net present value is calculated using the: A) internal rate of return

    B) required rate of return

    C) rate of return required by the investment bankers

    D) None of these answers is correct. Answer: B

    Diff: 2

    Terms: net present value (NPV) method Objective: 2

    AACSB: Reflective thinking

12) All of the following are methods that aid management in analyzing the expected results of capital

    budgeting decisions EXCEPT:

    A) accrual accounting rate-of-return method B) discounted cash-flow method

    C) future-value cash-flow method

    D) payback method

    Answer: C

    Diff: 2

    Terms: capital budgeting

    Objective: 2

    AACSB: Reflective thinking

    7

    Copyright ? 2012 Pearson Education, Inc.

13) The capital budgeting method which calculates the expected monetary gain or loss from a project by

    discounting all expected future cash inflows and outflows to the present point in time using the required

    rate of return is the:

    A) payback method

    B) accrual accounting rate-of-return method

    C) sensitivity method

    D) net present value method

    Answer: D

    Diff: 2

    Terms: net present value (NPV) method

    Objective: 2

    AACSB: Reflective thinking

    14) Assume your goal in life is to retire with two million dollars. How much would you need to save at the

    end of each year if interest rates average 6% and you have a 20-year work life?

    A) $29,130

    B) $54,369

    C) $240,204

    D) $752,952

    Answer: B

    Explanation: B) S (36.786) = $2,000,000

    S = $54,368.51

    Diff: 3

    Terms: net present value (NPV) method

    Objective: 2

    AACSB: Analytical skills

15) Assume your goal in life is to retire with three million dollars. How much would you need to save at

    the end of each year if interest rates average 5% and you have a 25-year work life?

    A) $ 49,110

    B) $ 55,596

    C) $ 62,858

    D) $67,508

    Answer: C

    Explanation: C) Look up annuity factor in the table or use function on a calculator or computer.

    S (47.727) = $3,000,000

    S = $62,857.50

    Diff: 3

    Terms: net present value (NPV) method

    Objective: 2

    AACSB: Analytical skills

    8

    Copyright ? 2012 Pearson Education, Inc.

    16) Assume your goal in life is to retire with 2 million dollars. How much would you need to save at the end of each year if investment rates average 9% and you have a 15-year work life? A) $51,108

    B) $ 68,118

    C) $ 75,706

    D) $ 82,572

    Answer: B

    Explanation: B) Look up annuity factor in the table or use function on a calculator or computer. S (29.361) = $2,000,000

    S = $68,117.57

    Diff: 3

    Terms: net present value (NPV) method

    Objective: 2

    AACSB: Analytical skills

Answer the following questions using the information below:

    Hawkeye Cleaners has been considering the purchase of an industrial dry-cleaning machine. The existing machine is operable for three more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $120,000. The new machine will cost $400,000 and an additional cash investment in working capital of $120,000 will be required. The new machine will reduce the average amount of time required to wash clothing and will decrease labor costs. The investment is expected to net $100,000 in additional cash inflows during the year of acquisition and $300,000 each additional year of use. The new machine has a three-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.

    17) What is the net present value of the investment, assuming the required rate of return is 10%? Would the company want to purchase the new machine?

    A) $164,000; yes

    B) $100,000; no

    C) $(100,000); yes

    D) $(164,000); no

    Answer: A

    Explanation:

    A) Yr. 0 ($120,000 - $400,000 - $120,000) × 1.000 = $(400,000)

    Yr. 1 $100,000 × 0.909 = 90,900

    Yr. 2 $300,000 × 0.826 = 247,800

    Yr. 3 $300,000 × 0.751 = 225,300

     $ 164,000

    Diff: 3

    Terms: net present value (NPV) method

    Objective: 2

    AACSB: Analytical skills

    9

    Copyright ? 2012 Pearson Education, Inc.

    18) What is the net present value of the investment, assuming the required rate of return is 24%? Would the company want to purchase the new machine?

    A) $(65,600); yes

    B) $(32,800); no

    C) $32,800; yes

    D) $65,600; no

    Answer: C

    Explanation:

    C) Yr. 0 ($120,000 - $400,000 - $120,000) × 1.000 = $(400,000)

    Yr. 1 $ 100,000 × 0.806 = 80,600

    Yr. 2 $300,000 × 0.650 = 195,000

    Yr. 3 $300,000 × 0.524 = 157,200

     $ 32,800

    Diff: 3

    Terms: net present value (NPV) method, required rate of return (RRR)

    Objective: 2

    AACSB: Analytical skills

    Answer the following questions using the information below:

    Jonesville Hospital has been considering the purchase of a new x-ray machine. The existing machine is operable for five more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $90,000. The new machine will cost $650,000 and an additional cash investment in working capital of $20,000 will be required. The new machine will reduce the average amount of time required to take the x-rays and will allow an additional amount of business to be done at the hospital. The investment is expected to net $60,000 in additional cash inflows during the year of acquisition and $230,000 each additional year of use. The new machine has a five-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.

    19) What is the net present value of the investment, assuming the required rate of return is 12%? Would the hospital want to purchase the new machine?

    A) $(97,340); no

    B) $51,430 no

    C) $ 97,340; yes

    D) $166,830; yes

    Answer: C

    Explanation:

    C) Yr. 0 ($90,000 - $650,000 - $20,000) × 1.000 = $(580,000)

    Yr. 1 $ 60,000 × 0.893 = 53,580

    Yr. 2 $230,000 × 0.797 = 183,310

    Yr. 3 $230,000 × 0.712 = 163,760

    Yr. 4 $230,000 × 0.636 = 146,280

    Yr. 5 $230,000 × 0.567 = 130,410

     $ 97,340

    Diff: 3

    Terms: net present value (NPV) method

    Objective: 2

    AACSB: Analytical skills

    10

    Copyright ? 2012 Pearson Education, Inc.

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