Chapter 15

Income Taxes in Capital Budgeting Decisions

True/False
1.
F
Medium

The present value of the tax savings under the optional

straight-line method will ordinarily be greater than the
present value of the tax savings under the MACRS table method.

2.
F
Medium

Depreciation expenses taken on financial reports is relevant

for capital budgeting decisions since it affects the company's
net income.

3.
T
Medium

The reduction in taxes made possible by a depreciation tax

shield equals the depreciation deduction multiplied by the tax
rate.

4.
F
Hard

If a company is operating at a profit, all cash inflows

associated with an investment project should be multiplied by
one minus the tax rate to be placed on an after-tax basis.

5.
T
Easy

Depreciation deductions shield revenues from taxation and

thereby lower the amount of taxes that a company must pay.

6.
F
Medium

The release of working capital at the end of an investment

project is a taxable cash inflow.

7.
T
Medium

Not all cash inflows are taxable.

8.
T
Easy

If a company operates at a profit, the after-tax cost of a taxdeductible cash expense is determined by multiplying the cash
expense by one minus the tax rate.

9.
F
Medium

The working capital required at the start of an investment is a

taxable cash outflow.

10.
F
Hard

To determine the effect of income taxes on a project, multiply

the net present value of the project by one minus the tax rate.

ManagerialAccounting,9/e

40

11.
T
Medium

Due to the half-year convention, assets in the 3-year property

class are depreciated over four years.

12.
F
Easy

When a company invests in equipment, it gets to immediately

expense the cost of the equipment on the company's tax reports.

13.
F
Medium

If an asset is in the MACRS 3-year property class, but has an

estimated useful life of six years, it should be depreciated
over six years on tax reports.

14.
T
Medium

An asset that is in the MACRS 5-year property class would be

depreciated over six years.

15.
T
Hard

Under the MACRS system, any salvage value realized when an

asset is sold is taxed if the asset has exceeded the useful
life assumed in its property class.

Multiple Choice
16.
B
Easy
CMA
adapted

Depreciation expense reduces income taxes by an amount equal

to:
a. one minus the tax rate times the amount of deprecation.
b. the tax rate times the amount of depreciation.
c. the amount of the depreciation.
d. one minus the amount of depreciation.

17.
C
Medium

The calculation of the net present value of an investment

project requires that the depreciation tax shield be included
at:
a. the amount of the depreciation with no adjustment for taxes.
b. the amount of the depreciation times one minus the tax rate.
c. the amount of the depreciation times the tax rate.
d. zero, since depreciation is not relevant to the calculation
of net present value.

18.
A
Medium
CMA
adapted

In a capital budgeting decision, the use of MACRS tables as

compared to the optional straight-line method will result in:
a. equal total depreciation for both methods.
b. more total depreciation for the MACRS tables method.
c. more total depreciation for the optional straight-line
method.
d. less depreciation for the MACRS tables method in the early
years of asset life.

41 ManagerialAccounting,9/e

19.
C
Medium
CMA
adapted

The use of the MACRS tables instead of the optional

line method of depreciation has the effect of:
a. raising the hurdle rate necessary to justify the
b. decreasing the net present value of the project.
c. increasing the present value of the depreciation
d. increasing the cash outflows at the beginning of
project.

20.
B
Medium

Which of the following is correct?

a. Use of the MACRS tables requires that salvage value be
deducted in computing depreciation deductions.
b. Use of the optional straight-line method requires that
salvage value not be considered in computing depreciation
deductions.
c. The use of both MACRS tables and the optional straight-line
method requires that salvage value be deducted in computing
depreciation deductions.
d. None of the above are true.

21.
C
Medium

When computing depreciation deductions under the MACRS system,

taxpayers must:
a. use the half-year convention under which taxpayers are
allowed to take only a half year's depreciation in the first
year of an asset's life.
b. use the half-year convention under which taxpayers are
allowed to take only a half year's depreciation in the last
year of an asset's life.
c. use the half-year convention under which taxpayers are
allowed to take only a half year's depreciation in the first
and last years of an asset's life.
d. calculate depreciation for partial periods using the exact
number of days if the asset is acquired at some time other
than the beginning or end of the fiscal year.

22.
D
Hard
CMA
adapted

Which of the following would decrease the net present value of

a project?
a. A decrease in the income tax rate.
b. A decrease in the initial investment.
c. An increase in the useful life of the project.
d. An increase in the discount rate.

23.
D
Hard

A piece of equipment is in the MACRS 5-year property class and

is being depreciated using the MACRS tables. The tax rate is
35%. If the
tax savings from the depreciation tax shield in Year 3 is
$4,500, then the original cost of the equipment was:
a. $36,058.
b. $6,923.
c. $12,857.
d. $66,964.

ManagerialAccounting,9/e

straightproject.
tax shield.
the

42

24.
A
Medium

A company anticipates a taxable cash receipt of $50,000 in year

4 of a project. The company's tax rate is 30% and its discount
rate is 12%. The present value of this future cash flow is
closest to:
a. $22,243.
b. $35,000.
c. $9,533.
d. $15,000.

25.
D
Medium

A company anticipates a taxable cash receipt of $20,000 in year

3 of a project. The company's tax rate is 30% and its discount
rate is 8%. The present value of this future cash flow is
closest to:
a. $6,000.
b. $4,763.
c. $14,000.
d. $11,114.

26.
C
Medium

A company anticipates a taxable cash receipt of $50,000 in year

3 of a project. The company's tax rate is 30% and its discount
rate is 14%. The present value of this future cash flow is
closest to:
a. $10,125.
b. $35,000.
c. $23,624.
d. $15,000.

27.
D
Medium

A company anticipates a taxable cash expense of $10,000 in year

2 of a project. The company's tax rate is 30% and its discount
rate is 8%. The present value of this future cash flow is
closest to:
a. ($3,000).
b. ($2,572).
c. ($7,000).
d. ($6,001).

28.
A
Medium

A company anticipates a taxable cash expense of $40,000 in year

2 of a project. The company's tax rate is 30% and its discount
rate is 10%. The present value of this future cash flow is
closest to:
a. ($23,140).
b. ($9,917).
c. ($12,000).
d. ($28,000).

43 ManagerialAccounting,9/e

29.
C
Medium

A company anticipates a taxable cash expense of $60,000 in year

2 of a project. The company's tax rate is 30% and its discount
rate is 14%. The present value of this future cash flow is
closest to:
a. ($13,850).
b. ($42,000).
c. ($32,318).
d. ($18,000).

30.
D
Medium

A company anticipates a depreciation deduction of $20,000 in

year 2 of a project. The company's tax rate is 30% and its
discount rate is 12%. The present value of the depreciation tax
shield resulting from this deduction is closest to:
a. $11,161.
b. $14,000.
c. $6,000.
d. $4,783.

31.
C
Medium

A company anticipates a depreciation deduction of $30,000 in

year 3 of a project. The company's tax rate is 30% and its
discount rate is 12%. The present value of the depreciation tax
shield resulting from this deduction is closest to:
a. $21,000.
b. $14,947.
c. $6,406.
d. $9,000.

32.
A
Medium

A company anticipates a depreciation deduction of $70,000 in

year 2 of a project. The company's tax rate is 30% and its
discount rate is 14%. The present value of the depreciation tax
shield resulting from this deduction is closest to:
a. $16,159.
b. $49,000.
c. $21,000.
d. $37,704.

33.
B
Medium

A company needs an increase in working capital of $20,000 in

project that will last 4 years. The company's tax rate is 30%
and its discount rate is 10%. The present value of the release
of the working capital at the end of the project is closest to:
a. $6,000.
b. $13,660.
c. $9,562.
d. $14,000.

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44

34.
A
Medium

A company needs an increase in working capital of $50,000 in

project that will last 4 years. The company's tax rate is 30%
and its discount rate is 8%. The present value of the release
of the working capital at the end of the project is closest to:
a. $36,751.
b. $15,000.
c. $25,726.
d. $35,000.

35.
D
Medium

A company needs an increase in working capital of $70,000 in

project that will last 3 years. The company's tax rate is 30%
and its discount rate is 8%. The present value of the release
of the working capital at the end of the project is closest to:
a. $49,000.
b. $21,000.
c. $38,898.
d. $55,568.

36.
B
Hard

Eyring Industries has a truck purchased seven years ago at a

cost of $6,000. At the time of purchase, the ultimate salvage
value was estimated at $500, but salvage value was ignored in
depreciation deductions. The truck is now fully depreciated.
Assuming a tax rate of 40%, if the truck is sold for $500, the
after-tax cash inflow for capital budgeting purposes will be:
a. $500.
b. $300.
c. $200.
d. $100.

37.
B
Easy

Suppose a machine costs $20,000 now, has an expected life of

eight years, and will require a $7,000 overhaul at the end of
the third year. If the tax rate is 40%, then the after-tax cost
of this overhaul would be:
a. $12,000.
b. $4,200.
c. $8,000.
d. $2,800.

38.
B
Easy

Suppose a machine that costs $80,000 has

years. Also suppose that depreciation on
for tax purposes in year 4. The tax rate
savings from the depreciation tax shield
a. $4,800 inflow.
b. $3,200 inflow.
c. $4,800 outflow.
d. $3,200 outflow.

45 ManagerialAccounting,9/e

a useful life of 10
the machine is $8,000
is 40%. The tax
in year 4 would be:

39.
A
Hard

Consider a machine which costs $115,000 now and which has a

useful life of seven years. This machine will require a major
overhaul at the end of the fourth year which will cost "X"
dollars. If the tax rate is 40%, and if the after-tax cash
outflow for this overhaul is $3,600, then the amount of "X" in
dollars is:
a. $6,000.
b. $9,000.
c. $2,160.
d. $1,440.

40.
D
Easy

Last year the sales at Jersey Company were $200,000 and were
all cash sales. The expenses at Jersey were $125,000 and were
all cash expenses. The tax rate was 30%. The after-tax net cash
inflow at Jersey last year from these operations was:
a. $37,500.
b. $60,000.
c. $22,500.
d. $52,500.

41.
C
Easy

Last year a firm had taxable cash receipts of $800,000 and the
tax rate was 30%. The after-tax net cash inflow from these
receipts was
a. $800,000.
b. $640,000.
c. $560,000.
d. $240,000.

42.
B
Easy

A company had tax-deductible cash expenses of $650,000 last

year and the tax rate was 30%. The after-tax net cash outflow
for these expenses was:
a. $195,000.
b. $455,000.
c. $650,000.
d. $390,000.

43.
D
Medium

At the Bartholomew Company last year all sales were for cash
and all expenses were paid in cash. The tax rate was 30%. If
the after-tax net cash inflow from these operations last year
was $10,500, and if the total before tax cash expenses were
$35,000, then the total before-tax cash sales must have been:
a. $65,000.
b. $60,000.
c. $45,000.
d. $50,000.

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46

44.
B
Medium
CMA
adapted

Superstrut is considering replacing an old press that cost

$80,000 six years ago with a new one that would cost $245,000.
The old press has a net book value of $15,000 and could be sold
for $5,000. The increased production of the new press would
require an investment in additional working capital of $6,000.
The company's tax rate is 40%. Superstrut's net investment now
in the project would be:
a. $256,000.
b. $242,000.
c. $250,000.
d. $245,000.

45.
A
Medium

Kane Company is in the process of purchasing a new machine for

its production line. It is near the end of the year, and the
machine is being offered at a special discount if purchased
before the end of the year. Kane has determined that the
depreciation deduction for tax purposes on the new machine for
the year of purchase would be $13,000. The tax rate is 30%. If
Kane purchases the machine and reports a positive net income
for the year, then the tax savings from the deprecation tax
shield related to this machine for the year of purchase would
be:
a. $3,900.
b. $9,100.
c. $13,000.
d. $0.

46.
C
Easy

Last year the sales at Seidelman Company were $700,000 and were
all cash sales. The company's expenses were $450,000 and were
all cash expenses. The tax rate was 35%. The after-tax net cash
inflow at Seidelman last year was:
a. $700,000.
b. $250,000.
c. $162,500.
d. $87,500.

47 ManagerialAccounting,9/e

Reference: 15-1
The Lorenz Company is deciding whether or not it should replace an old piece
of equipment with new equipment that is more efficient. The following data
relate to this investment decision:
Cost of the new equipment now ..............
Annual cash operating costs of
the new equipment ........................
Useful life of the new equipment............
Salvage value of the new equipment
in seven years ...........................
Book value of the old equipment now ........
Salvage value of the old equipment now .....
Salvage value of the old equipment in
seven years ..............................
Original cost of the old equipment three
years ago ................................
Annual cash operating costs of the
old equipment ............................
Overhaul of the old equipment needed at
the end of four years ....................

$120,000
$ 50,000
7 years
$ 8,000
$ 40,000
$ 30,000
$

4,000

$ 80,000
$ 70,000
$15,000

The old equipment is in the MACRS 5-year property class and is being
depreciated by the optional straight-line method, but this equipment will
last for seven more years. The new equipment is also in the MACRS 5-year
property class and will be depreciated using MACRS tables. The tax rate is
30% and the company's after-tax cost of capital is 12%. The following
questions are based on the incremental-cost approach to the net present
value method. All questions should be answered from point of view of
replacing the old equipment with the new equipment.
47.
A
Medium
Refer To:
15-1

The present value of the net annual savings in cash operating

costs (for all years) in favor or the new equipment is closest
to:
a. $63,896.
b. $91,280.
c. $159,740.
d. $223,636.

48.
B
Easy
Refer To:
15-1

The present value of the overhaul of the old equipment that is

avoided is closest to:
a. $15,000.
b. $6,678.
c. $10,500.
d. $9,540.

49.
D
Medium
Refer To:
15-1

The present value of the tax savings at the end of one year
from the loss on the sale of the old equipment is closest to:
a. $10,000.
b. $3,000.
c. $7,000.
d. $2,679.

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48

50.
C
Hard
Refer To:
15-1

The present value of the difference in tax savings between the

two pieces of equipment (for all years) arising from the
depreciation tax shield in favor of the new equipment is
closest to:
a. $24,000.
b. $26,571.
c. $16,751.
d. $12,912.

Reference: 15-2
The Moon Company is contemplating the purchase of a new machine to replace
an old machine. The following data are available concerning this investment
possibility:
New machine:
Purchase price now .............................
Annual cash operating costs ....................
Useful life ....................................
Salvage value at the end of seven years ........
Old machine:
Original purchase price three years ago ........
Book value now .................................
Annual cash operating costs ....................
Salvage value at the end of seven years ........
Overhaul needed four years from now ............
Salvage value of the machine now ...............

$50,000
$20,000
7 years
$ 3,000
$40,000
$20,000
$30,000
$ 2,000
$ 7,000
$20,000

The machine is in the MACRS 5-year property class and would be depreciated
using the MACRS tables. The old machine is also in the 5-year property class
and is being depreciated by the optional straight-line method. However, this
old machine could last seven more years if overhauled in four years. The
company requires a 12% after-tax return on all equipment purchases, and the
tax rate is 30%. The following questions are based on the total-cost
approach to the net present value method:
51.
A
Medium
Refer To:
15-2

From the point of view of buying the new machine, the present
value of the salvage to be received in seven years is closest
to:
a. $949.
b. $2,100.
c. $1,356.
d. $3,000.

52.
D
Easy
Refer To:
15-2

From the point of view of buying the new machine, the present
value of the annual cash operating costs (for all years) is
closest to:
a. $72,435.
b. $(72,435).
c. $(95,844).
d. $(63,896).

49 ManagerialAccounting,9/e

53.
C
Hard
Refer To:
15-2

From the point of view of buying the new machine, the present
value of the tax savings (for all years) arising from the
depreciation tax shield) is closest to:
a. $15,183.
b. $12,400.
c. $11,071.
d. $10,630.

54.
D
Easy
Refer To:
15-2

From the point of view of keeping the old machine, the present
value of the overhaul needed at the end of Year 4 is closest
to:
a. $(4,900).
b. $(5,675).
c. $(7,000).
d. $(3,116).

55.
B
Hard
Refer To:
15-2

From the point of view of keeping the old machine, the present
value of the tax savings (for all years) arising from the
depreciation tax shield is closest to:
a. $6,000.
b. $4,910.
c. $15,000.
d. $16,368.

Reference: 15-3
Maxwell Company purchased a new machine January 1 of Year 1. Data relating
to the machine are as follows:
Cost of machine ..... $180,000
Salvage value ....... 30,000
Useful life ......... 8 years
This machine is in the MACRS 5-year property class. Maxwell uses a 10%
discount rate in capital budgeting analysis. The companys tax rate is 30%.
56.
D
Medium
Refer To:
15-3

If Maxwell uses the MACRS tables, what will be the present

value of the depreciation tax shield recorded in Year 2 (to the
nearest dollar)?
a. $27,754.
b. $11,894.
c. $33,304.
d. $14,273.

57.
A
Medium
Refer To:
15-3

If Maxwell uses the optional straight-line method, what will be

the present value of the depreciation tax shield recorded in
Year 4?
a. $7,376.
b. $6,147.
c. $14,343.
d. $17,212.

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50

Reference: 15-4
Shields Company is considering the purchase of a new computer to replace an
old computer. The new computer will have a useful life of six years with a
salvage value of $4,000. The computer will be depreciated using the MACRS
tables, and it belongs in the MACRS 5-year property class. The tax rate is
35%, and the company's after-tax cost of capital is 10%. The new computer
will provide annual savings in cash operating costs (before taxes) of
$15,000. The new computer would cost $45,000. The old fully depreciated
computer it would replace could be sold now for a salvage value of $4,000.
The new computer requires a $3,000 cash investment in working capital which
will be released at the end of six years for use elsewhere.
58.
C
Medium
Refer To:
15-4

The present value of the after-tax cash flow from the salvage
received on the sale of the old computer would be:
a. $4,000.
b. $1,400.
c. $2,600.
d. $0.

59.
A
Hard
Refer To:
15-4

The present value of the tax savings (for all years) resulting
from the depreciation tax shield is (rounded to the nearest
dollar):
a. $12,174.
b. $22,610.
c. $34,785.
d. $45,000.

60.
A
Medium
Refer To:
15-4

The present value of the after-tax annual savings in cash

operating costs (for all years) is:
a. $42,461.
b. $22,864.
c. $65,325.
d. $36,962.

61.
D
Hard
Refer To:
15-4

The present value of the after-tax net cash flows

during Year 2 (to the nearest dollar) is:
a. $19,948.
b. $16,231.
c. $8,500.
d. $12,217.

62.
B
Hard
Refer To:
15-4

The present value of the after-tax net cash flows (all cash
inflows less all cash outflows) occurring during Year 6 (to the
nearest dollar) is:
a. $7,480.
b. $9,172.
c. $7,706.
d. $8,657.

51 ManagerialAccounting,9/e

occurring

63.
A
Hard
Refer To:
15-4

A piece of equipment is in the MACRS 5-year property class and

is being depreciated by the optional straight-line method. The
tax rate is 35%. If the tax savings from the depreciation tax
shield on this equipment is $3,500 in Year 3, then the original
cost of this equipment was:
a. $50,000.
b. $17,500.
c. $21,000.
d. $52,083.

Reference: 15-5
The Fargo Company is considering a new machine to replace an old machine.
The following data are available:
Annual cash operating cost savings from the
new machine ................................ $ 60,000
Cost of the new machine ....................... 150,000
Salvage value of the new machine in 9 years ...
20,000
Salvage value of the old machine now ..........
15,000
Useful life of the new machine ................ 9 years
Income tax rate ...............................
40%
After-tax cost of capital .....................
16%
The new machine is in the MACRS 5-year property class. The company computes
depreciation for tax purposes using MACRS tables. The old machine has been
fully depreciated for tax purposes. Each of the following questions is
independent:
64.
D
Hard
Refer To:
15-5

The present value of the tax savings (for all years) arising
from the depreciation tax shield provided by the new machine is
closest to:
a. $60,000.
b. $96,488.
c. $101,295.
d. $40,518.

65.
A
Medium
Refer To:
15-5

The present value of the after-tax cash inflows (for all years)
due to the annual cost savings from the new machine is closest
to:
a. $165,852.
b. $276,420.
c. $117,864.
d. $540,000.

66.
C
Medium
Refer To:
15-5

The present value of the cash flow arising from the salvage
value of the new machine is closest to:
a. $5,712.
b. $2,104.
c. $3,156.
d. $5,260.

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52

67.
D
Medium
Refer To:
15-5

Consider only the cash flows which will occur now. The present
value of these cash flows is:
a. -$150,000.
b. -$135,000.
c. -$201,000.
d. -$141,000.

Reference: 15-6
The Smith Lumber Company is considering cutting trees on a plot of land to
which it has cutting rights. The following data are available:
Investment required now in new equipment ........ $300,000
Working capital investment required .............
40,000
Overhaul of equipment needed in 2 years .........
70,000
Net annual cash inflow from sale of logs ........
90,000
Cash cost to reseed the land in 4 years .........
50,000
Salvage value of the equipment in 4 years .......
20,000
Income tax rate .................................
40%
After-tax cost of capital .......................
16%
The equipment would be in the MACRS 3-year property class, and its cost
would be depreciated using the MACRS tables. This investment project would
end with the reseeding of the land in four years.
68.
B
Medium
Refer To:
15-6

The present value of the annual cash inflows (in total) from
the sale of logs is closest to:
a. $251,820.
b. $151,092.
c. $243,198.
d. $100,728.

69.
A
Hard
Refer To:
15-6

The present value of the tax savings (in total) arising from
the depreciation tax shield provided by the equipment is
closest to:
a. $90,420.
b. $26,050.
c. $131,917.
d. $220,503.

70.
C
Hard
Refer To:
15-6

Consider only the cash flows which occur during the fourth
year. The net present value of the cash flows that occur during
the fourth year (ignoring the depreciation tax shield) is
closest to:
a. $76,000.
b. $22,080.
c. $41,952.
d. $13,248.

53 ManagerialAccounting,9/e

Reference: 15-7
The Elwood Express Company needs a new piece of equipment in order to fill a
contract that it has just signed with the US Army. This equipment will have
a useful life of seven years. It will be depreciated using the MACRS tables,
and it belongs in the MACRS 5-year property class. The new equipment has a
cash purchase cost of $400,000; however, an old, fully depreciated piece of
equipment would be sold now for a salvage value of $25,000. At the end of
seven years, the new equipment will have a salvage value of $30,000. The net
annual cash operating inflows from the contract will be $100,000. The tax
rate is 30%, and the company's after-tax cost of capital is 14%.
71.
B
Medium
Refer To:
15-7

The present value of the net annual after-tax cash operating

inflows (for all years) is closest to:
a. $428,800.
b. $300,160.
c. $128,640.
d. $259,780.

72.
A
Hard
Refer To:
15-7

The present value of the tax savings (for all years) resulting
from the depreciation tax shield is closest to:
a. $84,635.
b. $282,117.
c. $450,000.
d. $420,000.

73.
D
Medium
Refer To:
15-7

The present value of the net cash flows (all cash inflows less
all cash outflows) occurring during year 7 is closest to:
a. $21,000.
b. $8,400.
c. $91,000.
d. $36,400.

74.
C
Medium
Refer To:
15-7

The present value of the net cash flows (all cash inflows less
all cash outflows including the depreciation tax shield)
occurring during year 3 is closest to:
a. $93,040.
b. $23,040.
c. $62,802.
d. $15,552.

ManagerialAccounting,9/e

54

Reference: 15-8
Simmons Company is considering two investment projects, A and B.
following data are available:
Investment in delivery
trucks now ..............
Investment in working
capital now .............
Net annual operating cash
inflows ..................
Life of the project ........

Project A
$120,000
-18,000
7 years

The

Project B
-$100,000
16,000
7 years

The delivery trucks will have a total salvage value of $10,000 at the end of
seven years; these trucks are in the 5-year MACRS property class and will be
depreciated by the optional straight-line method. At the end of seven years
the working capital will be released for use elsewhere. The income tax rate
is 30% and Simmons' after-tax cost of capital is 12%.
75.
C
Medium
Refer To:
15-8

The present value of the after-tax net annual operating cash

inflows of Project A is closest to:
a. $51,117.
b. $82,152.
c. $57,506.
d. $73,024.

76.
D
Hard
Refer To:
15-8

The present value of the tax savings (for all years) due to the
depreciation tax shield for Project A is closest to:
a. $85,237.
b. $25,776.
c. $81,888.
d. $24,566.

Reference: 15-9
Lee Company is considering replacing an old delivery van with a new van. The
following data relate to this investment decision:
Cost of the new van now ................................
Annual cash operating costs of the new van .............
Useful life of the new van .............................
Salvage value of the new van in six years ..............
Original cost of the old van two years ago .............
Book value of the old van now ..........................
Salvage value of the old van now .......................
Salvage value of the old van in six years ..............
Annual cash operating costs of the old van .............
Overhaul of the old van needed three years from now ....

$20,000
$ 7,000
6 years
$ 3,500
$17,000
$ 5,000
$ 3,200
$
500
$ 9,000
$ 6,500

The old van is in the MACRS 5-year property class and is being depreciated
by the optional straight-line method, but this van will last for six more
years. The new van also is in the MACRS 5-year property class and will be
depreciated using the MACRS tables. The tax rate is 40% and the company's
after-tax cost of capital is 12%. The following questions are based on the
incremental cost approach to the net present value method. All questions
should be answered from the point of view of replacing the old van with the
new van.
55 ManagerialAccounting,9/e

77.
D
Medium
Refer To:
15-9

The net incremental outlay for the purchase of the new van is:
a. $20,000.
b. $13,300.
c. $23,200.
d. $16,800.

78.
C
Medium
Refer To:
15-9

The present value of the overhaul of the old van that is

avoided is:
a. $4,628.
b. $6,500.
c. $2,777.
d. $1,851.

79.
A
Medium
Refer To:
15-9

The present value of the after-tax net savings in cash

operating costs (for all years) is:
a. $4,933.
b. $3,289.
c. $17,266.
d. $8,222.

Essay
80.
Hard

Vernal Company has been offered a 7-year contract to supply a

part for the military. After careful study, the company has
developed the following estimated data relating to the
contract:
Cost of equipment needed ........................ $300,000
Working capital needed to carry inventories .....
50,000
Annual net cash inflow ..........................
90,000
Salvage value of equipment ......................
10,000
The equipment above would be in the MACRS 5-year property
class. It is not expected that the contract would be extended
beyond the initial contract period. The company's after-tax
cost of capital is 10%, and the tax rate is 30%.
Required:
Use net present value analysis to determine whether or not the
contract should be accepted.

ManagerialAccounting,9/e

56

Answer:
Years
Amount
Cost of equipment needed .... Now $(300,000)
Working capital needed ...... Now
( 50,000)
Net annual cash inflows
$90,000 x (1-0.30) ........ 1-7
63,000
Depreciation: Income tax savings
$300,000 x 0.200 x .3 ..... 1
18,000
$300,000 x 0.320 x .3 ..... 2
28,800
$300,000 x 0.192 x .3 ..... 3
17,200
$300,000 x 0.115 x .3 ..... 4
10,350
$300,000 x 0.115 x .3 ..... 5
10,350
$300,000 x 0.058 x .3 ..... 6
5,220
Salvage value
$10,000 x (1-0.30) ........ 7
7,000
Working capital released .... 7
50,000
Net present value ...........

10%
Factor
1.000
1.000

Present
Value
$(300,000)
( 50,000)

4.868

306,684

0.902
0.826
0.751
0.683
0.621
0.564

16,362
23,789
12,977
7,069
6,427
2,944

0.513
0.513

3,591
25,650
$ 55,493

The contract should be accepted, since the project has a positive

net present value.
81.
Hard

FM Company has been offered a 7-year contract to supply a part

to a major aircraft manufacturer. After careful study, the
company has developed the following data relating to the
contract:
Cost of equipment needed.............................. $400,000
Working capital needed to carry inventories........... 60,000
Annual before-tax cash receipts from delivery of parts,
less related cash operating costs................... 97,000
Salvage value of equipment at termination of the
contract............................................ 12,000
The equipment would be in the MACRS 5-year property class. The
contract is not expected to be extended beyond the initial
contract period. The company's cost of capital is 10% and the
tax rate is 35%.
Required:
Use net present value analysis to determine if the contract should
be accepted. Round all computations to the nearest dollar.

57 ManagerialAccounting,9/e

Answer:
Year
Cost of
equipment ..
0
$(400,000)
Working capital
needed .....
0
(60,000)
Annual savings 1-7
306,927
Depreciation:
400,000 x 0.200 1
25,452
400,000 x 0.320 2
37,005
400,000 x 0.192 3
20,187
400,000 x 0.115 4
10,996
400,000 x 0.115 5
9,998
400,000 x 0.058 6
4,580
Salvage ....... 7
4,001
Working capital
released .... 7
30,780
Net present value
$(10,074)

Tax
Effect

Cash Flow

After-tax
Cash Flow

10%
Factor

Present
_Value

$(400,000)

$(400,000)

1.000

(60,000)

(60,000)

1.000

97,000

1-0.35

63,050

4.868

80,000

0.35

28,000

0.909

128,000

0.35

44,800

0.826

76,800

0.35

26,880

0.751

46,000

0.35

16,100

0.683

46,000

0.35

16,100

0.621

23,200

0.35

8,120

0.564

12,000

1-0.35

7,800

0.513

60,000

0.513

60,000

The contract should not be accepted as the project has a negative

net present value.
82.
Hard

Anaconda Mining Company owns the mining rights to several

tracts of land in which copper ore has been found. The amount
of ore on some of the tracts is low-grade, and the company is
unsure whether it would be profitable to extract and sell the
ore these tracts contain. One such tract is the Elton tract, on
which the following information has been gathered:
Investment in equipment ............................ $600,000
Working capital investment .........................
85,000
Annual cash receipts from sale of ore, net of
related cash operating expenses (before taxes) ... 110,000
Cost of restoring land at the completion of
mining activities ................................
70,000
The ore body in the Elton tract will be exhausted after 10
years of mining. The equipment can be sold for 15% of its
original cost when extraction is completed. The company uses
the MACRS tables in computing depreciation deductions. The
equipment related to this project is in the MACRS 7-year
property class. The tax rate is 35%, and the company's aftertax cost of capital is 10%.

ManagerialAccounting,9/e

58

Required:
Compute the net present value of the Elton tract (round all dollar
amounts to the nearest whole dollar) and make a recommendation
regarding the viability of this investment.

Answer:
Year
Cost of
equipment ...
0
$(600,000)
Working capital
needed ......
0
(85,000)
Net annual cash
receipts .... 1-10
439,368
Depreciation:
600,000 x 0.143
1
27,297
600,000 x 0.245
2
42,497
600,000 x 0.175
3
27,599
600,000 x 0.125
4
17,929
600,000 x 0.089
5
11,607
600,000 x 0.089
6
10,541
600,000 x 0.089
7
9,588
600,000 x 0.045
8
4,413
Cost of restoring
land ........ 10
(17,563)
Salvage (15% of
$600,000) ... 10
22,581
Working capital
released .... 10
32,810
Net present value
(56,333)

Tax
Effect

Cash Flow

After-tax
Cash Flow

10%
Factor

Present
_Value

$(600,000)

$(600,000)

1.000

(85,000)

(85,000)

1.000

110,000

1-0.35

71,500

6.145

85,800

0.35

30,030

0.909

147,000

0.35

51,450

0.826

105,000

0.35

36,750

0.751

75,000

0.35

26,250

0.683

53,400

0.35

18,690

0.621

53,400

0.35

18,690

0.564

53,400

0.35

18,690

0.513

27,000

0.35

9,450

0.467

(70,000)

1-0.35

45,500

0.386

90,000

1-0.35

58,500

0.386

85,000

85,000

0.386

The project should not be undertaken as the net present value is

59 ManagerialAccounting,9/e

negative.
83.
Hard

Roy Company is trying to decide whether to invest in one of two

projects, X or Z. Associated data for each investment project
follow:
Project

Cost of equipment .....

Useful life ...........
Annual net cash inflow
Salvage value .........

X
$90,000
6 years
$25,000
$ 8,000

Z
$140,000
9 years
$ 30,000
$ 12,000

The equipment for each project is in the MACRS 5-year property

class. Roy uses the optional straight-line method for
calculating depreciation for tax purposes. The tax rate is 30%.
Roy's after-tax cost of capital is 12%.
Required:
a. Compute the net present value of each project and indicate
which appears preferable in terms of net present value.
b. Compute the profitability index for each project, and
indicate which project would be preferable using this
investment criterion.

Answer:
a. The net present values of the projects are computed below:
Year

Cash
Flow

Project X:
Cost of
equipment ..
0 $(90,000)
Annual Savings
1-6
25,000
Depreciation:
$90,000 x 0.1
1
9,000
$90,000 x 0.2
2
18,000
$90,000 x 0.2
3
18,000
$90,000 x 0.2
4
18,000
$90,000 x 0.2
5
18,000
$90,000 x 0.1
6
9,000
Salvage ......
6
8,000
Net present value
Project Z:
Cost of
equipment ..
Annual savings
Depreciation:
$140,000 x 0.1
$140,000 x 0.2
$140,000 x 0.2
ManagerialAccounting,9/e

0 $(140,000)
1-9
30,000
1
2
3

14,000
28,000
28,000

Tax
Effect
-1-.30
.30
.30
.30
.30
.30
.30
1-.30

After-tax 12%
Cash Flow Factor
$(90,000)
17,500
2,700
5,400
5,400
5,400
5,400
2,700
5,600

-$(140,000)
1-.30
21,000
.30
.30
.30

4,200
8,400
8,400

Present
Value

1.000
4.111

$(90,000)
71,943

0.893
0.797
0.712
0.636
0.567
0.507
0.507

2,411
4,304
3,845
3,434
3,062
1,369
2,839
$3,207

1.000 $(140,000)
5.328
111,888
0.893
0.797
0.712

3,751
6,695
5,981
60

$140,000 x 0.2
4
$140,000 x 0.2
5
$140,000 x 0.1
6
Salvage ......
9
Net present value

28,000
28,000
14,000
12,000

.30
.30
.30
1-.30

8,400
8,400
4,200
8,400

0.636
0.567
0.507
0.361

5,342
4,763
2,129
3,032
$3,581

Project Z would be preferable to Project X using the net present

value measure.
b.
Profitability index = Present value of cash inflows Investment
For Project X :

Profitability index = $93,207

= 1.0356

$90,000

For Project Z :

Profitability index = $143,581 $140,000

= 1.0256

Thus, Project X is preferred using the profitability index.

61 ManagerialAccounting,9/e

84.
Hard

Snyder Company is trying to decide whether to invest in one of

two projects, A or B. Data for each investment project follow:

Cost of equipment........................
Useful life..............................
Estimated net annual cash inflow.........
Salvage value at the end of useful life..

Project
A
B
$100,000
$150,000
6 years
6 years
$ 30,000
$ 44,000
$ 9,000
$ 14,000

The equipment for each project is in the MACRS 5-year property

class. Snyder Company uses the optional straight-line method
for calculating depreciation. The tax rate is 35%. Snyder's
cost of capital is 12%.
Required:
a. Compute the net present value of each project and indicate
which project appears preferable in terms of net present
value. Round all computations to the nearest dollar.
b. Compute the profitability index for each project, and
indicate which project would be preferable using this
investment criterion.
Answer:
a.
Project A:
Year

Cost of
equipment
0
$(100,000)
Annual
savings ... 1-6
80,165
Depreciation:
100,000 x 0.1
1
3,126
100,000 x 0.2
2
5,579
100,000 x 0.2
3
4,984
100,000 x 0.2
4
4,452
100,000 x 0.2
5
3,969
100,000 x 0.1
6
1,775
Salvage .....
6
2,966
Net present value
7,016

ManagerialAccounting,9/e

Cash Flow
$(100,000)

Tax
After-tax
Effect Cash Flow
-

$(100,000)

12%
Present
Factor _Value
1.000

30,000

1-0.35

19,500

4.111

10,000

0.35

3,500

0.893

20,000

0.35

7,000

0.797

20,000

0.35

7,000

0.712

20,000

0.35

7,000

0.636

20,000

0.35

7,000

0.567

10,000

0.35

3,500

0.507

9,000

1-0.35

5,850

0.507
$

62

Project B:
Year

Cost of
equipment
0
$(150,000)
Annual
savings ... 1-6
117,575
Depreciation:
150,000 x 0.1
1
4,688
150,000 x 0.2
2
8,369
150,000 x 0.2
3
7,476
150,000 x 0.2
4
6,678
150,000 x 0.2
5
5,594
150,000 x 0.1
6
2,262
Salvage .....
6
4,614
Net present value
7,256

Cash Flow

Tax
Effect

$(150,000)

After-tax
Cash Flow
$(150,000)

12%
Factor

Present
_Value

1.000

44,000

1-0.35

28,600

4.111

15,000

0.35

5,250

0.893

30,000

0.35

10,500

0.797

30,000

0.35

10,500

0.712

30,000

0.35

10,500

0.636

30,000

0.35

10,500

0.567

15,000

0.35

5,250

0.507

14,000

1-0.35

9,100

0.507
$

Project B would be preferable to Project A using the net present

value method.
b.

Profitability index = present value of cash inflows/investment

For Project A:
For Project B:

profitability index = 107,016/100,000 = 1.070.

profitability index = 157,256/150,000 = 1.048.

Project A is preferred using the profitability index.

85.
Hard

Roy Company is trying to decide whether to invest in one of two

projects, X and Z. Data for each investment project follow:

Cost of equipment .....................

Useful life ...........................
Estimated net annual cash inflow ......
Salvage value at the end of useful life

$
6
$
$

Project
X
Z
90,000
$140,000
years
6 years
25,000
$ 30,000
8,000
$ 12,000

The equipment for each project is in the MACRS 5-year property

class. Roy uses the optional straight-line method for
calculating depreciation. The tax rate is 35%. Roy's cost of
capital is 12%.
Required:
63 ManagerialAccounting,9/e

a. Compute the net present value of each project and indicate

which appears preferable in terms of net present value.
Round all computations to the nearest dollar.
b. Compute the profitability index for each project, and
indicate which project would be preferable using this
investment criterion.

ManagerialAccounting,9/e

64

Answer:
a.
Project X:
Year

Cost of
equipment
0
Annual
savings ... 1-6
Depreciation:
90,000 x 0.1 1
90,000 x 0.2 2
90,000 x 0.2 3
90,000 x 0.2 4
90,000 x 0.2 5
90,000 x 0.1 6
Salvage ..... 6
Net present value

Cash Flow

Tax
Effect

After-tax
Cash Flow

12%
Factor

Present
_Value

$(90,000)

$(90,000)

1.000

$(90,000)

25,000

1-0.35

16,250

4.111

66,804

9,000
18,000
18,000
18,000
18,000
9,000
8,000

0.35
0.35
0.35
0.35
0.35
0.35
1-0.35

3,150
6,300
6,300
6,300
6,300
3,150
5,200

0.893
0.797
0.712
0.636
0.567
0.507
0.507

2,813
5,021
4,486
4,006
3,572
1,597
2,636
$
935

Cash Flow

Tax
Effect

After-tax
Cash Flow

12%
Factor

Present
_Value

$(140,000)

$(140,000)

Project Z:
Year

Cost of
equipment
0
Annual
savings ... 1-6
Depreciation:
140,000 x 0.1 1
140,000 x 0.2 2
140,000 x 0.2 3
140,000 x 0.2 4
140,000 x 0.2 5
140,000 x 0.1 6
Salvage ..... 6
Net present value

1.000 $(140,000)

30,000

1-0.35

19,500

4.111

80,165

14,000
28,000
28,000
28,000
28,000
14,000
12,000

0.35
0.35
0.35
0.35
0.35
0.35
1-0.35

4,900
9,800
9,800
9,800
9,800
4,900
7,800

0.893
0.797
0.712
0.636
0.567
0.507
0.507

4,376
7,811
6,978
6,233
5,557
2,484
3,955
$(22,441)

Project X would be preferable to Project Z using the net present

value method.
b.

Profitability index = present value of cash inflows/investment

For Project X:
For Project Z:

profitability index = 90,935/90,000 = 1.010.

profitability index = 117,559/140,000 = 0.840.

Project X is preferred using the profitability index.

65 ManagerialAccounting,9/e

86.
Hard

Vasquez Company has been offered a 7-year contract to supply a

part to a major aircraft manufacturer. After careful study, the
company has developed the following data relating to the
contract:
Cost of equipment needed ........................... $300,000
Working capital needed to carry inventories ........
50,000
Annual before-tax cash receipts from delivery
of parts, less related cash operating costs .....
90,000
Salvage value of equipment at
termination of the contract ............. .......
10,000
The equipment above would be in the MACRS 5-year property
class. The contract is not expected to be extended beyond the
initial contract period. The company's cost of capital is 10%
and the tax rate is 35%.
Required:
Use net present value analysis to determine if the contract
should be accepted. Round all computations to the nearest
dollar.
Answer:
Year
Cost of
equipment ... 0
$(300,000)
Working capital
needed .... 0
(50,000)
Annual
savings ..... 1-7
Depreciation:
300,000 x 0.200 1
300,000 x 0.320 2
300,000 x 0.192 3
300,000 x 0.115 4
300,000 x 0.115 5
300,000 x 0.058 6
Salvage ....... 7
Working capital
released .... 7
Net present value

Cash Flow

Tax
After-tax
Effect Cash Flow

10%
Factor

Present
Value

$(300,000)

$(300,000)

1.000

(50,000)

(50,000)

1.000

90,000

1-0.35

58,500

4.868

284,778

60,000
96,000
57,600
34,500
34,500
17,400
10,000

0.35
0.35
0.35
0.35
0.35
0.35
1-0.35

21,000
33,600
20,160
12,075
12,075
6,090
6,500

0.909
0.826
0.751
0.683
0.621
0.564
0.513

19,089
27,754
15,140
8,247
7,499
3,435
3,334

50,000

50,000

0.513

25,650
$ 44,926

The contract should be accepted, since the project has a

positive net present value.

ManagerialAccounting,9/e

66

87.
Medium

A company is considering purchasing an asset for $50,000 which

would have a useful life of 4 years. The asset belongs to the
MACRS 3 year property class and would be depreciated for tax
purposes using the MACRS optional straight-line method. The
asset would generate annual net cash inflows of $20,000
throughout its useful life. There would be a need for an
increase in working capital of $2,000 which would be released
at the end of the project. The asset's salvage value would be
$5,000. The company's tax rate is 40% and its discount rate is
10%.
Required:
What is the net present value of the project?
Answer:

88.
Medium

Years
Cost of asset ............. Now
Working capital needed .... Now
Net annual cash inflows ... 1-4
Depreciation tax shield:
1
2
3
4

Amount
$(50,000)
$ (2,000)
$ 12,000

10%
Factor
1.000
1.000
3.170

Present
Value
$(50,000)
$ (2,000)
$ 38,040

$
$
$
$

3,333
6,667
6,667
3,333

0.909
0.826
0.751
0.683

$ 3,030
$ 5,507
$ 5,007
$ 2,277
$ 15,821

Salvage value .............

Working capital released ..
Net present value .........

$
$

3,000
2,000

0.683
0.683

$
$
$

4
4

2,049
1,366
5,276

A company is considering purchasing an asset for $60,000 which

would have a useful life of 5 years. The asset belongs to the
MACRS 3 year property class and would be depreciated for tax
purposes using the MACRS tables. The asset would generate
annual net cash inflows of $26,000 throughout its useful life.
There would be a need for an increase in working capital of
$6,000 which would be released at the end of the project. The
asset's salvage value would be $8,000. The company's tax rate
is 40% and its discount rate is 12%.
Required:
What is the net present value of the project?

Answer:
67 ManagerialAccounting,9/e

Years
Cost of asset ........... Now
Working capital needed .. Now
Net annual cash inflows
1-5
Depreciation tax shield:
1
2
3
4

Amount
$(60,000)
$ (6,000)
$ 15,600

12%
Factor
1.000
1.000
3.605

Present
Value
$(60,000)
$ (6,000)
$ 56,238

$ 7,992
$ 10,680
$ 3,552
$ 1,776

0.893
0.797
0.712
0.636

$ 7,137
$ 8,512
$ 2,529
$ 1,130
$ 19,308

Salvage value ...........

Working capital released
Net present value .......

$
$

0.567
0.567

$ 2,722
$ 3,402
$ 15,670

ManagerialAccounting,9/e

5
5

4,800
6,000

68