Question

6.         If the internal rate of return is the same as the minimum required rate of return used to compute the net present value of a proposed machine purchase, then the net present value will be:

            a. positive.                                        c.   zero.

            b. negative.                                       d.   unknown.

7.         The Valentine Company has decided to buy a machine costing $14,750. Estimated cash savings from using the new machine amount to $4,500 per year. The machine will have no salvage value at the end of its useful life of five years. The machine’s internal rate of return is closest to:

            a.   10%.                                             c.   14%.

           b. 12%.                                                d.   16%.

8.             A new machine costing $750,000 will yield cash savings of $250,000 each year for four years. In addition,
it is anticipated that the new machine will increase productivity and that the company will experience an
increase in contribution margin as a result. What annual dollar inflow from increased contribution margin would the company have to experience to make the machine an acceptable investment if the minimum desired rate of return is 18%?

                a. $28,810.41     b. $62,500.00     c. $77,500.00     d. $39,687.14

9.         The payback period of an investment is useful in determining its:

a. net present value.

b. overall profitability.

c. acceptability, if the company has an alternate future need for the invested funds.

10.      Jacobs Co. is considering buying several specialized tools at a cost of $5,000. The new tools will save the company $1,500 in manufacturing costs each year and are expected to last 4 years. Assume salvage is $0 and the tax rate is 34%. Jacobs Co. uses MACRS 200% Declining Balance method to compute depreciation for income tax purposes. The 200% Declining Balance depreciation rates are: 33.3% in year 1, 44.5% in year 2, 14.8% in year 3, and 7.4% in year 4. Using a minimum desired after-tax rate of return of 12%, the net present value of the tool purchase would be: (include the effects of taxes)

a. $124.69                                b. ($625.76)                          c. ($437.95)                          d. $836.47

11.      Refer to #10 above. Assume salvage is $1,000 and that Jacobs uses the straight-line method to compute depreciation for tax purposes. For tax purposes, these tools will be depreciated over a 3-year life under the assumption they were purchased mid-way through the first year and that residual value is $0 (Hint: use depreciation rates of 1/6 in year 1, 1/3 in year 2, 1/3 in year 3, and 1/6 in year 4). Using a minimum desired after-tax rate of return of 10%, the net present value of the tool purchase would be: (include the effects of taxes)

a. ($379.28)                             b. $986.34                             c. ($66.22)                            d. $125.72

Answer 1

Q6. Internal rate of return refers to rate of interest where Net Present Value is Zero (NPV is zero).

Therefore, where internal rate of return is same as minimum required rate, NPV shall be zero.

Answer is - c. zero

Q7. As is given in the question, Initial cost of the machine is $14750 and estimated cash savings each year is $4500 and salvage value is zero. Estimated useful life is 5 years.

Therefore, IRR would be the rate where PVAF (5 years, x%) = 14750/4500 = 3.278

Now, PVAF (Present Value Annuity Factor) for 5 year of all the given options is calculated as follows-

1. 10% - 3.790

2. 12% - 3.605

3. 14% - 3.433

4. 16% - 3.274

Hence, PVAF for 5 years at 16% is approximately equal to 3.278. Therefore, answer is d.16%

Q8. Given required rate of return = 18%, to justify the project company needs to have the present value of savings which equals the value of initial investment.

Initial Investment = $ 750000

Present Value Annuity Factor for 4 years @ 18% = 2.6900

Annual savings required = $ 750000/2.6900 = 278810.40

Out of this savings made in cash are $ 250000, therefore balance cashflow has to be saved from increased efficiency. i.e. 278810.40 - 250000 = 28810.41.

Therefore, answer to the question is a) 28810.41.

Q9. Payback period is useful in determining project when -

answer is c) acceptability, if the company has an alternate future need for the invested funds.

Reasons: Net present value principle only discounts the cashflows to its net present amount, it is independent irrespective of payback period. It does not take into account payback period. so it is eliminated.

Payback is calculated projectwise and furthermore payback is calculated in no of years rather than amount hence it does not take into account profitability. This option is eliminated.

when the company has alternative use of funds but the requirements of the alternative uses are not immediate but they are a little delayed. In such a situation company can check with the help of payback period which funds will be available by then.