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Principles of Accounting, Volume 2: Managerial Accounting

Problem Set A

Principles of Accounting, Volume 2: Managerial AccountingProblem Set A
PA 1.

LO 11.2Your company is planning to purchase a new log splitter for its lawn and garden business. The new splitter has an initial investment of $180,000. It is expected to generate $25,000 of annual cash flows, provide incremental cash revenues of $150,000, and incur incremental cash expenses of $100,000 annually.

What is the payback period and accounting rate of return (ARR)?

PA 2.

LO 11.2Jasmine Manufacturing is considering a project that will require an initial investment of $52,000 and is expected to generate future cash flows of $10,000 for years 1 through 3, $8,000 for years 4 and 5, and $2,000 for years 6 through 10. What is the payback period for this project?

PA 3.

LO 11.3Use the tables in Appendix B to answer the following questions.

  1. If you would like to accumulate $2,500 over the next 4 years when the interest rate is 15%, how much do you need to deposit in the account?
  2. If you place $6,200 in a savings account, how much will you have at the end of 7 years with a 12% interest rate?
  3. You invest $8,000 per year for 10 years at 12% interest, how much will you have at the end of 10 years?
  4. You win the lottery and can either receive $750,000 as a lump sum or $50,000 per year for 20 years. Assuming you can earn 8% interest, which do you recommend and why?
PA 4.

LO 11.3Ralston Consulting, Inc., has a $25,000 overdue debt with Supplier No. 1. The company is low on cash, with only $7,000 in the checking account and does not want to borrow any more cash. Supplier No. 1 agrees to settle the account in one of two ways:

Option 1: Pay $7,000 now and $23,750 when some large projects are finished, two years from today.

Option 2: Pay $35,000 three years from today, when even larger projects are finished.

Assuming that the only factor in the decision is the cost of money (8%), which option should Ralston choose?

PA 5.

LO 11.4Falkland, Inc., is considering the purchase of a patent that has a cost of $50,000 and an estimated revenue producing life of 4 years. Falkland has a cost of capital of 8%. The patent is expected to generate the following amounts of annual income and cash flows:

Year 1, 2, 3, and 4 respectively: Net Income: $5,100, 6,500, 6,300, 3,000; Operating cash flows: $17,050, 18,450, 18,250, 14,850.
  1. What is the NPV of the investment?
  2. What happens if the required rate of return increases?
PA 6.

LO 11.4There are two projects under consideration by the Rainbow factory. Each of the projects will require an initial investment of $35,000 and is expected to generate the following cash flows:

First year, Second Year, Third Year, Total (respectively): Alpha Project: 32,000, 22,500, 5,000, 59,500. Beta Project: 7,500, 23,500, 28,000, 59,000.

If the discount rate is 12%, compute the NPV of each project.

PA 7.

LO 11.4There are two projects under consideration by the Rainbow factory. Each of the projects will require an initial investment of $35,000 and is expected to generate the following cash flows:

First year, Second Year, Third Year, Total (respectively): Alpha Project: 32,000, 22,500, 5,000, 59,500. Beta Project: 7,500, 23,500, 28,000, 59,000.

Use the information from the previous exercise to calculate the internal rate of return on both projects and make a recommendation on which one to accept. For further instructions on internal rate of return in Excel, see Appendix C.

PA 8.

LO 11.4Pompeii’s Pizza has a delivery car that it uses for pizza deliveries. The transmission needs to be replaced and there are several other repairs that need to be done. The car is nearing the end of its life, so the options are to either overhaul the car or replace it with a new car. Pompeii’s has put together the following budgetary items:

Present Car: Transmission replacement and other work needed $8,500, annual Cash Operating Cost $12,500, Fair Market Value Now $5,000, FMV in five more years $500. New Car: Purchase cost new $31,000, Annual Cash Operating Cost 10,000, FMV in five more years $5,000.

If Pompeii’s replaces the transmission of the pizza delivery vehicle, they expect to be able to use the vehicle for another 5 years. If they sell the old vehicle and purchase a new vehicle, they will use that vehicle for 5 years and then trade it in for another new pizza delivery vehicle. If they trade for the new delivery vehicle, their operating expenses will decrease because the new vehicle is more gas efficient and the maintenance on a new car is less. This project is analyzed using a discount rate of 12%. What should Pompeii’s do?

PA 9.

LO 11.4Pitt Company is considering two alternative investments. The company requires a 12% return from its investments. Neither option has a salvage value.

Project X, Project Y, Respectively. Initial Investment $180,000, 118,000. Net cash flows anticipated in year: 1, 82,000, 35,000; 2, 59,000, 55,000; 3, 92,000, 72,000; 4, 81,000, 68,000; 5, 76,000, 27,000.

Compute the IRR for both projects and recommend one of them. For further instructions on internal rate of return in Excel, see Appendix C.

PA 10.

LO 11.5The Ham and Egg Restaurant is considering an investment in a new oven that has a cost of $60,000, with annual net cash flows of $9,950 for 8 years. The required rate of return is 6%. Compute the net present value of this investment to determine whether or not you would recommend that Ham and Egg invest in this oven.

PA 11.

LO 11.5Gallant Sports is considering the purchase of a new rock-climbing facility. The company estimates that the construction will require an initial outlay of $350,000. Other cash flows are estimated as follows:

Year 1 ($60,000). Year 2 $140,000. Year 3 $210,000. Year 4 $130,000.

Assuming the company limits its analysis to four years due to economic uncertainties, determine the net present value of the rock-climbing facility. Should the company develop the facility if the required rate of return is 6%?

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