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Exam 26: Incremental Analysis and Capital Budgeting

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Question 111

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If an incremental make or buy analysis indicates that it is cheaper to buy rather than make an item management should always make the decision to choose the lowest cost alternative.

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Question 112

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Rosco Manufacturing Company is considering three new projects each requiring an equipment investment of $20000. Each project will last for 3 years and produce the following cash inflows. $\begin{array}{crrr}\text { Year } & \mathrm{AA} &\mathrm{BB} & \mathrm{CC}\\\hline1 & \$ 7,000 & \$ 9,600 & \$ 11,000 \\2 & 9,000 & 9,600 & 10,000 \\3 &15,000&9,600&9,000\\\text { Total }&\$31,000&\$28,800&\$30,000\end{array}$ The equipment's salvage value is zero. Rosco uses straight-line depreciation. Rosco will not accept any project with a payback period over 2 years. Rosco 's minimum required rate of return is 12%. Instructions (a) Compute each project's payback period indicating the most desirable project and the least desirable project using this method. (Round to two decimals.) (b) Compute the net present value of each project. Does your evaluation change? (Round to nearest dollar.)

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The most desirable project is CC because...

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Question 113

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Downtown Unicycle Company has been manufacturing its own seats for its unicycles. The company is currently operating at 100% capacity and variable manufacturing overhead is charged to production at the rate of 70% of direct labor cost. The direct materials and direct labor cost per unit to make the bicycle seats are $8.00 and $9.00 respectively. Normal production is 50000 unicycles per year. A supplier offers to make the unicycle seats at a price of $20 each. If the unicycle company accepts this offer all variable manufacturing costs will be eliminated but the $30000 of fixed manufacturing overhead currently being charged to the unicycle seats will have to be absorbed by other products. Instructions (a) Prepare the incremental analysis for the decision to make or buy the bicycle seats. (b) Should Downtown Unicycle Company buy the seats from the outside supplier? Justify your answer.

FromZetherz Company produced and sold 50000 units of product and is operating at 80% of plant capacity. Unit information about its product is as follows: $\begin{array}{llr} \text { Sales Price } &&\$68\\ \text {Variable manufacturing cost } &\$42\\ \text { Fixed manufacturing cost (\$ 600,000 \div 50,000) } &12&54\\ \text { Profit per unit } &&\$14\end{array}$ The company received a proposal from a Danish company to buy 10000 units of FromZetherz Company's product for $49 per unit. This is a one-time only order and acceptance of this proposal will not affect the company's regular sales. The president of FromZetherz Company is reluctant to accept the proposal because he is concerned that the company will lose money on the special order. Instructions Prepare a schedule reflecting an incremental analysis of this proposal and indicate the effect the acceptance of this order might have on the company's income.

Management uses several capital budgeting approaches in evaluating projects for possible investment. Identify those approaches that are more desirable from a conceptual standpoint and briefly explain what features these approaches have that make them more desirable than other approaches. Also identify the least desirable approach and explain its major weaknesses.

Rumsy Company is considering buying equipment for $240000 with a useful life of five years and an estimated salvage value of $10000. If annual expected income is $21000 the denominator in computing the annual rate of return is

Which of the following stages of the management decision-making process is improperly sequenced?

Carelli Company has old inventory on hand that cost $36000. Its scrap value is $48000. The inventory could be sold for $120000 if manufactured further at an additional cost of $38000. What should Carelli do?

JP Company is considering two capital investment proposals. Estimates regarding each project are provided below: $\begin{array}{lr}&\text { Project Echo}&\text { Project Charlie }\\\text { Initial investment } & \$ 400,000&\$600,000 \\\text { Annual net income } & 20,000 &42,000\\\text { Net annual cash inflow } & 100,000&142,000 \\\text { Estimated useful life } & 5 \text { years } &6 \text { years } \\\text { Salvage value } & 0&0\end{array}$ The company requires an 11% rate of return on all new investments. $\begin{array}{lllll}\text { Periods } & 9 \%&10 \% &11 \% &12 \%\\\hline5 & 3.890 & 3.791 & 3.696 & 3.605 \\6 & 4.486 & 4.355 & 4.231 & 4.111\end{array}$ - The net present value for Project Charlie is

The annual rate of return technique requires dividing a project's annual cash inflows by the economic life of the project.

JK Company has a process that results in 15000 pounds of Product A that can be sold for $8 per pound. An alternative would be to process Product A further at a cost of $100000 and then sell it for $14 per pound. Should management sell Product A now or should Product A be processed further and then sold? What is the effect of the action?

Incremental analysis would be appropriate for

Sutton Inc. can produce 100 units of a component part with the following costs: $\begin{array} { l r } \text { Direct Materials } & \$ 130,000 \\\text { Direct Labor } & 103,000 \\\text { Variable Overhead } & 82,000 \\\text { Fixed Overhead } & 62,000\end{array}$ If Sutton Inc. can purchase the units externally for $300000 by what amount will its total costs change?

A major limitation of the annual rate of return approach is that it does not consider the _______________ of money.

Bayonette Inc. is considering Plan 1 which is estimated to have sales of $60000 and costs of $22500. The company currently has sales of $57000 and costs of $21500. Instructions Compare plans using incremental analysis.

In a decision to retain or replace old equipment the salvage value of the old equipment is relevant in incremental analysis.

Red Company produces 1000 units of a necessary component with the following costs: $\begin{array} { l r } \text { Direct Materials } & \$ 34,000 \\\text { Direct Labor } & 15,000 \\\text { Variable Overhead } & 8,000 \\\text { Fixed Overhead } & 10,000\end{array}$ Red's Company could avoid $6000 in fixed overhead costs if it acquires the components externally. If cost minimization is the major consideration and the company would prefer to buy the components what is the maximum external price that Red Company would accept to acquire the 1000 units externally?