Question

1. Justine Ltd. wants to automate one of its production processes. The new equipment will cost $180,000. In addition, Justin will incur installation and testing costs of $5,000 and $8,500 respectively. The expected life of the equipment is 8 years and the salvage value of the equipment is estimated at $18,000. The annual cash savings are estimated at $32,000. The company's required rate of return is 14%. Ignore income taxes. What is the net present value of this investment?

A) ($25,246)

B) $80,500

C) ($11,746)

D) ($45,056)

E) ($38,746

2.

The Sandy Company produces three products-A, B, and C-from a single raw material input. Product A can be sold at the split-off point for $40,000, or it can be processed further at a total cost of $15,000 and then sold for $58,000. Joint product costs total $60,000 annually. What is the correct course of action regarding Product A?

		A) It should be discontinued since revenues after further processing are less than total joint product costs.
		B) It should be sold at the split-off point.
		C) It should be processed further and then sold.
		D) It should be processed further only if its share of the total joint product costs is less than the incremental revenues from further processing.

3.

Boston Ltd. is considering investing in a new piece of machinery for its factory. The machine costs $340,000 and is expected to last 7 years. It estimates that annual cash flows would be $82,000 and the equipment would have a salvage value of $13,000. The company's hurdle rate is 11%. What is the net present value of this investment? (Ignore income taxes.)

		A) $87,625
		B) $46,400
		C) $52,662
		D) $234,000
		E) $247,000

4.

York Company plans to discontinue a department that has a contribution margin of $24,000 and $48,000 in fixed costs. Of the fixed costs, $21,000 cannot be avoided. What would be the effect of discontinuing the department on York's overall operating income?

		A) An increase of $3,000.
		B) A decrease of $3,000.
		C) An increase of $24,000.
		D) A decrease of $24,000.

Answer 1

1.

Net present value = Present value of cash inflows - Initial investment

Present value of cash inflow = $32,000*4.63886(PVAF@14%, 8 years) + $18,000*0.35056(PVF@14%, 8th year)

Present value of cash inflow = $148,443.52 + $6,310.08 = $154,754

Net present value = $154,754 - 193,500 = ($38,746)

Hence option E is correct.

2.

	Product A
Sale value after further processing	$58,000
Sale value at split off point	40,000
Incremental sales	18,000
Less: Further processing cost	15,000
Incremental profit (loss)	$3,000

Product A should be processed further and sold.

Hence option C is correct.

3.

Net present value = Present value of cash inflows - Initial investment

Present value of cash inflows = $82,000*4.71220(PVAF@11%, 7 years) + $13,000*0.48166(PVF@11%, 7th year)

Present value of cash inflows = $386,400.4 + 6,261.58 = $392,662

Net present value = $392,662 - 340,000 = $52,662

Hence option C is correct.

4.

	Effect on operating income
Contribution margin	($24,000)
Avoidable fixed costs	21,000
Total	($3,000)

The effect of discontinuing the department on York's overall operating income is a decrease of $3,000.

Hence option B is correct.