Managerial Accounting

Managerial Accounting

Problem 1
1. Find a Blog that relates to accounting or business – put the address of the blog in the form below
2. Tell me about one entry in the blog that occurred in the month of August or September.
Your Name
Accounting/Business Blog
Accounting/Business Blog Address:
Tell me about one entry on the blog and what
you thought of it.
Problem 2
3. Go to the Hershey plant tour at: http://www.hersheys.com/ads-and-videos/how-we-make-chocolate.aspx
4. Watch the videos 1 through 7 (if you are unable to figure out how to view the video on your computer, you may
read the print version)
5. Answer the following questions in the form below
a. Who are the suppliers to Hershey (they are a part of the value chain – see chapter one for definition of
value chain.)
b. List 3 direct materials in making the chocolate almond bar shown in the video
c. List 3 types of manufacturing overhead shown in the video
Hershey Video
Who are the suppliers to Hershey (they are a
part of the value chain – see chapter one for
definition of value chain.)
List 3 direct materials in making the chocolate
almond bar shown in the video
1
2
3
List 3 types of manufacturing overhead shown in
the video
1
2
3
Problem 3
Understanding Cost
ANALYZE A COST ISSUE.
Find an article from one of the newspapers below that deals with an issue related to costs.
IN YOUR OWN WORDS:
• describe the cost object
• determine the direct costs of the cost object
• are there indirect costs – and if so, how are these indirect costs being allocated to the cost object
• complete the table below
• any suggestions to improve the quality of the discussion
Possible Newspapers:
USA Today, The St. Louis Post Dispatch, The New York Times, The Wall Street Journal, The Washington Post
Newspaper
Date
Title of Article
Describe the cost object
Determine the direct costs of the cost object
What are the Indirect Costs
How are they being allocated
Suggestions
Managerial Accounting
Application Assignment 2
Assignment is due on November 29 in the Drop Box
Problem 1
Prepare the appropriate journal entries or calculations in good form – consider using an excel spreadsheet
1. The company estimated $800,000 in overhead and 100,000 of machine hours
2. Raw materials purchased on account $370,000
3. Raw materials used in production $190,000 of which $178,000 are direct materials & $12,000 are indirect
4. Direct labor of $90,000 and indirect of $110,000 is incurred
5. Depreciation of factory equipment is $40,000
6. Other manufacturing overhead costs are $70,000
7. There were 30,000 of machine hours worked.
8. Production orders of $520,000 were completed
9. $480,000 of goods were shipped at a sale price of 25% above cost (record both the sale and movement of
goods.)
Problem 2
1. The C&C candy company uses machine hours to allocate manufacturing overhead. The company estimates
$150,000 worth of manufacturing overhead and 3,000 machine hours.
2. The batch ticket for Batch 126 reveals the following information
3,000 oz of chocolate at 50 cents per ounce
400 hours of direct labor at $15 per hour
180 machine hours
82,500 candy bars were produced.
REQUIRED: DETERMINE THE COST OF ONE BAR
You may want to use a job cost sheet
Managerial Accounting
Application Assignment 3
Assignment is due on November 29 in the Drop Box
Problem 1 Quality Cost Report
Diego Enterprises was a pioneer in designing and producing precision surgical lasers. Diego’s
product was brilliantly designed, but the manufacturing process was neglected by management
with a consequence that quality problems have been chronic. When customers complained about
defective units, Diego would simply send out a repairperson or replace the defective unit with a
new one. Recently, several competitors came out with similar products without Diego’s quality
problems, and as a consequence Diego’s sales have declined.
To rescue the situation, Diego embarked on an intensive campaign to strengthen its quality
control at the beginning of the current year. These efforts met with some success—the
downward slide in sales was reversed, and sales grew from $95 million last year to $100 million
this year. To help monitor the company’s progress, costs relating to quality and quality control
were compiled for last year and for the first year of the quality campaign this year. The costs,
which do not include the last sales due to a reputation for poor quality, appear below:
Required:
1. Prepare a quality cost report for both
a. 2012 and
b. 2013. (Carry percentage computations to two decimal places.)
Cost (in thousands)

Product recalls $ 3,500.00 $ 600.00
Systems development $ 120.00 $ 680.00
Inspection $ 1,700.00 $ 2,770.00
Net cost of scrap $ 800.00 $ 1,300.00
Supplies used in testing $ 30.00 $ 40.00
Warranty repairs $ 3,300.00 $ 2,800.00
Rework labor $ 1,400.00 $ 1,600.00
Statistical process control $ – $ 270.00
Customer returns of defective goods $ 3,200.00 $ 200.00
Cost of testing equipment $ 270.00 $ 390.00
Quality engineering $ 1,080.00 $ 1,650.00
Downtime due to quality problems $ 600.00 $ 1,000.00
Managerial Accounting
Application Assignment 4
Assignment is due on November 29 in the Drop Box
Problem 1- Tops and Seals
Computing ABC Product Costs
Performance Products Corporation makes two products, Titanium Tops and Silicone Seals. Data
regarding the two products follow:
Direct Labor-Hours
per Unit
Annual Production
Tops…….. 0.40 20,000 Units
Seals……. 0.20 80,000 Units
Additional information about the company follows:
a. Tops require $17 in direct materials per unit, and Seals require $10.
b. The direct labor wage rate is $16 per hour.
c. Tops are more complex to manufacture than Seals, and they require special equipment.
d. The ABC system has the following activity cost pools:
Activity
Cost Pool
Activity
Measure
Estimated
Overhead Cost
Activity
Tops Seals Total
Machine setups….. Number of setups $21,600 100 80 180
Special processing….. Machine-hours $180,000 4,000 0 4,000
General factory….. Direct labor-hours $288,000 8,000 16,000 24,000
Required:
1. Compute the activity rate for each activity cost pool.
2. Determine the unit cost of each product according to the ABC system, including direct materials
and direct labor.
Managerial Accounting
Application Assignment 4 continued
Assignment is due on November 29 in the Drop Box
Problem 2
Diner Question – Calculating and Interpreting Activity-Based Costing Data
Sven’s Cookhouse is a popular restaurant located on Lake Union in Seattle. The owner of the restaurant has been
trying to better understand costs at the restaurant and has hired a student intern to conduct an activity-based
costing study. The intern, in consultation with the owner, identified three major activities. She then completed the
first stage allocations of cost to the activity cost pools, using data from last month’s operations. The results appear
below:
Activity Cost Pool Activity Measure Total Cost Total Activity
Serving a party of diners….. Number of parties served $12,000 5,000 parties
Serving a diner….. Number of diners served $90,000 12,000 diners
Serving a drink….. Number of drinks served $26,000 10,000 drinks
The above costs include all of the costs of the restaurant except for organization-sustaining costs such as rent,
property taxes, and top-management salaries. A group of diners who ask to sit at the same table are counted as a
party. Some costs, such as the costs of cleaning linen, are the same whether one person is at a table or the table is
full. Other costs, such as washing dishes, depend on the number of diners served.
Prior to the activity-based costing study, the owner knew very little about the costs of the restaurant. He knew that
that total cost for the month (including organization-sustaining costs) was $180,000 and that 12,000 diners had
been served. Therefore, the average cost per diner was $15.
Required:
1. According to the activity-based costing system, what is the total cost of serving each of the following parties of
diners?
a. A party of four diners who order three drinks in total.
b. A party of two diners who do not order any drinks.
c. A lone diner who orders two drinks.
2. Convert the total costs you computed in (1) above to costs per diner. In other words, what is the average cost
per diner for serving each of the following parties?
a. A party of four diners who order three drinks in total.
b. A party of two diners who do not order any drinks.
c. A lone diner who orders two drinks.
3. Why do the costs per diner for the three different parties differ from each other and from the overall average
cost of $15.00 per diner?
Managerial Accounting
Application Assignment 4 continued
Assignment is due on November 29 in the Drop Box
Problem 3 Wild
Determine product cost
Wild Products has a total of $1,551,000 in overhead costs. The company only produces two products (A & B) The
Company’s products and related statistics follow.
Product A Product B
Direct material (in pounds) 93,000 127,000
Direct labor hours 20,000 25,000
Machine hours 35,000 15,000
Number of setups 200 500
Number of units produced 10,000 5,000
Additional data: One direct labor hour costs $12 for total direct labor cost of $540,000 and the 220,000 pounds of
material were purchased for $363,000.
USE EXCEL!
a. Assume that Wild Products uses direct labor hours to apply overhead to products. Determine the total cost
for each product and the cost per unit.
b. Assume that Wild Products uses machine hours to apply overhead to products. Determine the total cost for
each product and the cost per unit.
c. Assume that Wild Products uses the following activity centers, cost amounts, and activity drivers to apply
overhead to products.
Cost Pool Cost Driver Cost Volume
Utilities # of machine hours $500,000 50,000
Setup # of setups 105,000 700
Material handling pounds of material 946,000 220,000
Determine the total cost for each product and the cost per unit.
Put your answers in the chart below
Product A Product B
Method used to allocate MOH Total Cost Unit Cost Total Cost Unit Cost
Direct Labor Hours
Machine Hours
ABC
Managerial Accounting
Application Assignment 4 continued
Assignment is due on November 29 in the Drop Box
Problem 4 ABC and Banking
Friendly Bank is developing an activity-based cost system for its teller department. A task
force has identified five different activities: (1) process deposits, (2) process withdrawals, (3)
answer customer inquiries, (4) sell negotiable instruments, and (5) balance drawers. By tracing
the costs of operating the teller department to these five activities, the task force complied the
following information regarding support costs and activities for one of its suburban branches:
Support
Activity
Estimated
Cost Activity Cost Driver Quantity
Purchase deposits $29,630 Number of deposits processed 33,250
Process withdrawals 26,080 Number of withdrawals processed 22,750
Answer inquires 24,860 Number of customer inquiries 45,000
Sell negotiable
instruments 4,860 Number of negotiable instruments sold 1,100
Balance drawers 4,290 Number of drawers balanced 1,300
$89,720
Required
(a)Compute the activity cost driver rates for each of the support activities. USE EXCEL!
(b) The task force has developed the following list of activities for a typical checking account marketed to retired
persons:
Support Activity Average Monthly Volume
Purchase deposits 2.3 deposits
Process withdrawals 6.0 withdrawals
Answer customers inquires 2.1 inquires
Sell negotiable instruments 0.5 instruments sold
Estimate the total monthly support costs for this checking account product.
USE EXCEL!
Managerial Accounting
Application Assignment 5
Assignment is due on November 29 in the Drop Box
Problem 1
The data below have been taken from the cost records of the Ivanhoe Book Company. The data relate to the cost of
operating one of the company’s processing facilities at various levels of activity:
Month
Books
Processed
Total Cost
January….. 8,000 $16,000
February….. 4,500 $10,000
March….. 7,000 $12,500
April….. 9,000 $15,500
May….. 3,750 $7,000
June….. 6,000 $12,500
July….. 3,000 $8,500
August….. 5,000 $11,500
Required:
1. Using the high low method, what is the approximate monthly fixed cost? The approximate variable cost per unit
processed?
2. What would you expect total fixed costs to be with 5500 books processed?
3. What would you expect total variable costs to be with 5500 books processed?
4. What would you expect total costs to be with 5500 books processed?
Managerial Accounting
Application Assignment 5 continued
Assignment is due on November 29 in the Drop Box
Problem 2
The Shangri La Spa, has accumulated records of the total electrical costs of the hotel and the number of occupancy-days
over the last year. An occupancy-day represents a room rented out for one day. The hotel’s business is highly seasonal,
with peaks occurring during the ski season and in the summer.
Month
Occupancy
Days
Electrical
Costs
January….. 2,604 $6,257
February….. 2,856 $6,550
March….. 3,534 $8,986
April….. 1,440 $4,022
May….. 540 $1,289
June….. 1,116 $3,591
July….. 3,162 $7,264
August….. 3,608 $8,111
September….. 1,260 $3,707
October….. 186 $1,712
November….. 1,080 $3,321
December….. 2,046 $5,196
Required:
1. Using the high-low method, estimate the fixed cost of electricity per month and the variable cost of electricity
per occupancy-day. Round off the fixed cost to the nearest whole dollar and the variable cost to the nearest
whole cent.
2. What other factors other than occupancy-days are likely to affect the variation in electrical costs from month to
month?
3. Use Least Square to determine the model that predicts electricity for the Shangri La Spa.
Managerial Accounting
Application Assignment 5 continued
Assignment is due on November 29 in the Drop Box
Problem 3
Zerbel Company, a wholesaler of large, custom-built air conditioning units for commercial buildings, has noticed
considerable fluctuation in its shipping expense from month to month, as shown below:
Month
Units
Shipped
Total Shipping
Expense
January….. 4 $2,200
February….. 7 $3,100
March….. 5 $2,600
April….. 2 $1,500
May….. 3 $2,200
June….. 6 $3,000
July….. 8 $3,600
Required:
1. Using the high-low method, estimate the cost formula for shipping expense.
2. Using the least-squares regression method, estimate the cost formula for shipping expense.
3. What factors, other than the number of units shipped, are likely to affect the Zerbel’s shipping expense? Explain.
Problem 4
Speedy Parcel Service operates a fleet of delivery trucks in a large metropolitan area. A careful study by the company’s
cost analyst has determined that if a truck is driven 120,000 miles during a year, the average operating cost is 11.6 cents
per mile. If a truck is driven only 80,000 miles during a year, the average operating cost increases to 13.6 cents per mile.
Required:
1. Using the high-low method, estimate the variable and fixed cost elements of the annual cost of truck operation.
Express the variable and fixed costs in the form Y = a + bX
2. If a truck were driven 100,000 miles during a year, what total cost would you expect to be incurred?
Managerial Accounting
Application Assignment 5 continued
Assignment is due on November 29 in the Drop Box
Problem 5
Kiefer Hockey Corporation has a single product, a high powered hockey stick whose selling price is $140 and whose
variable cost is $60 per unit. The company’s monthly fixed expense is $40,000.
Required:
1. Solve for the unit sales that are required to earn a target profit of $6,000.
2. Solve for the dollar sales that are required to each a target profit of $8,000.
Problem 6
The Glee Club is planning its annual Riverboat Extravaganza. The Extravaganza committee has assembled the following
expected costs for the event:
Dinner (per person) $7
Favors and program (per person) $3
Band $1,500
Tickets and advertising $700
Riverboat rental $4,800
Floorshow and strolling entertainers $1,000
The committee members would like to charge $30 per person for the evening’s activities.
Required:
1. Compute the break-even point for the Extravaganza (in terms of the number of persons that must attend).
2. Assume that only 250 persons attended the Extravaganza last year. If the same number of guests attend this
year, what price per ticket must be charged to break even?
Managerial Accounting
Application Assignment 6
Assignment is due on November 29 in the Drop Box
Think about a situation where you might want to determine the price to charge for an event.
Type of Event
What type of variable costs would you expect?
What type of fixed costs would you expect?
What other factors would influence the amount
you would charge for the event?
Using the information above, develop a cost-volume-profit problem compete with estimated information. You may
expect that those solving the problem will find the price to charge, the number that must attend, and/or the profit
you will earn based upon the information you provide.
Include the solution.

Beginning Inventory 10,000 10,000 10,000
Merchandise Purchases 60,000 70,000 35,000
Sales 60,000 70,000 40,000
Ending Inventory 10,000 10,000 5,000
• Units are sold for $12 each. One fourth of all sales are paid for in the month of sale and the balance is paid in the
following month. Accounts receivable at September 30 totaled $450,000.
• Disbursements for Purchases: Merchandise is purchased for $7 per unit. Half of the purchases are paid for in the
month of the purchase and the remainder is paid in the month following the purchase. One half of these inventory
purchases are paid in the month in which they are incurred and the balance will be paid in the following month. The
accounts payable balance for purchases at September 30 is $230,000.
• Operation Expenses: Operation expenses are paid for in the month incurred. Selling expenses are $20,000 in cash.
Administrative expenses paid for in cash are expected to total $100,000 each month. Wages are $25,000 per month.
Depreciation is $30,000 per month and is not included above.
• Cash at September 30 totaled $100,000.
• Other: A payment of $90,000 for the purchase of equipment is scheduled for October, $148,000 for purchase of
equipment is scheduled for November, and a dividend of $240,000 is to be paid in December.
• Because of their shaky credit, interest is 12% (or 1% per month)
• Further, the company must maintain a minimum cash balance of $100,000. Borrowing and repayments must be in
multiples of $5,000. Interest is paid only when loans are repaid.
Required: For the month of October, November & December you are to prepare the:
a) Schedule Of Expected Cash Collections
b) Inventory Purchase Budget (see production information in table)
c) Schedule Of Cash Disbursements For Purchases
d) Schedule Of Cash Disbursements For Expenses
e) Cash Budget
f) Indicate Your Ending Cash Balance
g) Indicate the Amount of Any Loan Outstanding on December 31.
Managerial Accounting
Application Assignment 8
Assignment is due on November 29 in the Drop Box
Problem 1
Net Present Value Method
The management of Shiney Company, a wholesale distributor of suntan products, is considering the purchase of a
$25,000 machine that would reduce operating costs in its warehouse by $4,000 per year. At the end of the machine’s 10-
year useful life, it will have no scrap value. The company’s required rate of return is 12%.
Required:
(Ignore income taxes)
1. Determine the net present value of the investment in the machine using the model shown in class.
2. What is the difference between the total, undiscounted cash inflows and cash outflows over the entire life of the
machine?
3. What else should Shiney consider?
Problem 2 Greening 4You is investigating the purchase of automated equipment that would save $100,000 each year in
direct labor. This equipment costs $750,000 and is expected to have a 10-year useful life with no salvage value. The
company requires a minimum 15% rate of return on all equipment purchases. This equipment would provide intangible
benefits such as greater flexibility and higher-quality output that are difficult to estimate and yet are quite significant.
Required:
(Ignore income taxes)
1. What dollar value per year would the intangible benefits have to be worth in order to make the equipment an
acceptable investment?
Problem 3
(Ignore income taxes.) Consider each case below independently.
A. Von Gontard Law Firm’s required rate of return is 15%. The firm can purchase a new investigative computer service
from a private investigator for a one time a cost of $40,350. The new service would generate cash inflows of $15,000
per year and have would be operational for the next four years with no salvage value. Compute the net present
value of the service. Use the model outlined in class. Is the service an acceptable investment? Explain.
B. Leven Products, Inc., is investigating the purchase of a new energy-efficient cold coffee bottling machine that has a
projected life of 15 years. It is estimated that the machine will save $20,000 per year in cash operating costs. What is
the machine’s internal rate of return if it costs $111,500 new? Is the machine an acceptable investment? Explain.
What risks should be included?
C. Sunset Press has just purchased a new system that will it allow it to publish books and articles more efficiently. The
cost is $14,125. The machine is expected to save $2,500 per year in cash operating costs and to have a 10-year life.
Compute the machine’s internal rate of return. If the company’s required rate of return is 16%, did it make a wise
investment? Explain. What risks should the company consider?
Managerial Accounting
Application Assignment 8 Continue
Assignment is due on November 29 in the Drop Box
Problem 4
The management of Phoenix Inc., a jewelry design company, is considering an investment in a high-quality printer with
the following cash flows:
Year Investment
Cash
Inflow
1 $38,000 $2,000
2 $7,000 $8,000
3 $4,000
4 $6,000
5 $15,000
6 $10,000
7 $7,000
8 $6,000
9 $5,000
10 $1,000
Required:
1. Determine the payback period of the investment.
2. Would the payback period be affected if the cash inflow in the last year were $25,000?
Problem 5
Pointed Company has $15,000 to invest. The company is trying to decide between two alternative uses of the funds as
follows:
Invest in
Project A
Invest in
Project B
Investment required $15,000 $15,000
Annual cash inflows $4,000 $0
Single cash inflow at the end of 10 years $60,000
Life of the project 10 years 10 years
Pointed Company uses a 12% discount rate.
Required:
(Ignore income taxes.)
• Which investment would you recommend that the company accept? Show all computations using net present
value. Prepare separate computations for each investment.
• Which do you recommend and why?
Managerial Accounting
Application Assignment 8 Continue
Assignment is due on November 29 in the Drop Box
Problem 6
Scalia’s Cleaning Service is investigating the purchase of an ultrasound machine for cleaning window blinds. The machine
would cost $136,700, including invoice cost, freight, and training of employees to operate it. Scalia’s has estimated that
the new machine would increase the company’s cash flows, net of expenses, by $25,000 per year. The machine would
have a 14-year useful life with no expected salvage value.
Required:
(Ignore income taxes)
1. Compute the machine’s internal rate of return to the nearest whole percent.
2. Compute the machine’s net present value. Use a discount rate of 16% and the format we used in class. Why do
you have a zero net present value?
3. Suppose that the new machine would increase the company’s annual cash flows, net of expenses, by only
$20,000 per year. Under these conditions, compute the internal rate of return to the nearest whole percent.
Problem 7
Frank Clean is beginning a six year Ph.D. program in Management. He wants to open some type of small business
operation that can be document while he is in school, but close when he graduates. He is considering several investment
alternatives, one of which is to open a Singles Laundromat located right next to a popular bar and coffee shop. After
careful study, Mr. Clean has determined the following:
a. Washers, dryers, and other equipment needed to open the Laundromat would cost $194,000. In addition,
$6,000 in working capital would be required to purchase an inventory of soap, bleaches, and related items and to
provide change for change machines. (The soap, bleaches, and related items would be sold to customers at
cost.) After six years, the working capital would be released for investment elsewhere.
b. The Laundromat would charge $1.50 per use for the washers and $0.75 per use for the dryers. Mr. Clean expects
the Laundromat to gross $1,800 each week from the washers and $1,125 each week from the dryers.
c. The only variable costs in the Laundromat would be 7 ½ cents per use for water and electricity for the washers
and 9 cents per use for gas and electricity for the dryers.
d. Fixed costs would be $3,000 per month for rent, $1,500 per month for cleaning, and $1,875 per month for
maintenance, insurance, and other items.
e. The equipment would have a 10% disposal value in six years.
Mr. Clean will not open the Laundromat unless it provides at least a 12% return.
Required:
(Ignore income taxes.)
1. Assuming that the Laundromat would be open 52 weeks a year, compute the expected net annual cash receipts
from its operation (gross cash receipts less cash disbursements). (Do not include the cost of the equipment, the
working capital, or the salvage values in these computations.)
2. Compute the NPV of the investment.
3. What factors should be considered by Mr. Clean
4. What would you recommend he do?
5. Outline the decision model you are using to make your decision. For full credit – be sure to show all of the steps
of the decision model
Managerial Accounting
Application Assignment 9
Assignment is due on November 29 in the Drop Box
Problem 1 Net Present Value Analysis Including Income Taxes
Kramer Corporation is considering two investment projects, each of which would require $50,000. Cost and cash flow
data concerning the two projects are given below:
Project A Project B
Investment in high-speed photocopier $50,000
Investment in working capital $50,000
Net annual cash inflows $9,000 $7,000
Life of the project 8 years 8 years
Project A is the actual purchase of the copier and Project B is to lease the copier (therefore no depreciation, just and
required working capital set-aside required by the lease.) The high-speed photocopier would have a salvage value of
$5,000 in eight years if purchased (if the company does not own the copier, they would not be able to sell it.) For tax
purposes, the company computes depreciation deductions assuming zero salvage value and uses straight-line
depreciation. The photocopier would be depreciated over eight years. At the end of eight years, the investment in
working capital would be released for use elsewhere. The company requires an after-tax return of 10% on all
investments. The tax rate is 30%.
Required:
1. Compute the net present value of each investment project.
2. Which do you recommend?
Problem 2 Net Present Value Analysis Including Income Taxes
Very Fancy Foods hires homeless worker from the local church and homeless shelters to assist in the packaging of its
gourmet frozen meals. This procession is all done by hand, at a cost of $60,000 per year. A machine is available that
could be used in place of the homeless workers. The machine would cost $140,000 and have a 10-year useful life. It
would require an operator at an annual cost of $18,000 and have annual maintenance costs of $7,000. A major overhaul
would be needed on the machine in five years at a total cost of $20,000. The salvage value of the machine in 10 years
would be $40,000.
For tax purposes, the company computes depreciation deductions assuming zero salvage value and uses straightline
depreciation. The machine would be depreciated over 10 years. Management requires a 15% after-tax return on all
equipment purchases. The company’s tax rate is 30%.
Required:
1. Determine the before-tax net annual cost savings that the new machine will provide.
2. Compute the machine’s net present value.
3. Would you recommend that the machine be purchased?
4. Outline the decision model you are using to make your decision. For full credit – be sure to show all of the steps of the decision
model.
Managerial Accounting
Application Assignment 9 Continued
Assignment is due on November 29 in the Drop Box
Problem 3 Basic Net Present Value Analysis Including Income Taxes
Happy Day Child Services has been offered an eight-year contract to transport children to schools and day care centers
throughout Salem. The contract would require HDCS to purchase several new buses at a total cost of $450,000. Other
data relating to the contract follow:
Net annual cash receipts (before taxes) from the contract $115,000
Cost of overhauling the motors in the buses in five years $45,000
Salvage value of the buses at termination of the contract $20,000
If the contract were accepted, several old, fully depreciated buses would be sold at a total price of $30,000. These funds
would be used to help purchase the new trucks. For tax purposes, the company computes depreciation deductions
assuming zero salvage value and uses straight-line depreciation. The trucks would be depreciated over eight years. The
company requires a 12% after-tax return on all equipment purchases. The tax rate is 30%.
Required:
1. Compute the net present value of this investment opportunity.
2. Would you recommend that the contract be accepted? Explain your answer.
3. Assume that taxes are lowered to 20% to spur investment, would that change your recommendation?
Problem 4
The Fredrick Recycling is considering a new pallet distribution center for recycling pallets. Relevant information
is as follows:
• Cost $750,000
• Useful Life 4 years but depreciated for 3 years –
• Depreciation $250,000 a year for 3 years
• Salvage Value at end of 4 years $200,000 (when it will be sold)
• Pallet Sales related to the project will be
$300,000 in year 1,
$400,000 in year 2
$500,000 in year 3
$400,000 in year 4
• Cost of to Recycle the Pallets = 30% of sales related to the project
• Administrative cost can be expressed as:
Administrative Cost:
Variable costs = 10% (Sales related to the project)
Fixed Costs = $10,000
• Working Capital Required $100,000 (and returned at the end of the project)
• Tax rate 30%
• Cost of capital = 13%
Required:
1. Compute the net present value of the distribution center.
2. Compute the internal rate of return for the project.
3. Would you recommend it?