Chapter 13

Capital Budgeting Decisions

Solutions to Questions

13-1 A capital budgeting screening 13-7 One assumption is that all cash
decision is concerned with whether a flows occur at the end of a period. Another
proposed investment project passes a is that all cash inflows are immediately
preset hurdle, such as a 15% rate of reinvested at a rate of return equal to the
return. A capital budgeting preference discount rate.
decision is concerned with choosing from
among two or more alternative investment 13-8 No. The cost of capital is not simply
projects, each of which has passed the the interest paid on long-term debt. The
hurdle. cost of capital is a weighted average of
the costs of all sources of financing, both
13-2 The “time value of money” refers debt and equity.
to the fact that a dollar received today is
more valuable than a dollar received in 13-9 The internal rate of return is the
the future simply because a dollar rate of return on an investment project
received today can be invested to yield over its life. It is computed by finding the
more than a dollar in the future. discount rate that results in a zero net
present value for the project.
13-3 Discounting is the process of
computing the present value of a future 13-10 The cost of capital is a hurdle that
cash flow. Discounting gives recognition to must be cleared before an investment
the time value of money and makes it project will be accepted. (a) In the case of
possible to meaningfully add together the net present value method, the cost of
cash flows that occur at different times. capital is used as the discount rate. If the
net present value of the project is positive,
13-4 Accounting net income is based on then the project is acceptable because its
accruals rather than on cash flows. Both rate of return is greater than the cost of
the net present value and internal rate of capital. (b) In the case of the internal rate
return methods focus on cash flows. of return method, the cost of capital is
compared to a project’s internal rate of
13-5 Unlike other common capital return. If the project’s internal rate of
budgeting methods, discounted cash flow return is greater than the cost of capital,
methods recognize the time value of then the project is acceptable.
money and take into account all future
cash flows. 13-11 No. As the discount rate increases,
the present value of a given future cash
13-6 Net present value is the present flow decreases. For example, the present
value of cash inflows less the present value factor for a discount rate of 12% for
value of the cash outflows. The net cash to be received ten years from now is
present value can be negative if the 0.322, whereas the present value factor
present value of the outflows is greater for a discount rate of 14% over the same
than the present value of the inflows. period is 0.270. If the cash to be received
in ten years is $10,000, the present value

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 1
in the first case is $3,220, but only $2,700 the more desirable is the investment
in the second case. Thus, as the discount project.
rate increases, the present value of a
given future cash flow decreases. 13-14 The payback period is the length of
time for an investment to fully recover its
13-12 The internal rate of return is more initial cost out of the cash receipts that it
than 14% because the net present value is generates. The payback method is used as
positive. The internal rate of return would a screening tool for investment proposals.
be 14% only if the net present value The payback method is useful when a
(evaluated using a 14% discount rate) is company has cash flow problems. The
zero. The internal rate of return would be payback method is also used in industries
less than 14% if the net present value where obsolescence is very rapid.
(evaluated using a 14% discount rate) is
negative. 13-15 Neither the payback method nor
the simple rate of return method considers
13-13 The project profitability index is the time value of money. Under both
computed by dividing the net present methods, a dollar received in the future is
value of the cash flows from an weighed the same as a dollar received
investment project by the required today. Furthermore, the payback method
investment. The index measures the profit ignores all cash flows that occur after the
(in terms of net present value) provided initial investment has been recovered.
by each dollar of investment in a project.
The higher the project profitability index,

© The McGraw-Hill Companies, Inc., 2012

2 Managerial Accounting, 14th Edition
Chapter 13: Applying Excel
The completed worksheet is shown below.

Note: Your worksheet may differ from the above in rows 29 and
30. The worksheet above has been set to use the rounded-off
discount factors rather than more exact factors without rounding.
For example, the factor 0.519 is rounded off from 0.519368664. If
the more exact factor is used to calculate the present value of the
$150,000 total cash flow at the end of year 5, the answer is
$77,905 rather than $77,850. These rounding errors cumulate so
that the more exact net present value is $31,493 rather than the
$31,410 as displayed. Either answer is okay.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 3
Chapter 13: Applying Excel (continued)
The completed worksheet, with formulas displayed, is shown
below.

© The McGraw-Hill Companies, Inc., 2018

4 Managerial Accounting, 16th Edition
Chapter 13: Applying Excel (continued)
1. With the change in the discount rate, the result is:

The net present value increases because the positive cash

inflows occur in the future. When the discount rate decreases,
the future cash flows have a larger present value.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 5
Chapter 13: Applying Excel (continued)
2. For the new project, the worksheet should look like this:

© The McGraw-Hill Companies, Inc., 2018

6 Managerial Accounting, 16th Edition
Chapter 13: Applying Excel (continued)
a. The net present value of the project is $(17,340). Again, your
answer may differ due to the precision of the calculations.

b. Increasing the discount rate results in making the negative

net present value even more negative. Decreasing the
discount rate improves the net present value. It turns
positive when decreasing the discount rate from 11% to 10%
as shown below.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 7
Chapter 13: Applying Excel (continued)
c. The internal rate of return is the discount rate at which the
net present value is zero. This occurs somewhere between
the discount rates 10% and 11%. The net present value at
10% is $5,330 as shown above. The net present value at
11% is $(740) as shown below. Therefore, the internal rate of
return is between 10% and 11%.

© The McGraw-Hill Companies, Inc., 2018

8 Managerial Accounting, 16th Edition
Chapter 13: Applying Excel (continued)
d. The amount of future uncertain salvage value that would be
required to make the net present value positive, which is
$53,410 ($33,410 + $20,000), can be found by
experimenting with the salvage value in the worksheet. It
can also be computed using the formula from the text as
follows:

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 9
The Foundational 15

1. The depreciation expense of $595,000 is the only non-cash

expense.

2. The annual net cash inflows are computed as follows:

$ 405,00
Net operating income.......................... 0
Add: Noncash deduction for
depreciation......................................
595,000
$1,000,00
Annual net cash inflow......................... 0

3. The present value of the annual net cash inflows is computed

as follows:
Present
Value of
14% Cash
Item Year(s) Cash Flow Factor Flows
Annual net cash $1,000,00 $3,433,00
inflows................ 1-5 0 3.433 0

4. The project’s net present value is computed as follows:

Years
Now 1-5
Purchase of equipment..... $(2,975,000
)
Sales................................. $2,735,00
0
Variable expenses............. (1,000,000
)
Out-of-pocket costs........... __________ (735,000)
Total cash flows (a)........... $(2,975,000 $1,000,00
) 0
Discount factor (b)............ 1.000 3.433
Present value (a)×(b)........ $(2,975,000 $3,433,00
) 0
Net present value.............. $458,000

© The McGraw-Hill Companies, Inc., 2018

10 Managerial Accounting, 16th Edition
© The McGraw-Hill Companies, Inc., 2018
Solutions Manual, Chapter 13 11
The Foundational 15 (continued)

5. The project profitability index for the project is:

Project
Net Present Investment Profitability
Value Required Index
Item (a) (b) (a) ÷ (b)
$2,975,00
Project $458,000 0 0.15*
* The answer of 0.1539 was rounded to 0.15.

6. The project’s internal rate of return is:

Looking in Exhibit 13B-2, and scanning along the five-period

line, we can see that the factor computed above, 2.975, is
closest to 2.991, the factor for the 20% rate of return.
Therefore, to the nearest whole percent, the internal rate of
return is 20%.

7. The payback period is determined as follows:

Investmen Cash Unrecovered
Year t Inflow Investment
$2,975,00 $1,000,0 $1,975,000
1 0 00
$1,000,0 $975,000
2 00
$1,000,0 $0
3 00
$1,000,0 $0
4 00
$1,000,0 $0
5 00

© The McGraw-Hill Companies, Inc., 2018

12 Managerial Accounting, 16th Edition
 The investment in the project is fully recovered in the 3rd
year. To be more exact, the payback period is approximately
2.98 years [= 2 + ($975,000 ÷ $1,000,000)].

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 13
The Foundational 15 (continued)

8. The simple rate of return is computed as follows:

9. If the discount rate was 16%, instead of 14%, the project’s net
present value would be lower because the discount factors
would be smaller.

10. The payback period would be the same because the initial
investment was recovered at the end of three years. The
salvage value at the end of five years is irrelevant to the
payback calculation.

11. The net present value would be higher because a $300,000

salvage value translates into a larger cash inflow in the fifth
year. Although the salvage value would need to be translated
to its lesser present value, it would still increase the project’s
net present value.

12. The simple rate of return would be higher. The salvage value
would lower the annual depreciation expense by $60,000
($300,000 ÷ 5 years), which in turn would raise the annual
net operating income and the simple rate of return.

© The McGraw-Hill Companies, Inc., 2018

14 Managerial Accounting, 16th Edition
The Foundational 15 (continued)

13. The new annual variable expense would be $1,230,750

($2,735,000 × 45%). The project’s actual net present value
would be computed as follows:
Years
Now 1-5
Purchase of equipment. . . $(2,975,000)
Sales................................ $2,735,000
Variable expenses........... (1,230,750)
Out-of-pocket costs......... __________ (735,000)
Total cash flows (a)......... $(2,975,000) $ 769,250
Discount factor (b).......... 1.000 3.433
Present value (a)×(b)...... $(2,975,000) $2,640,835
Net present value............ $(334,165)

14. The payback period is computed as follows:

Investmen Cash Unrecovered
Year t Inflow Investment
$2,975,00 $769,25 $2,205,750
1 0 0
$769,25 $1,436,500
2 0
$769,25 $667,250
3 0
$769,25 $0
4 0
$769,25 $0
5 0
The investment in the project is fully recovered in the 4th
year. To be more exact, the payback period is approximately
3.87 years [= 3 + ($667,250 ÷ $769,250)].

15. The simple rate of return is computed as follows:

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 15
* $2,735,000 – $1,230,750 – $735,000 – $595,000 = $174,250

© The McGraw-Hill Companies, Inc., 2018

16 Managerial Accounting, 16th Edition
Exercise 13-1 (10 minutes)

1. The payback period is determined as follows:

Investme Cash Unrecovered
Year nt Inflow Investment
1 $15,000 $1,000 $14,000
2 $8,000 $2,000 $20,000
3 $2,500 $17,500
4 $4,000 $13,500
5 $5,000 $8,500
6 $6,000 $2,500
7 $5,000 $0
8 $4,000 $0
9 $3,000 $0
10 $2,000 $0
The investment in the project is fully recovered in the 7th year.
To be more exact, the payback period is approximately 6.5
years [= 6 + ($2,500 ÷ $5,000)].

2. Because the investment is recovered prior to the last year, the

amount of the cash inflow in the last year has no effect on the
payback period.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 17
Exercise 13-2 (10 minutes)

1.
Years
Now 1-5
Purchase of machine................. $(27,000)
Reduced operating costs........... ________ $7,000
Total cash flows (a)................... $(27,000) $7,000
Discount factor (12%) (b).......... 1.000 3.605
Present value (a)×(b)................ $(27,000) $25,23
5
Net present value...................... $(1,765)

2.
Total
Cash Cash
Item Flow Years Flows
Annual cost
savings............... $7,000 5 $ 35,000
$(27,00
Initial investment. . 0) 1 (27,000)
Net cash flow........ $ 8,000

© The McGraw-Hill Companies, Inc., 2018

18 Managerial Accounting, 16th Edition
Exercise 13-3 (20 minutes)

1. Annual savings in part-time help..................... $3,800

Added contribution margin from expanded
sales (1,000 dozen × $1.20 per dozen)........ 1,200
Annual cash inflows......................................... $5,000

2.

3. Looking in Exhibit 13B-2, and scanning along the six-period

line, we can see that the factor computed above, 3.720, is
closest to 3.685, the factor for the 16% rate of return.
Therefore, to the nearest whole percent, the internal rate of
return is 16%.

4. The cash flows will not be even over the six-year life of the
machine because of the extra $9,125 inflow in the sixth year.
Therefore, the above approach cannot be used to compute the
internal rate of return in this situation. Using trial-and-error or
some other method, the internal rate of is 22%:

Now Years Year

1-6 6
Purchase of machine.................... $(18,600)
Reduced part-time help................ $3,800
Added contribution margin........... 1,200
Salvage value of machine............ _______ ______ $9,125
Total cash flows (a)...................... $(18,600) $5,000 $9,125
Discount factor (22%) (b)............. 1.000 3.167 0.303
Present value (a)×(b)................... $(18,600) $15,83 $2,765
5
Net present value......................... $0

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 19
Exercise 13-4 (15 minutes)

The equipment’s net present value without considering the

intangible benefits would be:
20% Present
Amount of Facto Value of
Item Year(s) Cash Flows r Cash Flows
Cost of the $(2,500,000
equipment.............. Now ) 1.000 $(2,500,000)
Annual cost savings. . 1-15 $400,000 4.675 1,870,000
Net present value...... $ (630,000)

The annual value of the intangible benefits would have to be

great enough to offset a $630,000 negative present value for the
equipment. This annual value can be computed as follows:
Required increase in present value $630,000
= = $134,759
Factor for 15 years 4.675

© The McGraw-Hill Companies, Inc., 2018

20 Managerial Accounting, 16th Edition
Exercise 13-5 (10 minutes)

1. The project profitability index for each proposal is:

Project
Proposa Net Present Investmen Profitability Index
l Value t Required
Number (a) (b) (a)  (b)
A $36,000 $90,000 0.40
B $38,000 $100,000 0.38
C $35,000 $70,000 0.50
D $40,000 $120,000 0.33

2. The ranking is:

Proposa Project
l Profitability
Number Index
C 0.50
A 0.40
B 0.38
D 0.33
Note that proposal D has the highest net present value, but it
ranks lowest in terms of the project profitability index.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 21
Exercise 13-6 (10 minutes)

1. The annual depreciation expense is computed as follows:

Cost of the new machine (a)................ $120,000

Useful life in years (b).......................... 10
Annual depreciation expense (a) ÷ (b). $12,000

2. The annual incremental net operating income is computed as

follows:
Operating cost of old machine............. $ 30,000
Less operating cost of new machine.... 12,000
Less annual depreciation on the new
machine ($120,000 ÷ 10 years)........ 12,000
Annual incremental net operating
income............................................... $ 6,000
3. The initial investment is computed as follows:
Cost of the new machine...................... $120,000
Less salvage value of old machine....... 40,000
Initial investment.................................. $ 80,000

4. The simple rate of return is computed as follows:

© The McGraw-Hill Companies, Inc., 2018

22 Managerial Accounting, 16th Edition
Exercise 13-7 (15 minutes)

1. Project A:
Years Year
Now 1-6 6
Purchase of equipment........$(100,000)
Annual cash inflows.............. $21,000
Salvage value....................... _______ ______ $8,000
Total cash flows (a)..............$(100,000) $21,000 $8,000
Discount factor (14%) (b)..... 1.000 3.889 0.456
Present value (a)×(b)...........$(100,000) $81,669 $3,648
Net present value................. $(14,683)

2. Project B:
Years Year
Now 1-6 6
Working capital invested. $(100,000)
Annual cash inflows......... $16,000
Working capital released. _______ ______ $100,00
0
Total cash flows (a)......... $(100,000) $16,000 $100,00
0
Discount factor (14%) (b) 1.000 3.889 0.456
Present value (a)×(b)...... $(100,000) $62,224 $45,600
Net present value............ $7,824

3. The $100,000 should be invested in Project B rather than in

Project A. Project B has a positive net present value whereas
Project A has a negative net present value.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 23
Exercise 13-8 (15 minutes)

1.Computation of the annual cash inflow associated with the new

electronic games:
Net operating income.................................... $40,000
Add noncash deduction for depreciation........ 35,000
Annual net cash inflow................................... $75,000
The payback computation would be:

Yes, the games would be purchased. The payback period is less

than the maximum 5 years required by the company.

2. The simple rate of return would be:

Yes, the games would be purchased. The 13.3% return exceeds

12%.

© The McGraw-Hill Companies, Inc., 2018

24 Managerial Accounting, 16th Edition
Exercise 13-9 (20 minutes)

1. The net present value is computed as follows:

Now Years
1-5
Purchase of equipment. . . $(3,000,000)
Sales............................... $ 2,500,00
0
Variable expenses........... (1,000,000
)
Out-of-pocket costs......... __________ (600,000)
Total cash flows (a)......... $(3,000,000) $ 900,00
0
Discount factor (15%) (b) 1.000 3.352
Present value (a)×(b)...... $(3,000,000) $3,016,80
0
Net present value............ $16,800

2.The simple rate of return would be:

3. The company would want Derrick to pursue the investment

opportunity because it has a positive net present value of
$16,800. However, Derrick might be inclined to reject the
opportunity because its simple rate of return of 10% is well
below his historical return on investment (ROI) of 20%. Derrick
may be justifiably concerned that implementing this project
would lower his ROI and his next pay raise.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 25
Exercise 13-10 (10 minutes)

1. Years Year
Now 1-3 3
Purchase of stock.................... $(13,000)
Annual cash dividend.............. $420
Sale of stock............................ _______ ____ $16,000
Total cash flows (a)................. $(13,000) $420 $16,000
Discount factor (14%) (b)........ 1.000 2.322 0.675
Present value (a)×(b).............. $(13,000) $975 $10,800
Net present value.................... $(1,225)

2. No, Kathy did not earn a 14% return on the Malti Company
stock. The negative net present value indicates that the rate of
return on the investment is less than the minimum required
rate of return of 14%.

© The McGraw-Hill Companies, Inc., 2018

26 Managerial Accounting, 16th Edition
Exercise 13-11 (30 minutes)

1. The project profitability index is computed as follows:

Project
Profitabili
Net Present Investment ty
Value Required Index
Project (a) (b) (a) ÷ (b)

A $44,323 $160,000 0.28

B $42,000 $135,000 0.31

C $35,035 $100,000 0.35

D $38,136 $175,000 0.22

2. a., b., and c.

Project Internal
Net Present Profitabilit Rate of
Value y Index Return
First preference..... A C D
Second preference B B C
Third preference.... D A A
Fourth preference.. C D B

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 27
Exercise 13-11 (continued)

3. Oxford Company’s opportunities for reinvesting funds as they

are released from a project will determine which ranking is
best. The internal rate of return method assumes that any
released funds are reinvested at the rate of return shown for a
project. This means that funds released from project D would
have to be reinvested in another project yielding a rate of
return of 22%. Another project yielding such a high rate of
return might be difficult to find.
The project profitability index approach also assumes that
funds released from a project are reinvested in other projects.
But the assumption is that the return earned by these other
projects is equal to the discount rate, which in this case is only
10%. On balance, the project profitability index is generally
regarded as being the most dependable method of ranking
competing projects.
The net present value is inferior to the project profitability
index as a ranking device, because it looks only at the total
amount of net present value from a project and does not
consider the amount of investment required. For example, it
ranks project C as fourth because of its low net present value;
yet this project is the best available in terms of the net present
value generated for each dollar of investment (as shown by the
project profitability index).

© The McGraw-Hill Companies, Inc., 2018

28 Managerial Accounting, 16th Edition
Exercise 13-12 (10 minutes)

Note: All present value factors in the computation below have

been taken from Exhibit 13B-1 in Appendix 13B, using a 12%
discount rate.
$104,95
Amount of the investment..................... 0
Less present value of Year 1 and Year
2 cash inflows:
Year 1: $30,000 × 0.893...................... $26,790
Year 2: $40,000 × 0.797...................... 31,880 58,670
Present value of Year 3 cash inflow........ $ 46,280
Therefore, the expected cash inflow for Year 3 is:
$46,280 ÷ 0.712 = $65,000.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 29
Exercise 13-13 (15 minutes)

1. The payback period is:

No, the equipment would not be purchased because the

payback period (4.8 years) exceeds the company’s maximum
payback time (4.0 years).

2. The simple rate of return would be computed as follows:

Annual cost savings......................................... $90,000
Less annual depreciation ($432,000 ÷ 12 36,000
years)............................................................
Annual incremental net operating income...... $54,000

No, the equipment would not be purchased because its 12.5%

rate of return is less than the company’s 14% required rate of
return.

© The McGraw-Hill Companies, Inc., 2018

30 Managerial Accounting, 16th Edition
Exercise 13-14 (10 minutes)

1. Project X:
Years
Now 1-6
Initial investment......... $(35,000)
Annual cash inflows...... ________ $12,00
0
Total cash flows (a)...... $(35,000) $12,00
0
Discount factor (18%) (b) 1.000 3.498
.....................................
Present value (a)×(b)... $(35,000) $41,97
6
Net present value......... $6,976

2. Project Y:
Year
Now 6
Initial investment.......... $(35,000)
Single cash inflow.......... _______ 90,000
Total cash flows (a)....... $(35,000) $90,00
0
Discount factor (18%) (b) 1.000 0.370
Present value (a)×(b).... $(35,000) $33,30
0
Net present value.......... $(1,700)

3. Project X should be selected. Project Y does not provide the

required 18% return, as shown by its negative net present
value.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 31
Exercise 13-15 (30 minutes)

1.

Looking in Exhibit 13B-2 and scanning along the 5-period line, a

factor of 3.433 represents an internal rate of return of 14%.

2. The machine’s net present value is computed as follows:

Now Years
1-5
Purchase of machine...... $(137,320
)
Annual cash inflows........ _________ $40,000
Total cash flows (a)........ $(137,320 $40,000
)
Discount factor (b)......... 1.000 3.433
Present value (a)×(b)..... $(137,320 $137,32
) 0
Net present value........... $0

The reason for the zero net present value is that 14% (the
discount rate we have used) represents the machine’s internal
rate of return. The internal rate of return is the discount rate
that results in a zero net present value.

© The McGraw-Hill Companies, Inc., 2018

32 Managerial Accounting, 16th Edition
Exercise 13-15 (continued)

3.

Looking in Exhibit 13B-2 and scanning along the 5-period line, a

factor of 3.696 corresponds to the factor for 11%. Thus, the
internal rate of return is 11%.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 33
Problem 13-16 (20 minutes)

Now 1 2 3 4
Purchase of equipment. . $(275,000
)
Working capital (100,000)
investment.....................
Annual net cash receipts. . $120,000 $120,000 $120,000 $120,000
Road construction.......... (40,000)
Working capital released. . 100,000
Salvage value of _________ ________ _______ _______ 65,000
equipment.....................
Total cash flows (a)........ $(375,000 $120,000 $120,000 $80,000 $285,000
)
Discount factor (20%) (b). 1.000 0.833 0.694 0.579 0.482
Present value (a)×(b).... $(375,000 $99,960 $83,280 $46,320 $137,370
)
Net present value.......... $(8,070)

No, the project should not be accepted; it has a negative net present value at a 20%
discount rate. This means that the rate of return on the investment is less than the
company’s required rate of return of 20%.

Note: The annual net cash receipts ($120,000) can also be discounted their present value
using the appropriate discount factor (2.589) from Exhibit 13B-2 in Appendix 13B.

© The McGraw-Hill Companies, Inc., 2018

34 Managerial Accounting, 16th Edition
Problem 13-17 (20 minutes)

1. The net present value is computed as follows:

Now Years
1-5
Purchase of equipment. . . $(3,500,00
0)
Sales............................... $3,400,00
0
Variable expenses.......... (1,600,00
0)
Out-of-pocket costs......... __________ (700,000
)
Total cash flows (a)......... $(3,500,00 $1,100,00
0) 0
Discount factor (16%) (b) 1.000 3.274
Present value (a)×(b)...... $(3,500,00 $3,601,40
0) 0
Net present value............ $101,400

2. The internal rate of return is computed as follows:

Looking in Exhibit 13B-2 and scanning along the five-period line,

we can see that the factor computed above, 3.182, is closest to
3.199, the factor for the 17% rate of return. Therefore, to the
nearest whole percent, the internal rate of return is 17%.

3. The simple rate of return is computed as follows:

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 35
© The McGraw-Hill Companies, Inc., 2018
36 Managerial Accounting, 16th Edition
Problem 13-17 (continued)

4. The company would want Casey to invest in the project

because it has a positive net present value of $101,400 and an
internal rate of return of 17%. However, Casey might be
inclined to reject the project because its simple rate of return of
11.4% is well below his historical return on investment (ROI) of
20%. Casey may be justifiably concerned that implementing
this project would lower his ROI and his next pay raise.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 37
Problem 13-18 (20 minutes)

The net present value is computed as follows:

Now 1 2 3 4
Purchase of equipment. . . $(130,000
)
Working capital (60,000)
investment......................
Sales................................ $250,000 $250,000 $250,000 $250,000
Variable expenses........... (120,000) (120,000) (120,000) (120,000)
Fixed out-of-pocket costs (70,000) (70,000) (70,000) (70,000)
Overhaul of equipment.... (8,000)
Working capital released. 60,000
Salvage value of _________ ________ _______ _______ 12,000
equipment.......................
Total cash flows (a)......... $(190,000 $60,000 $52,000 $60,000 $132,000
)
Discount factor (15%) (b) 1.000 0.870 0.756 0.658 0.572
Present value (a)×(b)...... $(190,000 $52,200 $39,312 $39,480 $75,504
)
Net present value............ $16,496

Note: The sales ($250,000), variable expenses ($120,000), and fixed out-of-pocket costs
($70,000) can also be discounted their present values using the appropriate discount factor
(2.855) from Exhibit 13B-2 in Appendix 13B.

© The McGraw-Hill Companies, Inc., 2018

38 Managerial Accounting, 16th Edition
Problem 13-19 (30 minutes)

1. The income statement would be:

Sales.................................................... $300,000
Variable expenses:
Cost of ingredients (20% ×
$300,000)....................................... $60,000
Commissions (12.5% × $300,000).... 37,500 97,500
Contribution margin............................. 202,500
Fixed expenses:
Salaries............................................. 70,000
Rent ($3,500 × 12)............................ 42,000
Depreciation*.................................... 16,800
Insurance.......................................... 3,500
Utilities.............................................. 27,000 159,300
Net operating income.......................... $ 43,200
* $270,000 – $18,000 = $252,000
$252,000 ÷ 15 years = $16,800 per year

2. The formula for the simple rate of return is:

Yes, the franchise would be acquired because it promises a rate

of return in excess of 12%.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 39
Problem 13-19 (continued)

3. The formula for the payback period is:

*Net operating income + Depreciation = Annual net cash

inflow
$43,200 + $16,800 = $60,000
According to the payback computation, the franchise would not
be acquired. The 4.5 years payback is greater than the
maximum 4 years allowed. Payback and simple rate of return
can give conflicting signals as in this example.

© The McGraw-Hill Companies, Inc., 2018

40 Managerial Accounting, 16th Edition
Problem 13-20 (30 minutes)

1. The annual net cost savings would be:

Reduction in labor costs................................... $108,000
Reduction in material waste............................ 6,500
Total................................................................. 114,500
Less increased maintenance costs................... 36,000
Annual net cost savings................................... $ 78,500
2. Using this cost savings figure, and other data from the text, the net present value
analysis would be:
Now 1 2 3 4 5 6
Cost of machine........ $(250,00
0)
Software and (80,000)
installation
Salvage value of old
equipment............... 12,000
Annual net cost $78,50 $78,50 $78,50 $78,50 $78,50 $78,50
savings...................... 0 0 0 0 0 0
Replacement of parts (45,000
)
Salvage value of new
machine.................. _______ ______ ______ ______ ______ ______ 20,000
Total cash flows (a)... $(318,00 $78,50 $78,50 $33,50 $78,50 $78,50 $98,50
0) 0 0 0 0 0 0
Discount factor (16%) 1.000 0.862 0.743 0.641 0.552 0.476 0.410
(b)
© The McGraw-Hill Companies, Inc., 2018
Solutions Manual, Chapter 13 41
Present value (a)×(b) $(318,00 $67,66 $58,32 $21,47 $43,33 $37,36 $40,38
................................. 0) 7 6 4 2 6 5
Net present value..... $(49,450
)
No, the automated welding machine should not be purchased. Its net present value is
negative.
Note: The annual net cost savings ($78,500) can also be discounted to their present value
using the appropriate discount factor (3.685) from Exhibit 13B-2 in Appendix 13B.

© The McGraw-Hill Companies, Inc., 2018

42 Managerial Accounting, 16th Edition
Problem 13-20 (continued)

3. The dollar value per year that would be required for the
intangible benefits is:

Thus, the automated welding machine should be purchased if

management believes that the intangible benefits are worth at
least $13,419 per year.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 43
Problem 13-21 (30 minutes)

1. The formula for the project profitability index is:

The indexes for the projects under consideration would be:

Project 1: $66,140 ÷ $270,000 = 0.24
Project 2: $72,970 ÷ $450,000 = 0.16
Project 3: $73,400 ÷ $360,000 = 0.20
Project 4: $87,270 ÷ $480,000 = 0.18

2. a., b., and c.

Net Project Internal
Present Profitabilit Rate of
Value y Index Return
First preference..... 4 1 2
Second preference 3 3 1
Third preference.... 2 4 4
Fourth preference.. 1 2 3

© The McGraw-Hill Companies, Inc., 2018

44 Managerial Accounting, 16th Edition
Problem 13-21 (continued)

3. Which ranking is best will depend on Revco Products’

opportunities for reinvesting funds as they are released from
the project. The internal rate of return method assumes that
any released funds are reinvested at the internal rate of return.
This means that funds released from project #2 would have to
be reinvested in another project yielding a rate of return of
19%. Another project yielding such a high rate of return might
be difficult to find.
The project profitability index approach assumes that funds
released from a project are reinvested in other projects at a
rate of return equal to the discount rate, which in this case is
only 10%. On balance, the project profitability index is the most
dependable method of ranking competing projects.
The net present value is inferior to the project profitability
index as a ranking device because it looks only at the total
amount of net present value from a project and does not
consider the amount of investment required. For example, it
ranks project #1 as fourth in terms of preference because of its
low net present value; yet this project is the best available in
terms of the amount of cash inflow generated for each dollar of
investment (as shown by the project profitability index).

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 45
Problem 13-22 (20 minutes)

1. The annual net cash inflows would be:

Reduction in annual operating costs:
Operating costs, present hand
method........................................... $30,000
Operating costs, new machine.......... 7,000
Annual savings in operating costs..... 23,000
Increased annual contribution margin:
6,000 boxes × $1.50 per box............ 9,000
Total annual net cash inflows............... $32,000

2. The net present value is computed as follows:

Now 1 2 3 4 5
Purchase of machine. . $(120,00
0)
Annual net cash inflows $32,000 $32,000 $32,000 $32,000 $32,000
Replacement parts..... (9,000)
Salvage value of ________ ______ ______ _______ ______ 7,500
machine....................
Total cash flows (a).... $(120,00 $32,000 $32,000 $23,000 $32,000 $39,500
0)
Discount factor (20%) 1.000 0.833 0.694 0.579 0.482 0.402
(b)
Present value (a)×(b). $(120,00 $26,656 $22,208 $13,317 $15,424 $15,879
0)
Net present value....... (26,516)

© The McGraw-Hill Companies, Inc., 2018

46 Managerial Accounting, 16th Edition
Note: The annual net cash inflows ($32,000) can also be discounted to their present value
using the appropriate discount factor (2.991) from Exhibit 13B-2 in Appendix 13B.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 47
Problem 13-23 (45 minutes)

1. The payback periods for Products A and B are calculated using

a two-step process. First, the annual net cash inflows are
calculated as follows:

Product A Product B
Sales revenues............................. $250,000 $350,000
Variable expenses........................ (120,000) (170,000)
Fixed out-of-pocket operating (70,000) (50,000)
costs
Annual net cash inflows................ $ 60,000 $130,000

The second step is to compute each product’s payback period

as follows:

Product A Product B
Investment required (a)................ $170,000 $380,000
Annual net cash inflow (b)............ $60,000 $130,000
Payback period (a) ÷ (b).............. 2.83 2.92 years
years

© The McGraw-Hill Companies, Inc., 2018

48 Managerial Accounting, 16th Edition
Problem 13-23 (continued)

2. The net present values for Products A and B are computed as

follows:

Product A:
Years
Now 1-5
Purchase of equipment......... $(170,000
)
Sales..................................... $250,00
0
Variable expenses................. (120,000
)
Fixed out-of-pocket costs...... (70,000
)
Total cash flows (a)............... $(170,000 $60,000
)
Discount factor (16%) (b)...... 1.000 3.274
Present value (a)×(b)............ $(170,000 $196,44
) 0
Net present value.................. $26,440

Product B:
Years
Now 1-5
Purchase of equipment......... $(380,00
0)
Sales..................................... $350,00
0
Variable expenses................. (170,000
)
Fixed out-of-pocket costs...... (50,000)
Total cash flows (a)............... $(380,00 $130,00
0) 0
Discount factor (b)................ 1.000 3.274
Present value (a)×(b)............ $(380,00 $425,62
0) 0
Net present value.................. $45,620

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 49
Problem 13-23 (continued)

3. The internal rate of return for each product is calculated as

follows:

Product Product
A B
Investment required (a)........................ $170,00 $380,00
0 0
Annual net cash inflow (b).................... $60,000 $130,00
0
Factor of the internal rate of return (a) 2.833 2.923
÷ (b)

Looking in Exhibit 13B-2 and scanning along the 5-period line, a

factor of 2.833 falls right between 22% and 23%, so we’ll
estimate an internal rate of return for Product A of 22.5%. A factor
of 2.923 is closest to 21%, so we’ll estimate an internal rate of
return for Product B of 21%.

4. The project profitability index for each product is computed as

follows:

Product Product
A B
Net present value (a)............................ $26,440 $45,620
Investment required (b)........................ $170,00 $380,00
0 0
Project profitability index (a) ÷ (b)....... 0.16 0.12

5. The simple rate of return for each product is computed as

follows:

Product Product
A B
Annual net cash inflow......................... $60,000 $130,00
0
Depreciation expense........................... 34,000 76,000
Annual incremental net operating $26,000 $ 54,000
income.................................................
© The McGraw-Hill Companies, Inc., 2018
50 Managerial Accounting, 16th Edition
 Product Product
A B
Annual incremental net operating $26,000 $54,000
income (a)
Initial investment (b)............................ $170,00 $380,00
0 0
Simple rate of return (a) ÷ (b).............. 15.3% 14.2%

6. The net present value calculations suggest that Product B is

preferable to Product A. However, the project profitability index
reveals that Product A is the preferred choice. The payback
period, internal rate of return, and simple rate of return all
favor Product A over Product B. However, it bears emphasizing
that Lou Barlow may be inclined to reject both products
because the simple rate of return for each product is lower than
his division’s historical return on investment of 18%.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 51
Problem 13-24 (45 minutes)

1. Present cost of transient workers................... $40,000

Less out-of-pocket costs to operate the cherry
picker:
$14,00
Cost of an operator and assistant................ 0
Insurance..................................................... 200
Fuel.............................................................. 1,800
3,00
Maintenance contract.................................. 0 19,000
Annual savings in cash operating costs.......... $21,000

2. The first step is to determine the annual incremental net

operating income:
Annual savings in cash operating costs..... $21,000
Less annual depreciation ($94,500 ÷ 12
years)...................................................... 7,875
Annual incremental net operating income $13,125

No, the cherry picker would not be purchased. The expected

return is less than the 16% return required by the farm.

3. The formula for the payback period is:

* In this case, the cash inflow is measured by the annual

savings in cash operating costs.
Yes, the cherry picker would be purchased. The payback period

© The McGraw-Hill Companies, Inc., 2018

52 Managerial Accounting, 16th Edition
 is less than 5 years. Note that this answer conflicts with the
answer in Part 2.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 53
Problem 13-24 (continued)

4. The formula for the internal rate of return is:

Looking in Exhibit 13B-2 and scanning along the 12-period line,

we can see that the factor computed above, 4.500, is closest to
4.439, the factor for the 20% rate of return. Therefore, to the
nearest whole percent, the internal rate of return is 20%.

No, the simple rate of return is not an accurate guide in

investment decisions. It ignores the time value of money.

© The McGraw-Hill Companies, Inc., 2018

54 Managerial Accounting, 16th Edition
Problem 13-25 (30 minutes)

1. The present value of the purchase alternative is computed as

follows:

Purchase Alternative:
Now 1 2 3
Purchase of cars...... $(170,00
0)
Annual servicing $(3,000) $(3,000) $(3,000)
costs...................
Repairs.................... (1,500) (4,000) (6,000)
Resale value of cars ________ ______ ______ 85,000
Total cash flows (a). $(170,00 $(4,500) $(7,000) $76,000
0)
Discount factor (b). . 1.000 0.847 0.718 0.609
Present value $(170,00 $(3,812) $(5,026) $46,284
(a)×(b)................ 0)
Net present value.... $(132,55
4)

2. The present value of the lease alternative is computed as

follows:

Lease Alternative:
Now 1 2 3
Security deposit...... $(10,000)
Annual lease $(55,00 $(55,00 $(55,00
payments 0) 0) 0)
Refund of deposit.... _______ _______ _______ 10,000
Total cash flows (a). $(10,000) $(55,00 $(55,00 $(45,00
0) 0) 0)
Discount factor (b). . 1.000 0.847 0.718 0.609
Present value $(10,000) $(46,58 $(39,49 $(27,40
(a)×(b).................... 5) 0) 5)
Net present value. . . $(123,48
0)

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Solutions Manual, Chapter 13 55
Note: The annual servicing costs ($3,000) and the annual lease
payments ($55,000) can also be discounted to their present
values using the appropriate discount factor (2.174) from Exhibit
13B-2 in Appendix 13B.

3. The company should lease the cars because this alternative

has the lowest present value of total costs.

© The McGraw-Hill Companies, Inc., 2018

56 Managerial Accounting, 16th Edition
Problem 13-26 (30 minutes)

1. The annual incremental net operating income can be

determined as follows:
$180,00
Ticket revenue (50,000 × $3.60)......... 0
Selling and administrative expenses:
Salaries............................................. $85,000
Insurance.......................................... 4,200
Utilities.............................................. 13,000
Depreciation*.................................... 27,500
Maintenance...................................... 9,800
Total selling and administrative
expenses........................................... 139,500
Net operating income.......................... $ 40,500
*$330,000 ÷ 12 years = $27,500 per year
2. The simple rate of return is:

Yes, the water slide would be constructed. Its return is greater

than the specified hurdle rate of 14%.

3. The payback period is:

*Net operating income + Depreciation = Annual net cash flow

$40,500 + $27,500 = $68,000

Yes, the water slide would be constructed. The payback period

is within the 5-year payback required by Mr. Sharkey.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 57
Problem 13-27 (30 minutes)

1. Average weekly use of the auto wash and the vacuum will be:

The expected annual net cash receipts from operations would

be:
Auto wash cash receipts ($1,350 × 52)... $70,200
Vacuum cash receipts (405 × $1.00 ×
52)......................................................... 21,060
Total cash receipts................................. 91,260
Less cash disbursements:
Water (675 × $0.20 × 52)..................... $ 7,020
Electricity (405 × $0.10 × 52)............... 2,106
Rent ($1,700 × 12)................................ 20,400
Cleaning ($450 × 12)............................ 5,400
Insurance ($75 × 12)............................ 900
Maintenance ($500 × 12)...................... 6,000
Total cash disbursements......................... 41,826
Annual net cash receipts from operations $49,434

© The McGraw-Hill Companies, Inc., 2018

58 Managerial Accounting, 16th Edition
Problem 13-27 (continued)

2. The net present value is computed as follows:

Years Year
Now 1-5 5
Purchase of equipment. $(200,000)
Working capital............. (2,000)
Annual net cash flows. . . $49,434
Working capital $2,000
released...................
Salvage value
($200,000 × 10%)......... ________ ______ 20,000
Total cash flows (a)....... $(202,000) $49,434 $22,00
0
Discount factor (b)........ 1.000 3.791 0.621
Present value (a)×(b).... $(202,000) $187,404 $13,66
2
Net present value.......... $(934)

No, Mr. Duncan should not open the auto wash. The negative net
present value indicates that the rate of return on this investment is
slightly less than the 10% required rate of return.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 59
Problem 13-28 (20 minutes)

1. The net present value of keeping the old truck is computed as

follows:
Keep the old truck:
Now Years Year
1-5 5
Overhaul needed now. . $(7,000)
Annual operating costs (10,000)
Salvage value (old)...... ______ _______ $1,00
0
Total cash flows (a)...... $(7,000) $(10,000 $1,00
) 0
Discount factor (b)....... 1.000 3.274 0.476
Present value (a)×(b)... $(7,000) $(32,740 $476
)
Net present value......... $(39,264)

2. The net present value of purchasing the new truck is computed

as follows:

Purchase the new truck:

Now Years Year
1-5 5
Purchase new truck...... $(30,000)
Salvage value (old)...... 9,000
Annual operating costs (6,500)
Salvage value (new)..... _______ ______ $4,00
0
Total cash flows (a)...... $(21,000) $(6,500) $4,00
0
Discount factor (b)....... 1.000 3.274 0.476
Present value (a)×(b)... $(21,000) $(21,281 $1,90
) 4
Net present value......... $(40,377)

3. The company should keep the old truck because the present
value of the net cash outflows is $1,113 lower for that
alternative.

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60 Managerial Accounting, 16th Edition
Problem 13-29 (45 minutes)

1. A net present value computation for each investment follows:

Common stock: Years Year

Now 1-3 3
Purchase of the $(95,000)
stock.......................
Sales of the stock.... ________ ______ $160,00
0
Total cash flows (a). $(95,000) $0 $160,00
0
Discount factor (b). . 1.000 2.246 0.641
Present value $(95,000) $0 $102,56
(a)×(b).................... 0
Net present value. . . $7,560

Preferred stock: Years Year

Now 1-3 3
Purchase of the $(30,000)
stock.......................
Annual cash
dividend ($30,000 $1,800
× 0.06)....................
Sales of the stock.... ________ ______ $27,000
Total cash flows (a). $(30,000) $1,800 $27,000
Discount factor (b). . 1.000 2.246 0.641
Present value $(30,000) $4,043 $17,307
(a)×(b)....................
Net present value. . . $(8,650)

Bonds: Years Year

Now 1-3 3
Purchase of the $(50,000)
bonds......................
Annual interest $6,000
income
Sales of the bonds. . ________ ______ $52,700
Total cash flows (a). $(50,000) $6,000 $52,700
Discount factor (b). . 1.000 2.246 0.641
© The McGraw-Hill Companies, Inc., 2018
Solutions Manual, Chapter 13 61
 Present value $(50,000) $13,476 $33,781
(a)×(b)....................
Net present value. . . $(2,743)

Linda earned a 16% rate of return on the common stock, but not
on the preferred stock or the bonds.

© The McGraw-Hill Companies, Inc., 2018

62 Managerial Accounting, 16th Edition
Problem 13-29 (continued)

2. Considering all three investments together, Linda did not earn

a 16% rate of return. The computation is:
Net
Present
Value
Common stock...................... $ 7,560
Preferred stock..................... (8,650)
Bonds................................... (2,743)
Overall net present value..... $(3,833)
The defect in the broker’s computation is that it does not
consider the time value of money and therefore has overstated
the rate of return earned.

3.

Substituting the $239,700 investment and the factor for 14%

for 12 periods into this formula, we get:

Therefore, the required annual net cash inflow is: $239,700 ÷

5.660 = $42,350.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 63
Problem 13-30 (60 minutes)
1. Computation of the annual net cost savings:
Savings in labor costs (25,000 hours × $16 per $400,00
hour)................................................................. 0
Savings in inventory carrying costs..................... 210,000
Total..................................................................... 610,000
Less increased power and maintenance cost...... 30,000
$580,00
Annual net cost savings...................................... 0
2. The net present value is computed as follows:
Now 1 2 3 4 5
Cost of the robot. . $(1,600,00
0)
Installation &
software............... (450,000)
Annual net cost
savings................. $580,00 $580,0 $580,0 $580,0 $580,0
0 00 00 00 00
Inventory 400,000
reduction..............
Salvage value _________ _______ _______ _______ _______ 70,000
(old).....................
Total cash flows $(2,050,00 $980,00 $580,00 $580,00 $580,00 $650,00
(a)........................ 0) 0 0 0 0 0
Discount factor (b) 1.000 0.833 0.694 0.579 0.482 0.402
.............................
Present value
© The McGraw-Hill Companies, Inc., 2018
64 Managerial Accounting, 16th Edition
 (a)×(b)................. $(2,050,00 $816,34 $402,52 $335,82 $279,56 $261,30
0) 0 0 0 0 0
Net present value. $45,540
Yes, the robot should be purchased. It has a positive net present value at a 20% discount
rate.
Note: The annual net cost savings ($580,000) can also be discounted to their present value
using the appropriate discount factor (2.991) from Exhibit 13B-2 in Appendix 13B.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 65
Problem 13-30 (continued)
3. Recomputation of the annual net cost savings:
Savings in labor costs (22,500 hours × $16 per $360,00
hour)............................................................... 0
Savings in inventory carrying costs................... 210,000
Total................................................................... 570,000
Less increased power and maintenance cost.... 30,000
$540,00
Annual net cost savings.................................... 0
The revised present value computations are follows:
Now 1 2 3 4 5
Cost of the robot. . $(1,600,00
0)
Installation &
software............... (525,000)
Annual net cost
savings................. $540,00 $540,0 $540,0 $540,0 $540,0
0 00 00 00 00
Inventory 400,000
reduction..............
Salvage value _________ _______ _______ _______ _______ 70,000
(old).....................
Total cash flows $(2,125,00 $940,00 $540,00 $540,00 $540,00 $610,00
(a)........................ 0) 0 0 0 0 0
Discount factor (b) 1.000 0.833 0.694 0.579 0.482 0.402
.............................
Present value
© The McGraw-Hill Companies, Inc., 2018
66 Managerial Accounting, 16th Edition
 (a)×(b)................. $(2,125,00 $783,02 $374,76 $312,66 $260,28 $245,22
0) 0 0 0 0 0
Net present value. $(149,060)
It appears the rate of return that will be earned by the new equipment is less than 20%.
Note: The annual net cost savings ($540,000) can also be discounted to their present value
using the appropriate discount factor (2.991) from Exhibit 13B-2 in Appendix 13B.

© The McGraw-Hill Companies, Inc., 2018

Solutions Manual, Chapter 13 67
Problem 13-30 (continued)

4. a. Several intangible benefits are usually associated with

investments in automated equipment. These intangible
benefits include:
 Greater throughput.

 Greater variety of products.

 Higher quality.

 Reduction in inventories.

The value of these benefits can equal or exceed any savings

that may come from reduced labor cost. However, these
benefits are hard to quantify.

b.

Thus, the intangible benefits in (a) would have to generate a

cash inflow of $49,836 per year in order for the robot to yield a
20% rate of return.

© The McGraw-Hill Companies, Inc., 2018

68 Managerial Accounting, 16th Edition
Case 13-31 (45 minutes)

1. Rachel Arnett’s revision of her first proposal can be considered

a violation of the IMA’s Statement of Ethical Professional
Practice. She discarded her reasonable projections and
estimates after she was questioned by William Earle. She used
figures that had a remote chance of occurring. By doing this,
she violated the requirements to “Communicate information
fairly and objectively” and “disclose all relevant information
that could reasonably be expected to influence an intended
user’s understanding of the reports, analyses, or
recommendations.” By altering her analysis, she also violated
the Integrity standard. She engaged in an activity that would
prejudice her ability to carry out her duties ethically. In
addition, she violated the Competence standard—“Provide
decision support information and recommendations that are
accurate, clear, concise, and timely.”

2. Earle was clearly in violation of the Standards of Ethical

Conduct for Management Accountants because he tried to
persuade a subordinate to prepare a proposal with data that
was false and misleading. Earle has violated the standards of
Competence (Provide decision support information and
recommendations that are accurate, clear, concise, and
timely.), Integrity (Mitigate actual conflicts of interest. Regularly
communicate with business associates to avoid apparent
conflicts of interest.), and Credibility (Communicate information
fairly and objectively. Disclose all relevant information that
could reasonably be expected to influence an intended user’s
understanding of the reports, analyses, or recommendations.).

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Solutions Manual, Chapter 13 69
Case 13-31 (continued)

3. The internal controls Fore Corporation could implement to

prevent unethical behavior include:
 approval of all formal capital expenditure proposals by the
Controller and/or the Board of Directors.
 designating a non-accounting/finance manager to coordinate
capital expenditure requests and/or segregating duties during
the preparation and approval of capital expenditure requests.
 requiring that all capital expenditure proposals be reviewed by
senior operating management, which includes the Controller,
before the proposals are submitted for approval.
 requiring the internal audit staff to review all capital
expenditure proposals or contracting external auditors to
review the proposal if the corporation lacks manpower.

(Unofficial CMA Solution, adapted)

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70 Managerial Accounting, 16th Edition
Case 13-32 (45 minutes)

1. The net cash inflow from sales of the device for each year
would be:
Year
1 2 3 4-6
Sales in units.................... 9,000 15,000 18,000 22,000
Sales in dollars $525,00 $630,00 $770,00
(@ $35 each)................. $315,000 0 0 0
Variable expenses
(@ $15 each)................. 135,000 225,000 270,000 330,000
Incremental contribution
margin........................... 180,000 300,000 360,000 440,000
Fixed expenses:
Salaries and other*........ 85,000 85,000 85,000 85,000
Advertising..................... 180,000 180,000 150,000 120,000
Incremental fixed
expenses........................ 265,000 265,000
235,000 205,000
$125,00 $235,00
Net cash inflow (outflow).. $(85,000) $ 35,000 0 0
* Depreciation is not a cash expense and therefore must be
eliminated from this computation. The analysis is:
($315,000 – $15,000 = $300,000) ÷ 6 years = $50,000
depreciation;
$135,000 total expense – $50,000 depreciation = $85,000.

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Solutions Manual, Chapter 13 71
Case 13-32 (continued)

2. The net present value of the proposed investment would be:

Now 1 2 3 4 5 6
Cost of equipment $(315,00
............................ 0)
Working capital. . . (60,000)
Yearly net cash
flows.................... $(85,000 $35,00 $125,0 $235,0 $235,0 $235,0
) 0 00 00 00 00
Release of
working capital.... 60,000
Salvage value of
equipment........... _______ ______ ______ ______ ______ ______ 15,00
0
Total cash flows $(375,00 $(85,000 $35,00 $125,0 $235,0 $235,0 $310,0
(a) 0) ) 0 00 00 00 00
Discount factor
(14%) (b)............. 1.000 0.877 0.769 0.675 0.592 0.519 0.456
Present value
(a)×(b)................ $(375,00 $(74,545 $26,91 $84,37 $139,1 $121,9 $141,3
0) ) 5 5 20 65 60
Net present value $64,190

Since the net present value is positive, the company should pursue the new product.

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72 Managerial Accounting, 16th Edition
Appendix 13A
The Concept of Present Value

Exercise 13A-1 (10 minutes)

Present Value of Cash

Amount of Cash Flows 18% Flows
Investme Investment Investment Investme
Year nt A B Factor A nt B
1 $3,000 $12,000 0.847 $ 2,541 $10,164
2 $6,000 $9,000 0.718 4,308 6,462
3 $9,000 $6,000 0.609 5,481 3,654
4 $12,000 $3,000 0.516 6,192 1,548
$18,522 $21,828
Investment project B is best.

© The McGraw-Hill Companies, Inc., 2018. All rights reserved.

Solutions Manual, Appendix 13A 73
Exercise 13A-2 (10 minutes)

The present value of the first option is $150,000, since the entire
amount would be received immediately.
The present value of the second option is:
Annual annuity: $14,000 × 7.469 (Exhibit 13B-2) $104,566
Lump-sum payment: $60,000 × 0.104 (Exhibit
13B-1)............................................................... 6,240
Total present value.............................................. $110,806
Thus, Julie should accept the first option, which has a much higher
present value.
On the surface, the second option appears to be a better choice
because it promises a total cash inflow of $340,000 over the 20-
year period ($14,000 × 20 = $280,000; $280,000 + $60,000 =
$340,000), whereas the first option promises a cash inflow of only
$150,000. However, the cash inflows under the second option are
spread out over 20 years, causing the present value to be far less.

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74 Managerial Accounting, 16th Edition
Exercise 13A-3 (10 minutes)

1. From Exhibit 13B-1, the factor for 10% for 3 periods is 0.751.
Therefore, the present value of the required investment is:

$8,000 × 0.751 = $6,008

2. From Exhibit 13B-1, the factor for 14% for 3 periods is 0.675.
Therefore, the present value of the required investment is:

$8,000 × 0.675 = $5,400

© The McGraw-Hill Companies, Inc., 2018. All rights reserved.

Solutions Manual, Appendix 13A 75
Exercise 13A-4 (10 minutes)

1. From Exhibit 13B-1, the factor for 10% for 5 periods is 0.621.
Therefore, the company must invest:

$500,000 × 0.621 = $310,500

2. From Exhibit 13B-1, the factor for 14% for 5 periods is 0.519.
Therefore, the company must invest:

$500,000 × 0.519 = $259,500

© The McGraw-Hill Companies, Inc., 2018

76 Managerial Accounting, 16th Edition
Exercise 13A-5 (10 minutes)

1. From Exhibit 13B-2, the factor for 16% for 8 periods is 4.344.
The computer system should be purchased only if its net
present value is positive. This will occur only if the purchase
price is less:

$7,000 × 4.344 = $30,408

2. From Exhibit 13B-2, the factor for 20% for 8 periods is 3.837.
Therefore, the maximum purchase price would be:

$7,000 × 3.837 = $26,859

© The McGraw-Hill Companies, Inc., 2018. All rights reserved.

Solutions Manual, Appendix 13A 77
Exercise 13A-6 (10 minutes)

1. From Exhibit 13B-2, the factor for 12% for 20 periods is 7.469.
Thus, the present value of Mr. Ormsby’s winnings is:

$80,000 × 7.469 = $597,520

2. Whether or not it is correct to say that Mr. Ormsby is the state’s

newest millionaire depends on your point of view. He will
receive more than a million dollars over the next 20 years;
however, he is not a millionaire as shown by the present value
computation above, nor will he ever be a millionaire if he
spends his winnings rather than investing them.

© The McGraw-Hill Companies, Inc., 2018

78 Managerial Accounting, 16th Edition
Appendix 13C
Income Taxes and Net Present Value
Analysis

Exercise 13C-1 (10 minutes)

The project’s net present value is computed as follows:

Now Years
1-5
Purchase of equipment.................... $(2,000,00
0)
Sales................................................ $2,800,00
0
Variable expenses........................... (1,600,000
)
Out-of-pocket costs......................... (500,000)
Income tax expense ($300,000 × __________ (90,000)
30%)................................................
Total cash flows (a)......................... $(2,000,00 $610,000
0)
Discount factor (b).......................... 1.000 3.517
Present value (a)×(b)...................... $(2,000,00 $2,145,37
0) 0
Net present value............................ $145,370

© The McGraw-Hill Companies, Inc., 2018. All rights reserved.

Solutions Manual, Appendix 13C 79
Exercise 13C-2 (20 minutes)

1. The annual income tax expense is computed as follows:

Years
1-5
Annual tax expense:
Sales.................................... $250,00
0
Variable expenses............... (120,000
)
Out-of-pocket costs............. (70,000)
Depreciation expense
($130,000 ÷ 5).................. (26,000)
Incremental net income...... $ 34,00
0
Tax rate............................... 30%
Income tax expense............ $(10,200
)

2. The net present value is computed as follows:

Years
Now 1-5
Net present value:
Purchase equipment........... $(130,00
0)
Sales................................... $250,00
0
Variable expenses............... (120,000
)
Out-of-pocket costs............. (70,000)
Income tax expense............ ________ (10,200)
Total cash flows (a)............. $(130,00 $ 49,80
0) 0
Discount factor (b).............. 1.000 3.352
Present value (a) × (b)........ $(130,00 $166,93
0) 0
Net present value................ $36,930

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80 Managerial Accounting, 16th Edition
Problem 13C-3 (30 minutes)
1. and 2. The annual income tax expense for each year and the net present value are
computed as follows:

Now 1 2 3 4 5
Annual tax expense:
Sales....................... $350,00 $350,00 $350,00 $350,00 $350,000
0 0 0 0
Variable expenses... (180,00 (180,00 (180,00 (180,00 (180,000)
0) 0) 0) 0)
Out-of-pocket costs. (80,000) (80,000) (80,000) (80,000) (80,000)
Repair of equipment (18,000)
Depreciation (50,000) (50,000) (50,000) (50,000) (50,000)
expense...............
Incremental net $ 40,00 $ 22,00 $ 40,00 $ 40,00 $ 40,000
income 0 0 0 0
Tax rate................... 30% 30% 30% 30% 30%
Income tax expense $(12,00 $(6,600) $(12,00 $(12,00 $(12,000)
0) 0) 0)
Net present value:
Purchase equipment $(250,00
............................ 0)
Working capital....... (60,000)
Sales....................... $350,00 $350,00 $350,00 $350,00 $350,000
0 0 0 0
Variable expenses... (180,00 (180,00 (180,00 (180,00 (180,000)
0) 0) 0) 0)
Out-of-pocket costs. (80,000) (80,000) (80,000) (80,000) (80,000)
© The McGraw-Hill Companies, Inc., 2018. All rights reserved.
Solutions Manual, Appendix 13C 81
 Repair of equipment (18,000)
Release working 60,000
capital
Income tax expense ________ (12,000) (6,600) (12,000) (12,000) (12,000)
Total cash flows (a). $(310,00 $ 78,00 $ 65,40 $ 78,00 $ 78,00 $ 138,00
0) 0 0 0 0 0
Discount factor (b). . 1.000 0.893 0.797 0.712 0.636 0.567
Present value (a) × $(310,00 $69,654 $52,124 $55,536 $49,608 $78,246
(b) 0)
Net present value.... $(4,832)
Problem 13C-4 (30 minutes)
1. and 2. The annual income tax expense and net present value are computed as follows:

Now 1 2 3 4 5
Annual tax expense:
Sales....................... $410,00 $410,00 $410,00 $410,00 $410,00
0 0 0 0 0
Variable expenses... (175,00 (175,00 (175,00 (175,00 (175,00
0) 0) 0) 0) 0)
Out-of-pocket costs. (100,00 (100,00 (100,00 (100,00 (100,00
0) 0) 0) 0) 0)
Equipment (20,000) (20,000)
maintenance
Depreciation expense (84,000) (84,000) (84,000) (84,000) (84,000)
............................
Incremental net $ 51,00 $ 51,00 $ 31,00 $ 31,00 $ 51,00
income 0 0 0 0 0
Tax rate................... 30% 30% 30% 30% 30%
© The McGraw-Hill Companies, Inc., 2018
82 Managerial Accounting, 16th Edition
 Income tax expense $(15,30 $(15,30 $(9,300) $(9,300) $(15,30
0) 0) 0)
Net present value:
Purchase equipment $(420,00
............................ 0)
Working capital....... (65,000)
Sale of old equipment $80,000
............................
Sales....................... $410,00 $410,00 $410,00 $410,00 $410,00
0 0 0 0 0
Variable expenses... (175,00 (175,00 (175,00 (175,00 (175,00
0) 0) 0) 0) 0)
Out-of-pocket costs. (100,00 (100,00 (100,00 (100,00 (100,00
0) 0) 0) 0) 0)
Equipment (20,000) (20,000)
maintenance
Release working 65,000
capital
Income tax expense ________ (15,300) (15,300) (9,300) (9,300) (15,300)
Total cash flows (a). $(405,00 $119,70 $119,70 $105,70 $105,70 $184,70
0) 0 0 0 0 0
Discount factor (b). . 1.000 0.893 0.797 0.712 0.636 0.567
Present value (a) × $(405,00 $106,89 $95,401 $75,258 $67,225 $104,72
(b) 0) 2 5
Net present value.... $44,501
Problem 13C-5 (45 minutes)
1. and 2. The annual income tax expense and net present value of Product A are computed
as follows:
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Solutions Manual, Appendix 13C 83
 Now 1 2 3 4 5
Annual tax expense:
Sales....................... $370,00 $370,00 $370,00 $370,00 $370,000
0 0 0 0
Operating expenses (200,00 (200,00 (200,00 (200,00 (200,000)
0) 0) 0) 0)
Repairs.................... (45,000)
Depreciation (80,000) (80,000) (80,000) (80,000) (80,000)
expense...............
Incremental net $90,000 $90,000 $ 45,00 $90,000 $90,000
income 0
Tax rate................... 30% 30% 30% 30% 30%
Income tax expense $(27,00 $(27,00 $(13,50 $(27,00 $(27,000)
0) 0) 0) 0)
Net present value:
Purchase equipment $(400,00
............................ 0)
Working capital....... (85,000)
Sales....................... $370,00 $370,00 $370,00 $370,00 $370,000
0 0 0 0
Operating expenses (200,00 (200,00 (200,00 (200,00 (200,000)
0) 0) 0) 0)
Repairs.................... (45,000)
Release working 85,000
capital
Income tax expense ________ (27,000) (27,000) (13,500) (27,000) (27,000)
Total cash flows (a). $(485,00 $143,00 $143,00 $111,50 $143,00 $228,000

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84 Managerial Accounting, 16th Edition
 0) 0 0 0 0
Discount factor (b). . 1.000 0.877 0.769 0.675 0.592 0.519
Present value (a) × $(485,00 $125,41 $109,96 $75,263 $84,656 $118,332
(b) 0) 1 7
Net present value.... $28,629

Note: The sales ($370,000) and operating expenses ($200,000) can also be discounted to
their present values using the appropriate discount factor (3.433) from Exhibit 13B-2 in
Appendix 13B.

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Solutions Manual, Appendix 13C 85
Problem 13C-5 (continued)
3. and 4. The annual income tax expense and net present value of Product B are computed
as follows:

Now 1 2 3 4 5
Annual tax expense:
Sales....................... $390,00 $390,00 $390,00 $390,00 $390,000
0 0 0 0
Operating expenses (170,00 (170,00 (170,00 (170,00 (170,000)
0) 0) 0) 0)
Repairs.................... (70,000)
Depreciation (110,00 (110,00 (110,00 (110,00 (110,000)
expense............... 0) 0) 0) 0)
Incremental net $110,00 $110,00 $ 40,00 $110,00 $110,000
income 0 0 0 0
Tax rate................... 30% 30% 30% 30% 30%
Income tax expense $(33,00 $(33,00 $(12,00 $(33,00 $(33,000)
0) 0) 0) 0)
Net present value:
Purchase equipment $(550,00
............................ 0)
Working capital....... (60,000)
Sales....................... $390,00 $390,00 $390,00 $390,00 $390,000
0 0 0 0
Operating expenses (170,00 (170,00 (170,00 (170,00 (170,000)
0) 0) 0) 0)
Repairs.................... (70,000)
Release working 60,000
© The McGraw-Hill Companies, Inc., 2018
86 Managerial Accounting, 16th Edition
 capital
Income tax expense ________ (33,000) (33,000) (12,000) (33,000) (33,000)
Total cash flows (a). $(610,00 $187,00 $187,00 $138,00 $187,00 $247,000
0) 0 0 0 0
Discount factor (b). . 1.000 0.877 0.769 0.675 0.592 0.519
Present value (a) × $(610,00 $163,99 $143,80 $93,150 $110,70 $128,193
(b) 0) 9 3 4
Net present value.... $29,849

Note: The sales ($390,000) and operating expenses ($170,000) can also be discounted to
their present values using the appropriate discount factor (3.433) from Exhibit 13B-2 in
Appendix 13B.

© The McGraw-Hill Companies, Inc., 2018. All rights reserved.

Solutions Manual, Appendix 13C 87
Problem 13C-5 (continued)

5. Students should use the project profitability index to answer

this question as follows:
Product Product
A B
Net present value (a)........................... $28,629 $29,849
Investment required (b)....................... $485,00 $610,00
0 0
Project profitability index (a) ÷ (b)...... 0.059 0.049

Although Product A has the lower net present value, it has the
higher project profitability index; therefore, it should be chosen
over Product B.

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88 Managerial Accounting, 16th Edition