Problem 1: Present Value Analysis
James Hardy recently rejected a $20,000,000, five-year contract with the Vancouver Seals. The contract offer called for an immediate signing bonus of $7,500,000 and annual payments of $2,500,000. To sweeten the deal, the president of player personnel for the Seals has now offered a $22,000,000, five-year contract. This contract calls for annual increases and a balloon payment at the end of five years.
|
Year 1
|
$2,500,000
|
|
Year 2
|
2,600,000
|
|
Year 3
|
2,700,000
|
|
Year 4
|
2,800,000
|
|
YearS
|
2,900,000
|
|
Year 5 balloon pymt
|
8,500,000
|
|
Total
|
$22,000,000
|
Required:
Suppose you are Hardy's agent and you wish to evaluate the two contracts using a required rate of return of 15 percent. In present value terms, how much better is the second contract?
Problem 2: Choosing Among Alternative Investments
Quality Shoe Company is considering investing in one of two machines that attach heels to shoes. Machine A costs 70,000 and is expected to save the company 20,000 per year for six years. Machine B costs 85,000 and is expected to save the company 25,000 per year for six years. Determine the net present value for each machine and which machine should be purchased if the required rate of return is 13 percent, ignore taxes.
Problem 3: Present Value and "What If" Analysis
National Cruise Line, Inc. is considering the acquisition of a new ship that will cost $200,000,000. In this regard, the president of the company asked the CFO to analyze cash flows associated with operating the ship under two alternative itineraries: Itinerary 1, Caribbean Winter/Alaska Summer and Itinerary 2, Caribbean Winter/Eastern Canada Summer. The CFO estimated the following cash flows, which are expected to apply to each of the next 15 years: In this regard, the president of the company asked the CFO to analyze cash flows associated with operating the ship under two alternative itineraries: Itinerary 1, Caribbean Winter/Alaska Summer and Itinerary 2, Caribbean Winter/Eastern Canada Summer. The CFO estimated the following cash flows, which are expected to apply to each of the next 15 years:
|
Caribbean/Alaska
|
Caribbean/Eastern Canada
|
|
Net revenue
|
$120,000,000
|
$105,000,000
|
|
Less:
|
|
|
|
Direct program expenses
|
25,000,000
|
24,000,000
|
|
Indirect program expenses
|
20,000,000
|
20,000,000
|
|
Non-operating expenses
|
21,000,000
|
21,000,000
|
|
Add back depreciation
|
115,000,000
|
115,000,000
|
|
Cash flow per year
|
$169,000,000
|
$155,000,000
|
Part a. For each of the itineraries, calculate the present values of the cash flows using required rates of return of both 12% and 16% Assume a 15 -year time horizon. Should the company purchase the ship with either or both required rates of return?
Part b. The president is uncertain whether a 12 percent or a 16 percent required return is appropriate. Explain why, in the present circumstance, spending a great deal of time to determine the correct required return may not be necessary.
Part c. Focusing on a 12 percent required rate of return, what would be the opportunity cost to the company of using the ship in the Caribbean/Eastern Canada itinerary rather than a Caribbean/Alaska itinerary
Problem 4: Net Present Value and Taxes
Associated Penguin Productions is evaluating a film project. The president of Associated Penguin estimates that the film will cost $20,000,000 to produce. In its first year, the film is expected to generate $16,500,000 in net revenue, after which the film will be released to video. Video is expected to generate $10,000,000 in net revenue in its first year, $2,500,000 in its second year, and $1,000,000 in its third year. For tax purposes, amortization of the cost of the film will be $12,000,000 in year 1 and $8,000,000 in year 2. The company's tax rate is 35 percent, and the company requires a 12 percent rate of return on its films.
Required:
What is the net present value of the film project? To simplify, assume that all outlays to produce the film occur at time 0. Should the company produce the film?
Problem 5: Internal Rate of Return and Taxes
The Boston Culinary Institute is evaluating a classroom remodeling project. The cost of the remodel will be $350,000 and will be depreciated over 6 years using the straight-line method. The remodeled room will accommodate 5 extra students per year. Each student pays annual tuition of $22,000 The before-tax incremental cost of a student (e.g., the cost of food prepared and consumed by a student) is $2,000 per year. The company's tax rate is 40% and the company requires a 12% rate of return on the remodeling project.
Required:
Assuming a 6 -year time horizon, what is the internal rate of return of the remodeling project? Should the company invest in the remodel?
Problem 6: Comprehensive Capital Budgeting Problem
Van Doren Corporation is considering producing a new product, Autodial. Marketing data indicate that the company will be able to sell 45,000 units per year at $30. The product will be produced in a section of an existing factory that is cun-ently not in use. To produce Autodial, Van Doren must buy a machine that costs $500,000. The machine has an expected life of five years and will have an ending residual value of $15,000. Van Doren will depreciate the machine over six years using the straight-line
method for both tax and financial reporting purposes.
In addition to the cost of the machine, the company will incur incremental manufacturing costs of $370,000 for component parts, $425,000 for direct labor, and $200,000 of miscellaneous costs. Also, the company plans to spend $150,000 annually for advertising Autodial. Van Doren has a tax rate of 40 percent, and the company's required rate of return is 15 percent.
Required:
a. Compute the net present value.
b. Compute the payback period.
c. Compute the accounting rate of return.
d. Should Van Doren make the investment required to produce Autodial?
Problem 7: Master Budget
(Note: This problem is similar to the chapter review problem- only the numbers have been changed. Students who get "stuck" should consult the solution to the review problem.)
The results of operations for the Preston Manufacturing Company for the fourth quarter of 2014 were as follows (in thousands):
|
Sales
|
$550,000
|
|
Less variable cost of sales
|
330,000
|
|
Contribution margin
|
220,000
|
|
Less fixed production costs
|
$120,000
|
|
|
Less fixed selling and administrative expenses
|
55,000
|
175,000
|
|
Income before taxes
|
45,000
|
|
Less taxes on income
|
18,000
|
|
Net income
|
$ 27,000
|
Note: Preston Manufacturing uses the variable costing method. Thus, only variable production costs are included in inventory and cost of goods sold. Fixed production costs are charged to expense in the. period incurred.
The company's balance sheet as of the end of the fourth quarter of 2014 was as follows (in thousands):
|
Assets:
|
|
Cash
|
$160,000
|
|
Accounts receivable
|
220,000
|
|
Inventory
|
385,000
|
|
Total current assets
|
765,000
|
|
Property, plant, and equipment
|
440,000
|
|
Less accumulated depreciation
|
110,000
|
|
Total assets
|
1,095,000
|
|
|
Liabilities and owners' equity:
|
|
Accounts payable
|
$56,000
|
|
Common stock
|
550,000
|
|
Retained earnings
|
489,000
|
|
Total liabilities and owners' equity
|
$1,095,000
|
Additional information:
1. Sales and variable costs of sales are expected to increase by 12 percent in the next quarter.
2. All sales are on credit with 60 percent collected in the quarter of sale and 40 percent collected in the following quarter.
3. Variable cost of sales consists of 40 percent materials, 40 percent direct labor, and 20 percent variable overhead. Materials are purchased on credit, and 50 percent are paid for in the quarter of purchase and the remaining amount is paid for in the quarter after purchase. The inventory balance is not expected to change. Also, direct labor and variable overhead are paid in the quarter. the expenses are incurred.
4. Fixed production costs (other than $9,000 ofdepreciation) are. expected to increase by 3 percent. Fixed production costs requiring payment are paid in the quarter they are incurred.
5. Fixed selling and administrative costs (other than $7,000 of depreciation expense) are expected to increase by two percent. Fixed selling and administrative costs requiring payment are paid in the quarter they are incurred.
6. The tax rate is expected to be 40 percent. All taxes are paid in the quarter they are incurred.
7. No purchases of property, plant, or equipment are expected in the first quarter of 2015.
Required:
a. Prepare a budgeted income statementfor the first quarter of 2015.
b. Prepare a budgeted statement of cash receipts and disbursements for the first quarter of 2015.
c. Prepare a budgeted balance sheet as ofthe end ofthe first quarter of 2015.
PROBLEM 10-11. Cash Budget
In the fourth quarter of 2015, Eurofit Cycling, a bike shop, had the following net income:
|
Sales
|
$300,000
|
|
Less cost of sales
|
120,000
|
|
Gross margin
|
180,000
|
|
Selling and administration
|
57,000
|
|
Income before taxes
|
23,000
|
|
Income taxes
|
3,050
|
|
Net income
|
$ 9,950
|
|
|
Quarter 1
|
Quarter 2
|
Quarter 3
|
Quarter 4
|
|
Sales
|
$400,000
|
$475,000
|
$550,000
|
$600,000
|
|
Cost of sales
|
170,000
|
185,000
|
220,000
|
230,000
|
|
Purchases
|
160,000
|
200,000
|
225,000
|
267,000
|
|
Selling and administration
|
67,000
|
69,000
|
71,000
|
73,000
|
Taxes are 35 percent of pretax income. Fifty percent of sales are collected in the quarter of sale and 50 percent in the next quarter. Seventy percent of purchases are paid in the quarter of purchase and 30 percent in the next quarter. Selling and administrative expenses are paid in the quarter incurred except for $7,000 of depreciation included in selling and administrative expense. A capital expenditure for $20,000 is planned for the fourth quarter of 2015.
Required
Prepare a cash receipts and disbursements budget for each quarter of 2015.
Problem 7: Comprehensive Variance Problem
Bowser Products operates a small plant in New Mexico that produces dog food in batches of 1,500 pounds. The product sells for $6 per pound. Standard costs for 2015 are:
- Standard direct labor cost = $15 per hour
- Standard direct labor hours per batch = 10 hours
- Standard cost of material A = $0.35 per pound
- Standard pounds of material Aper batch = 800 pounds·
- Standard cost of material B = $0.55 per pound
- Standard pounds of material B per batch = 250 pounds
- Fixed overhead cost per batch = $500
At the start of 2015, the company estimated monthly production and sales of 50 batches. The company estimated that all overhead costs were fixed and amounted to $25,000 per month. During the month of June, 2015 (typically a somewhat slow month) 42 batches were produced (not an unusual level of production for this month).
The following costs were incurred:
- Direct labor costs were $7,800 for 460 hours
- 37,500 pounds of material Acosting 8,500 were purchased and used
- 12,000 pounds of material B costing $5,600 were purchased and used
- Fixed overhead of $23,000 was incurred
Required:
a. Calculate variances for material, labor, and overhead.
b. Prepare a summary of the variances. Does the unfavorable overhead volume variance suggest that overhead costs are out of control?