Capital Budgeting Decisions
Evaluate several capital budgeting decision scenarios. In a Word document, complete the exercises below and submit your responses per the instructions that follow.
Equity Corp.
Equity Corp. paid a consultant to study the desirability of installing some new equipment. The consultant recently submitted the following analysis:
Equity Corp. table
The corporate tax rate is 40%. Should Equity Corp. accept the project?
Used by permission of McGraw-Hill.
Declining Market, Inc.
Declining Market, Inc. is considering the problem of when to stop production of a particular product in its product line. Sales of the product in question have been declining, and all estimates are that they will continue to decline. Capital equipment used to manufacture the product is specialized but can be readily sold as used equipment. If the decision rule for this case says “Keep producing the product as long as its contribution to net earnings is positive” what, if anything, is wrong with that? [Contribution to new earnings, where t is the tax rate, is (1 – t) (Sales – Variance cost – Depreciation on equipment used to manufacture product).]
Used by permission of McGraw-Hill.
Demand for DVD Players
The demand for DVD players is expanding rapidly, but the industry is highly competitive. A plant to make DVD players costs $40 million, has an annual capacity of 100,000 units, and has an indefinite physical life. The variable production cost per unit is $20 and is not expected to change. If the cost of capital is 10%, what is the price of a DVD player?
Used by permission of McGraw-Hill.
Flower City Grocery
The Flower City Grocery is faced with the following capital budgeting decision. Its display freezer system must be repaired. The cost of this repair will be $1,000 and the system will be usable for another 5 years. Alternatively, the firm could purchase a new freezer system for $5,000 and sell the old one for $500. The new freezer system has more display space and will increase the profits attributable to frozen foods by 30%. Profits for that department were $5,000 in the last fiscal year. The company’s cost of capital is 9%. Ignoring taxes, what should the firm do?
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