## Capital Budgeting Decisions

Chee Company has gathered the following data on a proposed investment project:

Investment required in equipment………….

$320,000

Annual cash inflows…………………………….

Year 1: $50,000

Year 2: 50,000

Year 3: 60,000

Year 4: 40,000

Year 5: 65,000

Year 6: 50,000

Year 7: 70,000

Year 8: 65,000

Salvage value………………………………………

$60,000

Life of the investment…………………………..

8 years

Required rate of return…………………………

10%

Assets will be depreciated using straight

line depreciation method

Required:

- Show all calculations in good form. Answers without supporting calculations will earn zero marks.
- Calculate the annual incremental net income for all eight (8) years.
- Using the net present value and the internal rate of return methods, is this a good investment?

Part B: Variance Analysis for Decision Making

Bronfenbrenner Co. uses a standard cost system for its single product in which variable overhead is applied on the basis of direct labor hours. The following information is given:

Standard costs per unit:

Raw materials (2 grams at $16 per gram)……….

Direct labor (1 hour at $10 per hour)……………..

Variable overhead (1 hours at $2.5 per hour)…..

Actual experience for current year:

Units produced…………………………………………….

30,000 units

Purchases of raw materials (20,000 grams at $19 per gram)…………………………………………..

Raw materials used………………………………………

35,000 grams

Direct labor (18,000 hours at $10 per hour)…….

Variable overhead cost incurred…………………….

$50,000

Required:

- Show all calculations in good form. Answers without supporting calculations will earn zero marks.
- Compute the following variances for raw materials, direct labor, and variable overhead, assuming that the price variance for materials is recognized at point of purchase:

a. Direct materials price variance.

b. Direct materials quantity variance.

c. Direct labor rate variance.

d. Direct labor efficiency variance.

e. Variable overhead spending variance.

f. Variable overhead efficiency variance.

g. As a manager, why is variance analysis important?

Part C: Evaluation of Decentralized Organizations

The Clipper Corporation had net operating income of $340,000 and average operating assets of $1,700,000. The corporation requires a return on investment of 20%.

Required:

Show all calculations in good form. Answers without supporting calculations will earn zero marks.

a. Calculate the company’s return on investment (ROI) and residual income (RI).

b. Clipper Corporation is considering an investment of $80,000 in a project that will generate annual net operating income of $15,000. Would it be in the best interests of the company to make this investment?

c. Clipper Corporation is considering an investment of $80,000 in a project that will generate annual net operating income of $15,000. If the division planning to make the investment currently has a return on investment of 18% and its manager is evaluated based on the division’s ROI, will the division manager be inclined to request funds to make this investment?

d. Clipper Corporation is considering an investment of $80,000 in a project that will generate annual net operating income of $15,000. If the division planning to make the investment currently has a residual income of $40,000 and its manager is evaluated based on the division’s residual income, will the division manager be inclined to request funds to make this investment?