Sandcastles, Inc.’s management has recently been looking at a proposal to purchase a new brick molding machine. With the new machine, the company would not have to buy bricks. The estimated useful life of the machine is 15 years, and the purchase price, including all setup charges, is $400,000. The residual value is estimated to be$40,000. The net addition to the company’s cash inflow as a result of the savings from making the bricks is estimated to be $70,000 a year. Sandcastle’s management has decided on a minimum rate of return of 14 percent. Using the net present value method to evaluate this capital investment, determine whether the company should purchase the machine. Support your answer.

Holt Enterprises recently paid a dividend, $D_{0}$, of $\$2.75$. It expects to have nonconstant growth of $18\%$ for $2$ years followed by a constant rate of $6\%$ thereafter. The firm’s required return is $12\%$. How far away is the horizon date?

Leisure Resorts, Ltd., has approached EZ Printers, Inc., with a special order to produce 300,000 two-page brochures. Most of EZ’s work consists of recurring short-run orders. Leisure Resorts is offering a one-time order, and EZ has the capacity to handle the order over a two-month period.

Leisure Resorts’ management has stated that the company would be unwilling to pay more than $48 per 1,000 brochures. EZ’s controller assembled the following cost data for this decision analysis:

$$\begin{array}{ll} \text{Direct materials (paper)} & \text{\$26.80 per 1,000 brochures}\\ \text{Direct labor costs} & \text{\$6.80 per 1,000 brochures}\\ \text{Direct materials (ink)} & \text{\$4.40 per 1,000 brochures}\\ \text{Variable production overhead} & \text{\$6.20 per 1,000 brochures}\\ \text{Machine maintenance (fixed cost)} & \text{\$1.00 per direct labor dollar}\\ \text{Other fixed production overhead} & \text{\$2.40 per direct labor dollar}\\ \text{Variable packing costs} & \text{\$4.30 per 1,000 brochures}\\ \text{General and administrative expenses (fixed}\\ \text{$\quad$costs) to be allocated} & \text{\$5.25 per direct labor dollar}\\ \end{array}$$

Required

1. Prepare an analysis for EZ’s management to use in deciding whether to accept or reject Leisure Resorts’ offer. What decision should be made?

2. What is the lowest possible price EZ can charge per thousand and still make a $6,000 profit on the order?

Beef Products, Inc., processes cattle. It can sell the meat as sides of beef or process it further into final cuts (steaks, roasts, and hamburger). As part of the company’s strategic plan, management is looking for new markets for meat or meat by-products. The production process currently separates hides and bones for sale to other manufacturers. However, management is considering whether it would be profitable to process the hides into leather and the bones into fertilizer. The costs of the cattle and of transporting, hanging, storing, and cutting sides of beef are $100,000. The company’s accountant provided these data:

$$\begin{array}{lrrr} & \textbf{Sales Revenue if} & \textbf{Sales Revenue if Sold} & \textbf{Additional}\\ \textbf{Product} & \textbf{Sold at Split-Off} & \textbf{After Further Processing} & \textbf{Processing Costs}\\ \\ \text{Meat} & \$100,000 & \$200,000 & \$80,000\\ \text{Bones} & 20,000 & 40,000 &25,000\\ \text{Hides} & 50,000 &60,000& 5,000\\ \end{array}$$

Should the products be processed further? Explain your answer.

As the CEO of your cookie company, you are interested in how public companies with a segment that includes cookies report their operating results. Because public companies are required to report on their segments, it is possible to evaluate the performance of comparable segments of different companies.

Access the website of Kraft Foods, Inc., which markets Nabisco cookies (www.kraftfoodscompany.com/About), and the website of Kellogg Company, which markets Keebler cookies (www.kelloggcompany.com). Find information about these companies’ major segments. Which segments are comparable, and which are not comparable? Which segments of these companies do you think include their brand of cookies?

Suppose your cookie company is now a corporation that has granted franchises to more than 50 stores. Currently, only 10 of the 50 stores have computerized machines for mixing cookie dough. Because of a tremendous increase in demand for cookie dough, you, as the corporation’s president, are considering purchasing 10 more computerized mixing machines by the end of this month. You are writing a memo evaluating this purchase that you will present at the board of directors’ meeting next week.

According to your research, the 10 new machines will cost a total of $320,000. They will function for an estimated five years and should have a total residual value of$32,000. All of your corporation’s capital investments are expected to produce a 20 percent minimum rate of return, and they should be recovered in three years or less. All fixed assets are depreciated using the straight-line method. The forecasted increase in operating results for the aggregate of the 10 new machines follows.

$$\begin{array}{c} \textbf{Cash Flow Estimates}\\ \end{array}$$

$$\begin{array}{crr} \textbf{Year} & \textbf{Cash Inflows} & \textbf{Cash Outflows}\\ \\ 1 & \$310,000 & \$210,000\\ 2 & 325,000& 220,000\\ 3 & 340,000 & 230,000\\ 4 & 300,000 & 210,000\\ 5 & 260,000 & 180,000\\ \end{array}$$

1. In preparation for writing your memo, answer the following questions:

$\quad\quad$ a. What kinds of information do you need to prepare this memo?

$\quad\quad$ b. Why is the information relevant?

$\quad\quad$ c. Where would you find the information?

$\quad\quad$ d. When would you want to obtain the information?

2. Using the following methods, analyze the purchase of the machines and decide if your corporation should purchase them.

$\quad\quad$ a. the net present value method (Round to the nearest dollar.)

$\quad\quad$ b. the accounting rate-of-return method (Round percentages to one decimal place.)

$\quad\quad$ c. the payback period method (Round to one decimal place.)

Sisters Restaurant purchases cheesecakes and offers them as dessert items on its menu. The cheesecakes cost $24 each, and a cake contains 8 pieces. The supplier recently gave notice that the price will rise by 20 percent immediately. Sisters has idle equipment that with only a few minor changes could be used to produce similar cheesecakes. Cost estimates have been prepared under the assumption that the company could make the product itself. Direct materials would cost$7 per cheesecake. Direct labor required would be 0.5 hour per cheesecake at a labor rate of $24 per hour. Variable overhead would be$9 per cheesecake. Fixed overhead, which would be incurred under either decision alternative, would be $35,200 a year for depreciation and$230,000 a year for other costs. Production and usage are estimated at 3,600 cheesecakes a year. (Assume that any idle equipment cannot be used for any other purpose.)

Required

1. Prepare an incremental analysis to determine whether the cheesecakes should be made within the company or purchased from the outside supplier at the higher price.

2. Compute the variable unit cost to (a) make one cheesecake and (b) buy one cheesecake.

Admiralty Corporation is analyzing a proposal to switch its factory over to a lights-out operation. To do so, it must acquire a fully automated machine. The machine will be able to produce an entire product line in a single operation. Projected annual net cash inflows from the machine are $180,000, and projected net income is$120,000. Why is the projected net income lower than the projected net cash inflows? Identify possible causes for the $60,000 difference.

GAME Enterprises manufactures three computer games called Rocket Star, Game Master, and Rock Warrior. The product line data follow.

$$\begin{array}{lrrr} & \textbf{Rocket Star} & \textbf{Game Master} & \textbf{Rock Warrior}\\ \\ \text{Current unit sales demand} & 20,000 & 30,000 & 18,000\\ \text{Machine hours per unit} & 2.0 & 1.0 &2.5\\ \text{Selling price per unit} & \$20.00 & \$16.00 & \$30.00\\ \text{Unit variable manufacturing costs} & \$12.50 & \$10.00 & \$18.75\\ \text{Unit variable selling costs} & \$6.50 & \$5.00 & \$6.25\\ \end{array}$$

The current production capacity is 100,000 machine hours.

1. Which computer game should be manufactured first? Which should be manufactured second? Which last?

2. How many of each type of computer game should be manufactured and sold to maximize the company’s contribution margin based on the current production activity of 100,000 machine hours? What is the total contribution margin for that combination?

Stock X has a 10% expected return, a beta coefficient of 0.9, and a 35% standard deviation of expected returns. Stock Y has a 12.5% expected return, a beta coefficient of 1.2, and a 25% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%. a. Calculate each stock’s coefficient of variation. b. Which stock is riskier for a diversified investor? c. Calculate each stock’s required rate of return. d. On the basis of the two stocks’ expected and required returns, which stock would be more attractive to a diversified investor? e. Calculate the required return of a portfolio that has $7,500 invested in Stock X and$2,500 invested in Stock Y. f. If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return?

Edge Company’s production vice president believes keeping up-to-date with technological changes is what makes the company successful and feels that a machine introduced recently would fill an important need. The machine has an estimated useful life of four years, a purchase price of $250,000, and a residual value of$25,000. The company controller has estimated average annual net income of $11,250 and the following cash flows for the new machine:

$$\begin{array}{c} \textbf{Cash Flow Estimates}\\ \end{array}$$

$$\begin{array}{crrr} \textbf{Year} & \textbf{Cash Inflows} & \textbf{Cash Outflows} & \textbf{Net Cash Inflows}\\ \\ 1 & \$325,000 & \$250,000 & \$75,000\\ 2 & 320,000 & 250,000 &70,000\\ 3 & 315,000 & 250,000 &65,000\\ 4 & 310,000 & 250,000& 60,000\\ \end{array}$$

The company uses a 12 percent minimum rate of return and a three-year payback period for capital investment evaluation purposes.

Required

1. Analyze the data about the machine. Use the following evaluation approaches in your analysis:

$\quad\quad$ (a) the net present value method (Round to the nearest dollar.)

$\quad\quad$ (b) the accounting rate-of-return method (Round to one decimal place.)

$\quad\quad$ (c) the payback period method (Round to one decimal place.)

2. Summarize the information generated in requirement 1, and make a recommendation.

Blizzard, Inc., makes three kinds of snowboards, but it has a limited number of machine hours available to make them. Product line data follow.

$$\begin{array}{lrrr} & \textbf{Wood} & \textbf{Plastic} & \textbf{Graphite}\\ \\ \text{Machine hours per unit} & 1.25 & 1.0& 1.5\\ \text{Selling price per unit} & \$100 & \$120 & \$200\\ \text{Variable manufacturing cost per unit} & \$45 & \$50 & \$100\\ \text{Variable selling costs per unit} & \$15 & \$26 & \$37\\ \end{array}$$

In what order should the snowboard product lines be produced?

Bramer Corporation’s controller, Mara Jossen, was asked to prepare a capital investment analysis for a robot-guided aluminum window machine. This machine would automate the entire window-casing manufacturing line. She has just returned from an international seminar on the subject of qualitative inputs into the capital investment decision process and is eager to incorporate those new ideas into the analysis. In addition to the normal net present value analysis (which produced a significant negative result), Jossen factored in figures for customer satisfaction, scrap reduction, reduced inventory needs, and reputation for quality. With the additional information included, the analysis produced a positive response to the decision question.

When the chief financial officer finished reviewing Jossen’s work, he threw the papers on the floor and said, “What kind of garbage is this! You know it’s impossible to quantify such things as customer satisfaction and reputation for quality. How do you expect me to go to the board of directors and explain your work? I want you to redo the entire analysis and follow only the traditional approach to net present value. Get it back to me in two hours!”

What is Jossen’s dilemma? What ethical courses of action are available to her?

Torch Industries can issue perpetual preferred stock at a price of $57.00 a share. The stock would pay a constant annual dividend of$6.00 a share. What is the company’s cost of preferred stock, $\mathrm{T}_{\mathrm{P}} ?$

Assume that the risk-free rate is 3.5% and the market risk premium is 4%. What is the required return for the overall stock market? What is the required rate of return on a stock with a beta of 0.8?