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Free CMA Exam Braindumps (page: 17)

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In order to increase production capacity, Gunning Industries is considering replacing an existing production machine with a new technologically improved machine effective January 1.The following information is being considered by Gunning Industries:
· The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost an additional $30,000.
· The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit. Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per year.
· The investment in the new machine will require an immediate increase in working capital of $35,000. This cash outflow will be recovered after 5 years. · Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new machine has an estimated useful life of 5 years and zero salvage value.
· Gunning is subject to a 40% corporate income tax rate. Gunning uses the net present value method to analyze investments and will employ the following factors and rates:


Gunning Industries' discounted annual depreciation tax shield for the year of replacement is

  1. $13,817
  2. $16,762
  3. $20,725
  4. $22,800

Answer(s): A

Explanation:

Gunning uses straight-line depreciation. Thus, the annual charge is $38,000 [($160,000 ÷ $30,000) + 5 years], and the tax savings is $15,200 ($38,000 x 40%). That benefit will be received in 1 year, so the present value is $13,817 ($15,200 tax savings x .909 present value of $1 for 1 year at 10%).



View Related Case Study

In order to increase production capacity, Gunning Industries is considering replacing an existing production machine with a new technologically improved machine effective January 1. The following information is being considered by Gunning Industries:
· The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost an additional $30,000.
· The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit. Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per year.
· The investment in the new machine will require an immediate increase in working capital of $35,000. This cash outflow will be recovered after 5 years. · Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new machine has an estimated useful life of 5 years and zero salvage value.
· Gunning is subject to a 40% corporate income tax rate. Gunning uses the net present value method to analyze investments and will employ the following factors and rates:


The acquisition of the new production machine by Gunning Industries will contribute a discounted net-of-tax contribution margin of

  1. $242,624
  2. $303,280
  3. $363,936
  4. $454,920

Answer(s): D

Explanation:

The new machine will increase sales by 20,000 units a year. The increase in the pretax total contribution margin will be $200,000 per year [20,000 units x ($40 SP -- $30 VC)], and the annual increase in the after tax contribution margin will be $120,000 [$200,000 x (1.0-- .4)]. The present value of the after-tax increase in the contribution margin over the 5-year useful life of the machine is $454,920 ($120,000 x 3.791 PV o f an ordinary annuity for 5 years at 10%).



View Related Case Study

In order to increase production capacity, Gunning Industries is considering replacing an existing production machine with a new technologically improved machine effective January 1. The following information is being considered by Gunning Industries:

· The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost an additional $30,000.
· The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit. Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per year.
· The investment in the new machine will require an immediate increase in working capital of $35,000. This cash outflow will be recovered after 5 years. · Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new machine has an estimated useful life of 5 years and zero salvage value.
· Gunning is subject to a 40% corporate income tax rate. Gunning uses the net present value method to analyze investments and will employ the following factors and rates:


The overall discounted cash flow impact of Gunning Industries' working capital investment for the new production machine would be

  1. $(7,959)
  2. $(10,080)
  3. $(13,265)
  4. $(35,000)

Answer(s): C

Explanation:

The $35,000 of working capital requires an immediate outlay for that amount, but it will be recovered in 5 years. Thus, the net discounted cash outflow is $13,265 [$35,000 initial investment--($35,000 future 1inflow x .621 PV of $1 for 5 years at 10%)].



View Related Case Study

Jackson Corporation uses net present value techniques in evaluating its capital investment projects. The company is considering a new equipment acquisition that will cost $100,000, fully installed, and have a zero salvage value at the end of its five-year productive life. Jackson will depreciate the equipment on a straight-line basis for both financial and tax purposes. Jackson estimates $70,000 in annual recurring operating cash income and $20,000 in annual recurring operating cash expenses. Jackson's desired rate of return is 12% and its effective income tax rate is 40%. What is the net present value of this investment on an after-tax basis?

  1. $28,840
  2. $8,150
  3. $36,990
  4. $80,250

Answer(s): C

Explanation:

Annual cash outflow for taxes is $12,000 {[$70,000 inflows -- $20,000 cash operating expenses `--($100,000 ÷ 5) depreciation] x 40%}. The annual net cash inflow is therefore $38,000 ($70,000 --$20,000-- $12,000). The present value of these net inflows for a 5-year period is $136,990 ($38,000 x 3.605 present value of an ordinary annually for 5 years at 12%)1 and the NPV of the investment is $36,990 ($136,990 -- $100,000 investment).






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