Quip Corporation Wants to Purchase a New Machine for $300,000

question 163

Multiple Choice

Quip Corporation wants to purchase a new machine for $300,000. Management predicts that the machine will produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with an assumed residual (salvage) value of $50,000. Quip's combined income tax rate, t, is 40%.

Management requires a minimum after-tax rate of return of 10% on all investments. What is the approximate internal rate of return (IRR) of the proposed investment? (Note: To answer this question, students must have access to Table 2 from Appendix C, Chapter 12.) Assume that all cash flows occur at year-end.

• A) Less than 12%.
• B) Somewhere between 12% and 14%.
• C) Somewhere between 14% and 15%.
• D) Somewhere between 15% and 20%.
• E) Over 20%.

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Definitions:

Operating Activities

Operating activities involve the primary revenue-generating activities of an entity, as reflected in its profits or losses from core operations.

Depreciation

The method of allocating the cost of a tangible asset over its useful life, reflecting the loss of value over time.

Accounts Payable

Liabilities to creditors for goods, services, or supplies delivered or used in the earning process but not yet paid for.

Free Cash Flow

A financial measure representing the amount of cash generated by a business that is available for distribution to its security holders after accounting for reinvestment in assets.