Deck 11: Capital Investment Decisions

Question 1

Wishlist recently purchased a new packaging machine for $678,026. The machine has a remaining useful life of 10 years. Net cash flow per year will be $120,000. The internal rate of return is:

A) 16%.
B) 24%.
C) 12%.
D) 20%.

Answer 1

C

Question 2

After appraisal of an investment opportunity, the net present value was calculated as $1,000. This indicated that the project's return is:

A) greater than the discount rate used in the analysis.
B) greater than the company's rate of return.
C) equal to the market rate of return.
D) the opportunity rate.

Answer 2

A

Question 3

Joe is considering setting up a business selling free-range chickens. He estimates that his establishment costs will be $600,000 and his net cash flows for the first five years will be $100,000 in year 1, $200,000 in year 2 and stabilising at $250,000 in year 3. The payback period for the investment is:

A) 3.2 years.
B) 3 years.
C) 3.8 years.
D) 5 years.

Answer 3

A

Question 4

Container Ltd, a manufacturing firm, is considering investing $110,000 in a new mainframe computer. It is estimated that net cash flow per year will be $25,000 and the computer will have a 10-year useful life. The machine will be depreciated on a straight-line basis. The accounting rate of return is:

A) 25.45%.
B) 10.55%.
C) 22.72%.
D) 15.86%.

Question 5

Which of the following would be a reason for preferring $100 now rather than $100 in one year's time?

A) the effects of inflation
B) interest lost
C) risk
D) all of the above

Question 6

Use the information below to answer the following questions.
Han Ltd supplies chilli paste to large supermarket chains. The company is currently considering scrapping its old processor and investing in a new processor. Information about the investment is as follows:
Refer to the table above. The net present value (rounded) of the investment is:

A) $21,000
B) $16,500
C) $17,000
D) $18,195

Question 7

Use the information below to answer the following questions.
Han Ltd supplies chilli paste to large supermarket chains. The company is currently considering scrapping its old processor and investing in a new processor. Information about the investment is as follows:
Refer to the table above. Using the net present value approach, the management of Han Ltd will make which of the following decisions?

A) Increase the residual value of the processor.
B) Retain the current processor.
C) Accept the investment proposal and purchase the new processor.
D) Retain the current processor and buy the new processor.

Question 8

Martin Short, managing director of Mills Ltd, has received a report from his finance manager recommending four investment projects for his approval. However, the firm only has sufficient funds to invest in one project. The firm's rate of return is 6%. The accounting rate of return for each project is: A, 10%; B, 8%; C, 12%; and D, 14%. Short will select:

A) Project A.
B) Project D.
C) Project C.
D) Project B.

Question 9

Relevant cash flows for investment decisions are:

A) actual cash flows that do not differ between alternatives.
B) expected cash flows that will differ between alternatives.
C) expected cash flows that will not differ between alternatives.
D) actual cash flows that differ between alternatives.

Question 10

The potential benefits forgone by rejecting one alternative while accepting another is known as a/an:

A) opportunity cost.
B) past cost.
C) deprivation cost.
D) cost/benefit cost.

Question 11

An assessment method widely used in practice which enables managers to screen investment projects to determine which projects can recoup their investment outlay the fastest is the:

A) net present value method.
B) payback method.
C) internal rate of return method.
D) accounting rate of return method.

Question 12

The decision rule for the accounting rate of return method of assessing investment projects is to accept all projects with:

A) a positive return.
B) the highest return subject to a minimum required return.
C) the highest return.
D) none of the above

Question 13

Which of these is not generally regarded as an advantage of the payback method?

A) It emphasises early cash flows which have greater certainty.
B) It emphasises liquidity.
C) It avoids having to take into account the time value of money.
D) It minimises having to forecast too far into the future.

Question 14

Which of these costs would not be relevant to an investment decision to replace an existing asset with a newer model capable of increasing production?

A) future operating costs of existing asset
B) trade-in value of existing asset
C) disposal value of existing asset
D) carrying amount of asset to be replaced

Question 15

The internal rate of return is the discount rate that makes the net present value:

A) positive.
B) negative.
C) zero.
D) high.

Question 16

The investment decision method which takes the average profit and expresses it as a percentage of the average investment is:

A) accounting rate of return.
B) payback.
C) internal rate of return.
D) net present value.

Question 17

The net present value method, unlike the internal rate of return method, does not relate the return to the size of the amount invested. This problem can be overcome by which of these methods?

A) use of a profitability index
B) calculation of net present value per $1 of investment
C) the net present value method used in conjunction with the accounting rate of return method
D) both A and B

Question 18

Depreciation is not included in net present value analysis because it is:

A) a fixed cost.
B) a non-cash item.
C) an historic cost.
D) a variable cost.

Question 19

Which statement is true?

A) The internal rate of return method assumes that cash re-invested in the course of the life of the project earns at the same rate as the project.
B) The net present value method assumes that the re-investment rate is at the cost of capital.
C) Both the internal rate of return and the net present value methods assume that the re-investment rate is at the cost of capital.
D) A and B are both true.

Question 20

Which method of investment appraisal has been found in surveys to be used by 94% of Australian/New Zealand companies?

A) net present value
B) accounting rate of return
C) internal rate of return
D) payback

Question 21

In capital investment decision-making, PV stands for:

A) purchasing value.
B) present value.
C) profit vesting.
D) payback value.

Question 22

Use the information below to answer the following questions.
Han Ltd supplies chilli paste to large supermarket chains. The company is currently considering scrapping its old processor and investing in a new processor. Information about the investment is as follows:
Refer to the table above. What is the annual net cash flow in year 5?

A) $35,000
B) $30,000
C) $40,000
D) $50,000

Question 23

The decision to invest in a project should be based on:

A) both non-financial and qualitative information.
B) both financial and non-financial information.
C) both financial and quantitative information.
D) none of the above.

Question 24

Which of these factors influences the returns required by investors from an investment project?

A) inflation
B) risk premium
C) interest foregone
D) All are influences.

Question 25

Use the information below to answer the following questions.
Y3 Ltd is expanding its production of binoculars. The plant is expected to cost $750,000 and have a life of 5 years and a nil residual value. It will be ready for operation on 31 December 2014. The following income statement figures for the new binoculars are forecast: Depreciation has been calculated on a straight-line basis. You should assume that all cash flows occur at the end of the year in which they arise. The company's cost of capital is 10%. Ignore taxation.
Refer to the table above. The annual cash outflow for the project is:

A) $700,000
B) $850,000
C) $650,000
D) $750,000

Question 26

The profitability index allows potential investors to:

A) rank investments which use the rate of return approach.
B) rank investments which use the net present value approach.
C) rank investments by cash flow.
D) rank investments which use the internal rate of return approach.

Question 27

All of the investment appraisal methods below use cash flows exclusively except:

A) internal rate of return.
B) net present value.
C) accounting rate of return.
D) payback.

Question 28

The time value of money is an important concept in investment decisions, as it takes into account that:

A) a dollar received today is equal to a dollar received tomorrow.
B) a dollar received today is more valuable than a dollar received tomorrow.
C) a dollar received tomorrow is more valuable than a dollar received today.
D) it takes time to earn profits.

Question 29

Use the information below to answer the following questions.
Y3 Ltd is expanding its production of binoculars. The plant is expected to cost $750,000 and have a life of 5 years and a nil residual value. It will be ready for operation on 31 December 2014. The following income statement figures for the new binoculars are forecast: Depreciation has been calculated on a straight-line basis. You should assume that all cash flows occur at the end of the year in which they arise. The company's cost of capital is 10%. Ignore taxation.
Refer to the table above. The payback period is:

A) between years 3 and 4.
B) between years 1 and 2.
C) between years 2 and 3.
D) between years 4 and 5.

Question 30

TG Industries is considering investing in a fleet of six delivery vehicles. The annual running costs are expected to total $90,000 per vehicle, including the driver's salary. The vehicles are expected to operate for a total of five years. At present TG Industries uses a commercial carrier for its deliveries. The commercial carrier is expected to charge a total of $400,000 for each of the next five years to make the deliveries. What is the estimated net annual cash cost saving on delivery vehicle running costs if TG Industries invests in the fleet of six vehicles?

A) $400,000
B) $310,000
C) $140,000
D) $90,000

Question 31

The factor in net present value analysis that normally involves the least degree of uncertainty is:

A) the future cash flows.
B) the discount rate.
C) the life of the project.
D) the cost of the initial investment.

Question 32

The decision rule for the payback method of investment appraisal is:

A) choose the project with the shortest payback period.
B) choose the project with the longest payback period.
C) choose the project where the payback period is longer than a hurdle period.
D) below a maximum period, accept the project with the shortest payback period.

Question 33

Use the information below to answer the following questions.
Y3 Ltd is expanding its production of binoculars. The plant is expected to cost $750,000 and have a life of 5 years and a nil residual value. It will be ready for operation on 31 December 2014. The following income statement figures for the new binoculars are forecast: Depreciation has been calculated on a straight-line basis. You should assume that all cash flows occur at the end of the year in which they arise. The company's cost of capital is 10%. Ignore taxation.
Refer to the table above. The annual depreciation charge for the project is:

A) $300,000
B) $150,000
C) $250,000
D) $200,000

Question 34

Manosteel Ltd is considering the purchase of a new machine for $100,000. It is to be depreciated on a straight-line basis and is estimated to have no residual value at the end of a useful life of 10 years. The tax rate is 30 per cent. What will be the annual cash tax saving in relation to depreciation expense?

A) $100
B) $3,000
C) $10,000
D) $300

Question 35

The finding from surveys of the methods of business investments that is true is:

A) The payback method is hardly used in practice.
B) There is a tendency for larger businesses to use the discounting methods.
C) Businesses generally only use one method to assess each investment decision.
D) All of the statements are true.

Question 36

The main disadvantage of the internal rate of return method is that:

A) it is difficult for management to incorporate it into decision-making.
B) it is too simplistic.
C) it ignores the scale of projects, which could lead to wrong decisions being made.
D) all of the above.

Question 37

Using the net present value method, the decision rule for projects when finance is not a restriction is:

A) select the project with cash flows equal to the initial investment.
B) select the project with the largest cash inflows.
C) take on all projects with a positive NPV.
D) select the project where the cash inflows are greatest in the early years of the project.

Question 38

If a project has a net present value of $9,300 (initial outlay $100,000 and present value of net cash flows $109,300), the profitability index for the project would be:

A) 0.093
B) 1.0
C) 1.093
D) 0.9419

Question 39

If you banked $27,778 today at an interest rate of 20%, how much will you have in two years' time?

A) $40,000
B) $27,778
C) $33,334
D) $36,000

Question 40

Use the information below to answer the following questions.
Y3 Ltd is expanding its production of binoculars. The plant is expected to cost $750,000 and have a life of 5 years and a nil residual value. It will be ready for operation on 31 December 2014. The following income statement figures for the new binoculars are forecast: Depreciation has been calculated on a straight-line basis. You should assume that all cash flows occur at the end of the year in which they arise. The company's cost of capital is 10%. Ignore taxation.
Refer to the table above. The accounting rate of return is:

A) 30%.
B) 50%.
C) 80%.
D) 40%.

Question 41

Use the information below to answer the following questions.
Han Ltd supplies chilli paste to large supermarket chains. The company is currently considering scrapping its old processor and investing in a new processor. Information about the investment is as follows:
Refer to the table above. What is the annual net cash flow for years 1-4?

A) $50,000
B) $10,000
C) $20,000
D) $30,000

Question 42

A problem with the internal rate of return method is that it:

A) has difficulty handling projects with unconventional cash flows.
B) ignores the timing of cash flows.
C) ignores the time value of money.
D) all of the above.

Question 43

The formula for net present value per $1 of investment is:

A) present values of inflows/present value of outflows.
B) net present value/investment.
C) present value of inflows/initial investment.
D) net cash flows/investment.

Question 44

Which of these is an advantage of the payback method?

A) It emphasises the short-term.
B) It is easily understood.
C) It is simple.
D) All of the above.

Question 45

The net present value method of investment appraisal addresses each of the following, except:

A) the timing of the cash flows.
B) qualitative factors.
C) the whole of the relevant cash flows.
D) None of the above, i.e. all matters are addressed.

Question 46

Bev is considering purchasing a new button-holer for her business. She estimates that the machine will cost $90,000 and will be paid for in cash. Her cash savings from the first 4 years of operation of the machine will be $20,000 in year 1, $30,000 in year 2, $35,000 in year 3 and $35,000 in year 4. The payback period for the machine is:

A) 3.86 years.
B) 3.14 years.
C) 2. 66 years.
D) 4 years.

Question 47

Depreciation is a non-cash expense but affects cash flows from an investment because:

A) it affects the cost of the investment.
B) it affects the scrap value of the investment.
C) it affects the amount of tax paid.
D) all of the above

Question 48

Actol Ltd, a printing business, intends purchasing a new computerised printing machine for $800,000. The annual cash flows from the new machine are expected to be $150,000 per year. The machine has an eight-year useful life. The payback period is:

A) 5.33 years.
B) 5 years.
C) 6 years.
D) 8 years.

Question 49

A disadvantage associated with the use of the accounting rate of return method for assessing investment opportunities is:

A) it is a method that is not widely understood by business.
B) it is based on an accrual approach rather than cash flows.
C) it ignores the time value of money.
D) B and C

Question 50

The required rate of return is the acceptable percentage return on an investment after taking into account the _ of the investment.

A) minimum; risk
B) maximum; risk
C) maximum; opportunity cost
D) minimum; opportunity cost

Question 51

Courtmaster provides Superturf for tennis courts. The company has recently investigated investing in a new machine, which will speed up the laying of the Superturf. The old machine has a remaining life of 5 years, and the new equipment has a value of $150,000 with a five-year life. The expected additional cash inflows are $35,000 per year. In what range is the internal rate of return for the new machine?

A) 2-4%
B) 4-6%
C) 8-10%
D) 6-8%

Question 52

If the net present value analysis of a project resulted in a positive value and the company did not accept the project, it could be assumed that:

A) qualitative factors outweigh the benefit of the investment.
B) the return is greater than that required by the company.
C) the net initial investment cannot be recovered.
D) all of the above.

Question 53

Which of these is a disadvantage of the payback method of investment evaluation?

A) It disregards the time value of money.
B) It disregards the post-payback-period cash flows.
C) It is based on cash flows.
D) A and B

Question 54

The discount rate that should be used in net present value assessments is:

A) the specific cost of capital associated with funding a particular project.
B) the weighted average cost of capital of the business.
C) the government bond rate.
D) the expected rate of return required by ordinary shareholders.

Question 55

Which method of investment appraisal has been found in surveys to be the least popular with businesses?

A) payback
B) net present value
C) internal rate of return
D) accounting rate of return

Question 56

It is important to get investment decisions right for which of the following reasons?

A) Large amounts of resources are often involved.
B) They can be difficult and/or expensive to 'bail-out' of once started.
C) They may affect the business for many years.
D) All of the above.

Question 57

If the net present value of a project is $1,000 after using a discount rate of 8%, then one can conclude that the internal rate of return is:

A) less than 8%.
B) between 8% and 10%.
C) greater than 8%.
D) 8%.

Question 58

Projects can have multiple internal rates of return due to:

A) both positive and negative cash flows at different points during its life.
B) all positive cash flows.
C) all negative cash flows.
D) none of the above.

Question 59

The following data was obtained for three projects being considered by Manosteel Ltd. Only one project can be accepted due to funding limitations. Which project is the best given that Manosteel's required rate of return is 14%?

A) Project A
B) Project B
C) Project C
D) All projects should be accepted, as all have a positive net present value and an internal rate of return greater than the required rate of return.

Question 60

You have won a special type of lottery where you are to receive $200,000 in 4 years' time. The current interest rate is 6%. How much is the lottery win worth in today's dollars?

A) $158,400
B) $255,010
C) $170,000
D) $200,000

Question 61

An advantage of the internal rate of return method over the net present value method of investment appraisal is that:

A) the IRR method is more well known that the NPV method.
B) the IRR is expressed in percentage terms whereas the NPV is expressed in absolute terms.
C) the IRR is easier to calculate than the NPV.
D) all are advantages.

Question 62

Use the information below to answer the following questions. Depreciation has been calculated on a straight-line basis. You should assume that all cash flows occur at the end of the year in which they arise. The company's cost of capital is 10%. Ignore taxation.
Refer to the table above. The net present value (rounded) is:

A) $883,000
B) $860,500
C) $1,019,900
D) $984,000

Question 63

An investor has the opportunity to invest at 20 per cent per year. Rather than receiving $20,000 in a years' time, which of the following sums would the investor prefer to have now?

A) $15,000
B) $16,000
C) $16,800
D) $15,667