Deck 23: Capital Investment Decisions and the Time Value of Money

Question 1

A post- audit is an analysis of an investment that is made after the investment is underway or completed.

Answer 1

True

Question 2

Which of the following is a common capital budgeting method?

A)Acid test ratio
B)Internal rate of return
C)Debt- to- equity ratio
D)Return on assets

Answer 2

B

Question 3

Capital budgeting methods which do NOT incorporate time value of money are generally used for the initial stage of screening investment alternatives.

Answer 3

True

Question 4

Which of the following capital budgeting models is most likely to be used if a company's goal is to maximise their operating profit?

A)Net present value
B)Payback
C)Internal rate of return
D)Rate of return

Question 5

After a company invests in capital assets, which of the following activities will it perform in order to compare the actual to the projected net cash inflows?

A)Post- audit
B)Cash flow analysis
C)Pre and post analysis
D)Post- cash flow

Question 6

The further into the future the investment cash flows extend, the more likely it is that actual results will differ from the initial predictions.

Question 7

Which of the following is a common capital budgeting method?

A)Debt- to- equity ratio
B)Return on assets
C)Net present value
D)Inventory turnover

Question 8

The payback method and the accounting rate of return method are often used to perform an initial screening of investments, rather than a detailed in- depth analysis.

Question 9

Short- term investment decisions are inherently riskier than long- term decisions because they have a shorter period in which to recoup the investment.

Question 10

Which two methods are typically used for initial screening of investments, rather than for detailed in- depth analysis?

A)Net present value and payback
B)Accounting rate of return and net present value
C)Internal rate of return and net present value
D)Payback and accounting rate of return

Question 11

Which of the following BEST describes the term capital rationing?

A)When a company's resources are limited, it is choosing between alternative investment opportunities.
B)When a company has limited resources, it is finding ways to cut operating costs.
C)When a company is encountering cash flow shortages, it is finding ways of increasing revenues.
D)When a company has unlimited resources, it is finding the most number of profitable investment opportunities.

Question 12

When projecting the cash flows of an investment, the inflows are netted against the outflows.

Question 13

Which of the following is the ONLY capital budgeting method which uses accrual accounting information?

A)Accounting rate of return (ROR)
B)Internal rate of return (IRR)
C)Net present value (NPV)
D)Payback period

Question 14

The payback period and accounting rate of return (ROR)methods are more suitable to investments with a shorter time span.

Question 15

Which of the following BEST describes a post- audit?

A)An analysis of an investment's cash flows prior to committing to the initial investment
B)An audit of an operating unit of a company
C)An audit performed after financial statements have been issued
D)An analysis of an investment that is made after the investment is underway or completed

Question 16

Which of the following describes the purpose of a post- audit?

A)To evaluate the company's internal controls
B)To determine the amount of the initial investment outlay
C)To screen initial investment alternatives
D)To determine whether investments are going as planned, or whether they should be abandoned

Question 17

Capital budgeting applies to which of the following?

A)Budgeting for yearly operational expenses
B)Making decisions about the financing of operations
C)Deciding among various long- term investment decisions
D)Making decisions about sales budgets for the coming year

Question 18

When projecting future cash flows of an investment, which of the following is TRUE?

A)The initial investment is always treated separately from all other cash flows.
B)Cash flows are typically projected by accounting personnel without input from other business functions.
C)Cash flow data must also include non- cash transactions like depreciation.
D)Cash inflows and cash outflows are treated separately, rather than being netted together.

Question 19

Most capital budgeting methods focus on cash flows rather than profit.

Question 20

Capital rationing is when a company has limited resources, and it must find ways to reduce overhead expenses in all of its divisions and units.

Question 21

The payback method can only be used when the net cash inflows from a capital investment are the same for each period.

Question 22

Which capital budgeting method uses accrual accounting, rather than net cash flows, as a basis for calculations?

A)Internal rate of return
B)Payback
C)Accounting rate of return
D)Net present value

Question 23

Landmark Company is considering an investment in new equipment costing $360 000. The equipment will be depreciated on a straight- line basis over a five- year life and is expected to generate net cash inflows of $70 000 the first year, $80 000 the second year, and $120 000 every year thereafter until the fifth year. What is the payback period for this investment? The residual value is zero.

A)3.50 years
B)3.25 years
C)4 years
D)3.75 years

Question 24

ABC Company is adding a new product line that will require an investment of $1 500 000. The product line is estimated to generate cash inflows of $300 000 the first year, $250 000 the second year, and $200 000 each year thereafter for ten more years. What is the payback period?

A)6.00 years
B)2.73 years
C)7.25 years
D)6.75 years

Question 25

The payback method and the accounting accounting rate of return method are both conceptually better than the discounted cash flow models because they are based on cash flows.

Question 26

The accounting rate of return is the only capital budgeting method that uses accrual accounting.

Question 27

Neither the payback period nor the accounting rate of return capital budgeting method recognises the time value of money.

Question 28

The accounting rate of return method and the payback method are often used as preliminary screening measures, but are insufficient to fully evaluate a capital investment.

Question 29

All else being equal, investments with longer payback periods are more desirable.

Question 30

Pearl Manufacturing is considering an investment in equipment costing $660 000. The equipment will be depreciated on the straight- line basis over an eight- year period with an estimated residual value of $120 000. The investment is expected to generate annual net cash inflows of $135 000 for 8 years. Using the accounting rate of return model, what is the minimum average annual profit that must be generated from this investment in order to achieve a 14% accounting rate of return?

A)$54 600
B)$92 400
C)$18 900
D)$37 800

Question 31

The payback method ignores cash flows after the payback period, whereas the accounting rate of return includes them.

Question 32

The payback method uses discounted cash flows to make investment decisions.

Question 33

Capital budgeting is:

A)evaluating the ongoing profitability of a business.
B)making pricing decisions for products.
C)planning how to invest in long- term assets.
D)budgeting for overhead expenses.

Question 34

A criticism of the accounting rate of return method is that it ignores the time value of money.

Question 35

The payback method and the accounting rate of return method are powerful, comprehensive evaluation tools, and would normally be sufficient to make a final investment decision.

Question 36

The accounting rate of return calculations ignores the time value of money, but the payback period does include consideration of the time value of money.

Question 37

Which of the following is TRUE regarding capital rationing decisions for capital assets?

A)Companies should always choose the investment with the highest net present value.
B)Companies should consider several different methods of evaluation before choosing an investment.
C)Companies should always choose the investment with the shortest payback period.
D)Companies should always choose the investment with the highest accounting rate of return.

Question 38

Which of the following methods ignores the time value of money?

A)Payback
B)Internal rate of return
C)Net present value
D)Return on assets

Question 39

Sullivan Company is considering the purchase of a new machine costing $80 000. Sullivan's management is estimating that the new machine will generate additional cash flows of $12 000 a year for ten years and have a salvage value of $3 000 at the end of ten years. What is the machine's payback period?

A)7 years
B)5.33 years
C)6 years
D)6.7 years

Question 40

The payback method is a very thorough and comprehensive way to choose the best investment among alternatives.

Question 41

If an investment project's IRR is higher than the company's hurdle rate, the company should go forward with the investment.

Question 42

If a company uses a higher discount rate to calculate NPV of an investment, it reflects a higher level of perceived risk for the investment.

Question 43

Jim wants to invest $5 000 a year for the next 25 years to prepare for his retirement. If he wants to calculate the value of his investment at the end of the 25- year period, which of the following tables would be the best for him to use?

A)Present Value of an Annuity of $1
B)Future Value of an Annuity of $1
C)Future Value of $1
D)Present Value of $1

Question 44

Julio has just received a legal judgment in a civil court case which awards him a settlement of $24 000 to be received two years from now. In order to calculate the overall value of the award today, which of the following tables would be the best for him to use?

A)Future Value of $1
B)Future Value of an Annuity of $1
C)Present Value of an Annuity of $1
D)Present Value of $1

Question 45

Clapton Corporation is considering an investment in new equipment costing $900 000. The equipment will be depreciated on a straight- line basis over a ten- year life and is expected to have a salvage value of $90 000. The equipment is expected to generate net cash flows of $140 000 for each of the first five years and $100 000 for each of the last five years. What is the accounting rate of return associated with the equipment investment?

A)12.1%
B)7.9%
C)9.7%
D)17.3%

Question 46

Juan has just received a prize which entitles him to receive annual payments of $10 000 for the next 10 years. In order to calculate the overall value of the prize today, which of the following tables would be the best for him to use?

A)Future Value of an Annuity of $1
B)Present Value of $1
C)Present Value of an Annuity of $1
D)Future Value of $1

Question 47

Net present value is defined as the difference between the present value of the project's cash inflows and the investment's cost.

Question 48

The rate of return and payback methods DO NOT take into consideration the time value of money. Discounted cash flow methods DO make use of the time value of money.

Question 49

When evaluating a potential investment, managers should use more than one measure for making a sound investment decision.

Question 50

Using the NPV method of evaluating investments, a company should consider a project a good investment opportunity as long as the NPV of the total cash flows is positive.

Question 51

Considering the four common methods of evaluating investments-payback, rate of return, net present value, and internal rate of return-the discounted cash flow methods are superior because they consider both the time value of money and the profitability of the investment.

Question 52

Dylan Company is considering an investment in new equipment costing $720 000. The equipment will be depreciated on a straight- line basis over a five- year life and is expected to have a salvage value of $45 000. The equipment is expected to generate net cash flows totalling $970 000 during the five years. What is the accounting rate of return associated with the equipment investment?

A)15.4%
B)13.9%
C)30.4%
D)16.4%

Question 53

When calculating the net present value of future cash streams, dollars that are received sooner are worth more than dollars received later.

Question 54

If $1 000 is invested in an account with 4% interest compounding yearly, what will the balance of the account be after 4 years? (You may ignore small differences that result from rounding.)

A)$1 040
B)$1 170
C)$1 240
D)$1 218

Question 55

Wilhelmina has just received an inheritance of $50 000, and she would like to put it into an investment portfolio for 20 years. To calculate the value of the investment at the end of the 20- year period, which of the following tables would be the best for her to use?

A)Future Value of an Annuity of $1
B)Present Value of an Annuity of $1
C)Future Value of $1
D)Present Value of $1

Question 56

John Doe wins the lottery and may pick from the following three choices: Take $750 000 now. Take $1 000 000 ten years from now.
Take $90 000 at the end of this year, and at the end of each following year for ten instalments
In total.
Assume that John Doe uses a discount rate of 5% to evaluate his choices. If he selects the first option, how much is the present value of that alternative?

A)$450 000
B)$798 000
C)$750 000
D)$1 000 000

Question 57

The internal rate of return (IRR)is the rate of return, based on discounted cash flows, that a company can expect to earn by investing in a capital asset.

Question 58

Which of the following describes the term time value of money?

A)Wasted time can result in wasted money.
B)Money loses its purchasing power over time through inflation.
C)Money can only be used at certain times and for certain purposes.
D)When money is invested over time, it earns income and grows.

Question 59

Wasson Corporation is considering an investment project costing $520 000. The project is estimated to have an eight- year life, generate annual cash flows of $120 000 and have a salvage value of $40 000 after eight years. What is the project's payback period?

A)2.8 years
B)6.5 years
C)4.3 years
D)4 years

Question 60

Which of the following MOST accurately describes the term annuity?

A)An investment which grows in value over time
B)A stream of equal instalments of cash payments
C)A term life insurance policy
D)An instalment loan with amortising principal payments

Question 61

Which of the following is TRUE of discounted cash flow methods like NPV and IRR?

A)They use simple interest calculations.
B)They focus on the payback period.
C)They give an indication of an investment's profitability.
D)They assume that cash flows will be reinvested when received.

Question 62

Which of the following is TRUE of discounted cash flow methods like NPV and IRR?

A)They incorporate compound interest calculations.
B)They use simple interest calculations.
C)They focus on the payback period.
D)They use net income amounts rather than cash flows.

Question 63

Compound interest used in discounted cash flow calculations assumes that companies will reinvest future cash flows when they are received.

Question 64

Cash flows used in NPV and IRR analyses include all of the following EXCEPT:

A)future cost savings.
B)future increased sales.
C)residual value.
D)depreciation expense.

Question 65

Which of the following most accurately describes the discount rate used in NPV and IRR analyses?

A)The required rate of return, also known as the "hurdle rate"
B)The rate of interest charged for debt financing of an investment
C)The rate of inflation
D)The rate of interest earned on a savings account

Question 66

When a company is evaluating an investment with discounted cash flows, if the investment has a higher risk, the company will use a lower discount rate, and vice versa.

Question 67

Which of the following best describes the internal rate of return?

A)The ratio of average annual income to average amount invested
B)The rate at which an investment pays back
C)The discount rate that makes the cost of the investment equal to the present value of the cash flows
D)The discount rate that is used to borrow funds from a lender

Question 68

Which of the following best describes the term sensitivity analysis?

A)Testing the results of an investment under varying different assumptions
B)Evaluating several different investment options
C)Evaluating the risk level of an investment
D)Analysing the effect of an investment on workers' morale

Question 69

An investment would be considered a good prospect under which of the following conditions?

A)The present value of the cash flows exceeds the initial investment.
B)It has a residual value.
C)The cash inflows are greater than the initial investment.
D)The IRR is lower than the hurdle rate.

Question 70

Which of the following is the rate of return, based on discounted cash flows, that a company can expect to earn by investing in a capital asset?

A)Net present value (NPV)
B)Internal rate of return (IRR)
C)Payback period
D)Rate of return

Question 71

The term net present value means the difference between:

A)present value of the net inflows and the investment's cost.
B)the future value of the cash flows and the present value of the cash flows.
C)the initial investment and the residual value.
D)the total profit of the project and the initial investment.