Deck 16: Planning for Capital Investments

Question 1

An annuity is a series of equal payments over equal time intervals that earn a constant rate of return.

Answer 1

True

Question 2

Mary needs to have $20,000 one year from today. The formula to compute the amount of money that must be invested today is future value ÷ (1 − interest rate).

Answer 2

False

Question 3

The time value of money concept recognizes the fact that the present value of a dollar to be received in the future is worth more than a dollar.

Answer 3

False

Question 4

Matt needs to compute the present value of $5,000 to be received four years from now. He should multiply $5,000 by the appropriate present value interest factor obtained from the present value of $1 table.

Question 5

The present value of an annuity of $1 table could be constructed using the factors contained in the present value of $1 table.

Question 6

If the net present value for a capital investment is equal to zero, the internal rate of return for the investment is equal to the required rate of return.

Question 7

The cost of capital is sometimes referred to as the hurdle or discount rate.

Question 8

The future value of $1 table should be used to discount lump sum cash flows expected to occur in the future.

Question 9

A capital investment decision is essentially a decision to exchange current cash outflows for future cash inflows.

Question 10

The instantaneous computation power of spreadsheet software makes it ideal for answering "what-if" questions regarding present values.

Question 11

The assumption regarding ordinary annuities is that cash flows occur at the end of each period.

Question 12

The cost of capital represents the maximum acceptable rate of return that a capital investment should earn.

Question 13

If a project has a positive net present value, its internal rate of return will exceed the firm's hurdle rate.

Question 14

The compensation a company receives for investing in capital assets is referred to as a return on investment.

Question 15

In performing capital budgeting analysis that takes time value of money into account, cash flows generated by a capital project are assumed to be reinvested at the project's rate of return.

Question 16

Capital investments differ from stock and bond investments in that stock and bond investments can be sold in organized markets.

Question 17

Because of the expense of applying multiple techniques, managers should use a single capital budgeting technique to analyze potential capital investments.

Question 18

A project's net present value can be found by subtracting the cost of the project from the total present value of the future cash flows generated by the project.

Question 19

A dollar to be received in the future is subject to the effects of risk and inflation.

Question 20

Investment projects A and B offer equal cash inflows over their lives, but the cash inflows for project A occur sooner than those for project B. The two projects are otherwise identical (the cost is the same, for example). Based on this information, the internal rate of return for A is lower than for B.

Question 21

When the effect of income taxes is considered in a capital budgeting analysis, the amount of depreciation expense must be added back to after-tax income to calculate the annual cash inflow.

Question 22

The payback method of evaluating capital investments measures the recovery of the investment, but it does not measure profitability.

Question 23

All of the following are capital investment decisions except:

A) acquiring $100,000 of common stock.
B) buying a $5,000,000 manufacturing plant.
C) purchasing equipment for $80,000.
D) paying $600,000 to renovate a restaurant.

Question 24

When a capital investment is expected to provide unequal annual cash inflows, the payback period cannot be calculated.

Question 25

Sources of cash outflows from capital investments include incremental expenses and installation costs.

Question 26

Generally, the unadjusted rate of return should be calculated based on the average investment rather than the amount of the original investment in a depreciable asset such as equipment.

Question 27

The unadjusted rate of return is found by dividing the average incremental increase in annual operating income by the cost of the investment.

Question 28

When a capital investment is expected to provide unequal annual cash inflows, the payback period can be calculated by accumulating the incremental cash inflows until the sum equals the amount of the original investment.

Question 29

Which statement characterizes the time value of money concept?

A) The future value of a present dollar is greater than one dollar.
B) The present value of a future dollar is greater than one dollar.
C) The timing of cash flows is not relevant to decision making.
D) None of these answers are correct

Question 30

Generally, a company should use the MACRS method to calculate depreciation on its income tax return, due to the effects of the time value of money.

Question 31

A capital investment with an internal rate of return equal to or greater than the required rate of return is considered to be an acceptable investment.

Question 32

Cash inflows from a capital investment may include the salvage value of capital assets and increases in revenues.

Question 33

Evergreen Company has two investment opportunities. Both investments cost $5,000 and will provide the same total future cash inflows. The cash receipt schedule for each investment is given below: $\begin{array}{crc}&\text { Investment I }&\text {Investment II }\\\text { Period 1 } & \$ 1,850 & \$ 3,870 \\\text { Period 2 } & 1,850 & 3,360 \\\text { Period 3 } & 3,360 & 3,360 \\\text { Period } 4 & \underline{6,040} &\underline{ 1,510}\\\text { Total } &\underline{\$ 13,100}&\underline{\$ 13,100}\end{array}$ Select the correct statement.

A) Time value of money techniques are not useful for comparing these investments.
B) Evergreen should choose Investment II because it generates more immediate cash inflows.
C) Evergreen should be indifferent between the two investments because they provide the same total cash inflows.
D) Evergreen should choose Investment I because of the time value of money.

Question 34

Which of the following statements describes the cost of capital?

A) The internal rate of return on investments
B) The maximum acceptable rate of return on investments
C) The minimum rate of return on investments
D) The interest rate the bank charges its best customers

Question 35

Which of the following is not a factor in explaining why the present value of a future dollar is less than one dollar?

A) Inflation
B) Interest
C) Risk of failure to receive expected cash inflows
D) Historic cost

Question 36

The payback method shows how long will be required to recover the cost of an investment in a capital asset.

Question 37

The amount of the depreciation tax shield can be calculated by multiplying the amount of depreciation expense by the tax rate.

Question 38

Evergreen Company has two investment opportunities. Both investments cost $5,000 and will provide the same total future cash inflows. The cash receipt schedule for each investment is given below: $\begin{array}{crc}&\text { Investment I }&\text {Investment II }\\\text { Period 1 } & \$ 1,000 & \$ 3,000 \\\text { Period 2 } & 1,000 & 3,000 \\\text { Period 3 } & 2,000 & 2,000 \\\text { Period } 4 & \underline{4,000} &\underline{ 1,000}\\\text { Total } &\underline{\$ 8,000}&\underline{\$8,000}\end{array}$ Select the correct statement.

A) Evergreen should choose Investment I because of the time value of money.
B) Evergreen should choose Investment II because it generates more immediate cash inflows.
C) Evergreen should be indifferent between the two investments because they provide the same total cash inflows.
D) Time value of money techniques are not useful for comparing these investments .

Question 39

Depreciation on a capital investment (such as equipment) has the effect of decreasing the amount of income taxes that the company owning the asset must pay.

Question 40

If a company has to pay a given amount of income taxes over the life of a capital investment, managers of the company should seek to pay the taxes as early as possible in the investment's life.

Question 41

The cost of capital is called all of the following except:

A) cutoff rate.
B) discount rate.
C) hurdle rate.
D) All of these are terms for the cost of capital.

Question 42

Jiminez Company has two investment opportunities. Both investments cost $5,000 and will provide the following net cash flows: $\begin{array}{lcc}\text { Year }& \text { Investment A} & \text { Investment B} \\1 & \$ 3,000 & \$ 3,000 \\2 & 3,000 & 4,000 \\3 & 3,000 & 2,000 \\4 & 3,000 & 1,000\end{array}$ What is the total present value of Investment A's cash flows assuming an 8% minimum rate of return? ( PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round your intermediate calculations. Round your answer to the nearest whole dollar.)

A) $14,936.
B) $4,936.
C) $7,000.
D) $12,000.

Question 43

Jiminez Company has two investment opportunities. Both investments cost $5,100 and will provide the following net cash flows: $\begin{array}{lcc}\text { Year }& \text { Investment A} & \text { Investment B} \\1 & \$ 3,050 & \$ 3,050 \\2 & 3,050 & 4,060 \\3 & 3,050 & 2,050 \\4 & 3,050 & 1,020\end{array}$ What is the total present value of Investment A's cash flows assuming an 10% minimum rate of return? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round your answer to the nearest dollar.)

A) $10,635.
B) $4,568.
C) $8,365.
D) $3,050.

Question 44

Connor has $490,000 to invest in a 5-year annuity. Assuming the time value of money is 12%, what amount will Connor receive in cash each year?(PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Round your answer to the nearest dollar.)

A) $135,931
B) $98,000
C) $105,840
D) None of these answers is correct.

Question 45

Assuming equal time intervals between the payments and a constant rate of return, which of the following cash flow patterns represents an annuity? $\begin{array}{rrrrrrr}&\text { Year } & \text { Year } & \text { Year } & \text { Year } 4 & \text { Year }5& \text { Year } 6 \\\text {A)}&\$ 1,000 & \$ 1,000 & \$ 1,000 & \$ 1,000 & \$ 1,000 & \$ 1,000 \\\text {B)}&\$ 500 & \$ 0 & \$ 500& \$ 500 & \$500& \$0\\\text {C)}&\$100&\$200&\$300&\$400&\$500&\$600\end{array}$

A) A
B) B
C) C
D) Any of the answers can represent an annuity.

Question 46

Which of the following is not a major cash inflow from a capital investment?

A) Incremental revenue
B) Increase in working capital
C) Cost savings
D) Salvage value

Question 47

Harvey wants to determine the net present value for a proposed capital investment. He has determined the desired rate of return, the expected investment time period, a series of cash inflows of equal amount, the salvage value of the investment, and the required cash outflows. Which of the following tables would most likely be used to calculate the net present value of the investment?

A) Present value of annuity.
B) Future value of a lump sum.
C) Present value of annuity and present value of a lump sum.
D) Future value of annuity and future value of a lump sum.

Question 48

Ashley projects that she can get $190,000 cash per year for 5 years on a real estate investment project. If Ashley wants to earn a rate of return of 10%, what is the maximum that she should pay for the investment?(PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Round your answer to the nearest dollar.)

A) $123,487
B) $615,547
C) $720,250
D) $864,500

Question 49

What amount of cash would result at the end of one year, if $15,000 is invested today and the rate of return is 8%? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided.)

A) $16,200
B) $13,889
C) $15,000
D) $1,200

Question 50

A cash flow that only occurs in equal amounts each year is referred to as:

A) a lump sum.
B) a perpetuity.
C) an annuity.
D) None of these answers are correct.

Question 51

For a capital investment project to be acceptable, it must generate a rate of return:

A) less than the hurdle rate.
B) equal to or greater than the cost of capital.
C) equal to the conversion rate.
D) None of these answers are correct.

Question 52

Which one of the following statements best describes an ordinary annuity?

A) Series of cash inflows of varying amounts collected at the end of each period
B) Series of cash flows of equal amounts collected at the end of each period
C) Series of cash flows of varying amounts collected at the beginning of each period
D) Series of cash flows of equal amounts collected at the beginning of each period

Question 53

Connor has $300,000 to invest in a 5-year annuity. Assuming the time value of money is 10%, what amount will Connor receive in cash each year? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Round your answer to the nearest dollar.)

A) $79,139
B) $60,000
C) $96,631
D) None of these answers are correct.

Question 54

What amount of cash would result at the end of one year, if $22,000 is invested today and the rate of return is 9%? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Round your answer to the nearest dollar.)

A) $23,980
B) $22,000
C) $23,760
D) $20,020

Question 55

What amount of cash must be invested today in order to have $60,000 at the end of one year assuming the rate of return is 9%? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided.)

A) $45,455
B) $54,000
C) $55,046
D) $54,600

Question 56

Ashley projects that she can get $100,000 cash per year for 5 years on a real estate investment project. If Ashley wants to earn a rate of return of 12%, what is the maximum that she should pay for the investment? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Round your answer to the nearest dollar.)

A) $56,743
B) $446,429
C) $360,478
D) $560,000

Question 57

Assuming equal time intervals between the payments and a constant rate of return, which of the following cash flow patterns represents an annuity? $\begin{array}{rrrrrrr}&\text { Year } & \text { Year } & \text { Year } & \text { Year } 4 & \text { Year }5& \text { Year } 6 \\\text {A)}&\$ 1,360 & \$ 1,360 & \$ 1,360 & \$ 1,360 & \$ 1,360 & \$ 1,360 \\\text {B)}&\$ 1,040 & \$ 0 & \$ 1,040 & \$ 1,040 & \$ 1,040 & \$0\\\text {C)}&\$280&\$380&\$480&\$580&\$680&\$780\end{array}$

A) A
B) B
C) C
D) Any of the answers can represent an annuity.

Question 58

When calculating the present value of an ordinary annuity, it is assumed that:

A) cash flows will be reinvested at the required rate of return.
B) cash flows occur at the end of each accounting period.
C) the investor will wait until the end of the investment period to withdraw cash flows.
D) cash flows will be reinvested at the required rate of return and cash flows occur at the end of each accounting period.

Question 59

A customary assumption in capital budgeting analysis is that:

A) the desired rate of return includes the effects of compounding.
B) the cash inflows generated by the investment are not reinvested.
C) annual cash flows occur at the beginning of each period.
D) the time value of money is ignored.

Question 60

What amount of cash must be invested today in order to have $33,000 at the end of one year assuming the rate of return is 9%? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Round your answer to the nearest dollar.)

A) $27,775
B) $29,700
C) $30,275
D) $30,030

Question 61

Garrison Company has two investment opportunities. A cash flow schedule for the investments is provided below: $\begin{array}{ccc}\text { Year } & \text { Investment A} &\text { Investment B} \\0 & \$(5,000) & \$(6,000) \\1 & 2,000 & 3,000 \\2 & 2,000 & 2,000 \\3 & 2,000 & 2,000 \\4 & 2,000 & 1,000\end{array}$ Considering the unequal investments, which of the following techniques would be most appropriate for choosing between Investment A and Investment B?

A) Payback method
B) Present value index
C) Net present value method
D) None of these answers are correct.

Question 62

An investment that costs $40,000 will produce annual cash flows of $12,000 for a period of 4 years. Given a desired rate of return of 10%, what will the investment generate? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round your intermediate calculations. Round your answer to the nearest whole dollar.)

A) A positive net present value of $38,038.
B) A positive net present value of $1,962.
C) A negative net present value of $38,038.
D) A negative net present value of $1,962.

Question 63

The rate of return that equates the present value of cash inflows and outflows is the:

A) minimum rate of return.
B) internal rate of return.
C) desired rate of return.
D) hurdle rate.

Question 64

Theresa is considering starting a small business. She plans to purchase equipment costing $145,000. Rent on the building used by the business will be $26,000 per year while other operating costs will total $30,000 per year. A market research specialist estimates that Theresa's annual sales from the business will amount to $80,000. Theresa plans to operate the business for 6 years. Disregarding the effects of taxes, what will be the amount of annual net cash flow generated by the business?

A) $24,000
B) $56,000
C) $80,000
D) None of these answers is correct.

Question 65

Morrisey Company has two investment opportunities. Both investments cost $6,800 and will provide the same total future cash inflows. The cash receipt schedule for each investment is given below: $\begin{array}{ccc}&\text { Investment I}&\text { Investment II }\\\text { Period 1 } & \$ 1,900 & \$ 1,900 \\\text { Period } 2 & 1,900 & 3,080 \\\text { Period } 3 & 2,900 & 4,260\\\text { Period } 4 &\underline{ 5,440} & \underline{2,900} \\ \text { Total } &\underline{ \$ 12,140 }& \underline{\$ 12,140}\end{array}$ What is the net present value of Investment II assuming an 12% minimum rate of return? (PV of $1and PVA of $1) (Do not round intermediate calculations. Round your answer to nearest whole dollar.)

A) $2,227
B) $9,027
C) $(8,732)
D) $12,140

Question 66

Select the incorrect statement concerning the internal rate of return (IRR) method of evaluating capital projects.

A) The higher the IRR the better.
B) The internal rate of return is that rate that makes the present value of the initial outlay equal to zero.
C) If a project has a positive net present value then its IRR will exceed the hurdle rate.
D) A project whose IRR is less than the cost of capital should be rejected.

Question 67

Which of the following is the approximate internal rate of return for an investment that costs $33,550 and provides a $5,000 annuity for 10 years? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided.)

A) 5%
B) 6%
C) 8%
D) 10%

Question 68

An investment that costs $20,000 will produce annual cash flows of $5,000 for a period of 6 years. Further, the investment has an expected salvage value of $3,000. Given a desired rate of return of 12%, what will the investment generate? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round your intermediate calculations. Round your answer to the nearest whole dollar.)

A) A positive net present value of $2,077.
B) A negative net present value of $2,077.
C) A positive net present value of $22,077.
D) A positive net present value of $557.

Question 69

Morrisey Company has two investment opportunities. Both investments cost $5,500 and will provide the same total future cash inflows. The cash receipt schedule for each investment is given below: $\begin{array}{ccc}&\text { Investment I}&\text { Investment II }\\\text { Period 1 } & \$ 1,000 & \$ 1,000 \\\text { Period } 2 & 1,000 & 2,000\\\text { Period } 3 & 2,000 & 3,000\\\text { Period } 4 &\underline{ 4,000} & \underline{2,000} \\ \text { Total } &\underline{ \$ 8,000 }& \underline{\$ 8,000}\end{array}$ What is the net present value of Investment II assuming an 8% minimum rate of return? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round your intermediate calculations. Round your answer to the nearest whole dollar.)

A) $6,492
B) $992
C) $5,880
D) $380

Question 70

A capital investment project may provide cash inflows from:

A) incremental revenues.
B) cost savings.
C) the salvage value of the investment.
D) All of these answers are correct.

Question 71

Theresa is considering starting a small business. She plans to purchase equipment costing $143,000. Rent on the building used by the business will be $23,000 per year while other operating costs will total $28,800 per year. A market research specialist estimates that Theresa's annual sales from the business will amount to $87,000. Theresa plans to operate the business for 6 years. Disregarding the effects of taxes, what will be the amount of annual net cash flow generated by the business?

A) $35,200
B) $51,800
C) $87,000
D) None of these answers is correct.

Question 72

An investment that cost $30,000 provided annual cash inflows of $9,000 per year for five years. The desired rate of return is 10%. The internal rate of return from the investment is: (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided.)

A) less than the desired rate of return.
B) equal to the desired rate of return.
C) greater than the desired rate of return.
D) the answer cannot be determined from the information provided.

Question 73

Shenandoah Springs Company is considering two investment opportunities whose cash flows are provided below: $\begin{array}{ccc}\text { Year } & \text { Investment A} &\text { Investment B} \\0 & \$(18,000) & \$(12,600) \\1 & 6,080 & 6,080 \\2 & 6,080 &4,960 \\3 &6,080 & 4,320 \\4 & 4,960 & 2,440\end{array}$ The company's hurdle rate is 10%. What is the present value index of Investment B? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round your answer to two decimal points.)

A) 1.07
B) 1.15
C) 1.00
D) None of these answers is correct.

Question 74

Which of the following would be considered a cash inflow in determining the value of a capital investment?

A) Incremental revenues from increased productivity
B) Cost savings from a reduction in labor hours
C) An increase in working capital commitments
D) Both incremental revenues from increased productivity and cost savings from a reduction in labor hours are correct.

Question 75

Cash outflows from a capital investment project include:

A) increases in operating expenses.
B) the reduction in the amount of working capital.
C) salvage value.
D) All of these answers are correct.

Question 76

An investment that costs $24,000 will produce annual cash flows of $4,800 for a period of 6 years. Further, the investment has an expected salvage value of $2,900. Given a desired rate of return of 12%, what will the investment generate? (PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round your answer to the nearest dollar.)

A) A negative net present value of $2,796.
B) A positive net present value of $24,000.
C) A positive net present value of $20,306.
D) A positive net present value of $1,550.

Question 77

An investment that costs $33,000 will produce annual cash flows of $11,020 for a period of 4 years. Given a desired rate of return of 9%, what will the investment generate?(PV of $1and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round intermediate calculations. Round your answer to the nearest dollar.)

A) A positive net present value of $35,702.
B) A negative net present value of $35,702.
C) A negative net present value of $2,702.
D) A positive net present value of $2,702.

Question 78

Select the incorrect statement concerning the present value index (PVI).

A) The PVI is computed by dividing the total present value of the cash inflows by the present value of the cash outflows.
B) The PVI should be used to evaluate two or more projects whose initial investments differ.
C) The lower the PVI, the better.
D) A project whose PVI is positive will also have a positive net present value.

Question 79

Cash outflows can be categorized into all of the following groups except:

A) opportunity costs associated with selecting a specific capital project.
B) outflows associated with the initial investment.
C) working capital commitments.
D) increases in operating expenses.

Question 80

Garrison Company has two investment opportunities. A cash flow schedule for the investments is provided below: $\begin{array}{ccc}\text { Year } & \text { Investment A} &\text { Investment B} \\0 & \$(5,800) & \$(7,200) \\1 & 2,320 & 3,480 \\2 & 2,320 & 2,320 \\3 & 2,320 & 2,320 \\4 & 2,320 & 1,160\end{array}$ Considering the unequal investments, which of the following techniques would be most appropriate for choosing between Investment A and Investment B?

A) Payback method
B) Present value index
C) Net present value method
D) None of these answers is correct.