Deck 6: Making Capital Investment Decisions

Question 1

Net Present Value is the only method of investment appraisal that

A) Considers the time value of money
B) Uses all the relevant cash flows in the analysis
C) Deals with cash outflows exceeding inflows after the start of the project
D) Uses the company's cost of capital to establish a discount rate
E) Considers the investment's direct impact on shareholder's wealth

Answer 1

E

Question 2

Of the current methods of investment appraisal, which offers the best measurement?

A) Internal Rate of Return
B) Payback Period
C) Marginal Rate of Return
D) Net Present Value
E) Cash back rate

Answer 2

D

Question 3

Which of the following best describes the discount rate that when applied to the future cash flows makes them equal to the initial cash expenditures?

A) Payback Period
B) Internal Rate of Return
C) Marginal Rate of Return
D) Net Present Value
E) Accounting Rate of Return

Answer 3

B

Question 4

A municipality is considering the purchase of two large lawn mowers which will be used to maintain baseball diamonds, soccer fields, parks and road boulevards. Increased fuel efficiency and improved speed, reducing employee hours, contribute to savings. Both machines have a useful life of six years. Machine A, costing $5,000, offers savings of $1000 a year and disposal value of $500. The Machine B costs $7,000, offers saving of $1,300 a year and a disposal value of $1,500. The municipality uses a 7% discount factor to assess its capital purchases.

A) Purchase Machine A as it has shorter payback period, 4 years.
B) Purchase neither machine because both have negative net present values.
C) Purchase Machine B as it has a higher NPV, $195.90.
D) Purchase Machine B as it has a shorter payback period, 3.5 years.
E) Purchase Machine A as it has a lower NPV, $99.65.

Question 5

LaVeryndre Ltd. needs to replace the roof and re-insulate a small manufacturing facility at a cost of $70,000. Based on degree-days data, the company expects to save $17,600, $19,200, $15,700, $17,100 and $14,000 over the next five years. Using 4% and 12% as trial discount rates, determine the internal rate of return on the investment.

A) 4.5%
B) 6.5%
C) 9.0%
D) 7.2%
E) 5.2%

Question 6

If, when calculated IRR through interpolation, over a 10-year investment horizon, the NPV, using an interest rate of 12%, is ($3,752.76) and the NPV, using an interest rate of 3%, is $6,360.04, IRR for the project is

A) 9.2%
B) 5.3%
C) 4.5%
D) 5.8%
E) 8.7%

Question 7

A specialty original equipment manufacturer (OEM) to the automobile industry, has maintained an ROCE above 12% over the past four years by insisting on an ARR of over 12%. However, in the past four periods, consumer spending has begun to decline. Interest rates are falling. The company should

A) Expect ROCE to drop significantly given fewer high yield investment opportunities available during economic slow-down
B) Focus R&D efforts to develop recession proof or counter cyclical investment opportunities
C) Shift resources immediately from producing vulnerable products to more recession proof market offerings
D) Review current process and financing contracts to institute cost cutting procedures
E) Take advantage of a well diversified product portfolio to limit exposure

Question 8

A metal fabricator requires a return of 11%. The company is considering the purchase of six 40-ton hydraulic shop presses at a cost of $11,300 each. The profit before depreciation over the next ten years is projected at $5,700, $6,800, $7,200 and $8,500 for the first four years and then expected to be $9,700 for the next six years. Depreciation is straight-line with a residual value of $13,400. Which of the following should you advise the metal fabricator do?

A) Invest because the ARR shows a positive return of 6.8%.
B) Invest because ARR is 10.7% over the required rate.
C) Not invest because ARR shows a return of (1.9%).
D) Invest as ARR shows a positive return of 13.4%.
E) Not invest as ARR is underachieved by 6.4%.

Question 9

Omaro Ltd. would like to clear their warehouse and yard of damaged equipment and metal scrap. If the company purchases an industrial recycling bin for $1800, a contractor will pick up the materials and pay by the kilogram for the scrap. Omaro adjusts all cash flows for time value and uses a 10% discount rate. What dollar value of scrap do they have to generate each year to be able to break even on their investment in three years?

A) $544
B) $ 600
C) $ 724
D) $ 844
E) $1,352

Question 10

A business would like to buy a large piece of equipment that will improve their cash flow over the next ten years by $30,000 annually. If the company's hurdle rate is 14% and they expect no residual value at the end of the period, how much should the company be willing to pay for the equipment?

A) $8,091
B) $98,745
C) $156,483
D) $187,839
E) $580,119

Question 11

Chrome Brite Plating Inc. is considering a purchase of a new nickel plating machine for $35,000. It expects that for the following five years, cash inflow will be $10,000, $20,000, $50,000, $70,000 and $75,000 as its business expands. If the company requires a return of 14% on new investment, the net present value (NPV) is

A) $103,314
B) $138,314
C) $173,314
D) $182,102
E) $339,102

Question 12

Machine A is bought for $200,000 and has a residual value of $80,000 after six years of use. The amortization is straight-line and the annual profit before depreciation generated by the machine is $30,000. What is the ARR?

A) 2.4%
B) 4.3%
C) 7.1%
D) 16.7%
E) 17.9%

Question 13

What is the primary factor in the creation of positive cash flow?

A) Expense reduction
B) Increases in sales revenue
C) Effective investment appraisal
D) An expanding economy
E) Product innovation

Question 14

In addition to most capital investment decisions, what additional investment is usually needed?

A) Tax deferral
B) Current asset investment
C) Sales and marketing expense
D) Interest rate projections
E) Infrastructure commitments

Question 15

The first trial of an IRR interpolation used an interest rate of 15% and produced a NPV of ($81,450) and the second trial of IRR at 6% produced an NPV of $56,000. Assuming a straight-line relationship between IRR and NPV, what percent reduction from 15% would result in the project's IRR?

A) 5.3%
B) 11.1%
C) 9.8%
D) 7.6%
E) 13.1%

Question 16

Korral Kids is a chain of children's premium outdoor clothing that is expanding into a neighbouring city. It can lease space in a downtown location requiring a major refitting for a cost of $550,000. Instead it could lease a smaller mall location with lower traffic but would only require redecoration and furnishing at $250,000. Income before depreciation expense for the mall location over the next three years is $40,000, $65,000, $85,000. It is projected to be $90,000 for the three years after that. Expected cash inflow for the downtown location is projected at $90,000, $125,000, $165,000, and $185,000 for the three years after that. If the company is looking for a 14% return it should

A) Invest in the downtown location as it has the highest cash flows
B) Invest in the downtown location as it has the highest NPV at $76,424
C) Invest in the mall location as it has the highest NPV at $33,520
D) Invest in the mall location as it has the highest present value at $283,520
E) Invest in the downtown location as it has the highest NPV at $576,424

Question 17

Fandango Company limited is considering purchasing one of three warehouse data management systems. The initial capital investment for System 1 is $9 million and improvements to net income before depreciation are estimated at being $500,000, $2.5 million and $3.5 million in the first three years and $5 million for the remaining system lifetime of six years. System 2, costing $10 million will yield income improvements of $1.5 million and $3.5 million in the first two years and $5 million for the remaining six years. System 3 costs $12 million and provides savings of $2 million, $3 million, and $4 million in the first three years and $5 million thereafter for six years. The best alternative judging by the payback method of investment appraisal is

A) System 1 which pays back by the end of Year 3
B) System 1 which pays back by the end of Year 2
C) System 2 which pays back by the end of Year 2
D) System 2 which pays back by the end of Year 3
E) System 3 which pays back by the end of Year 3

Question 18

If a business was considering an investment of $350,000 and the Net Present Value (NPV) of its expected cash flow at 12% was ($25,000) this would mean that the business should

A) Take on the project and expect $25000 less profit than projected
B) Not take on the project as the company will lose its investment of $375,000
C) Take on the project only if it can invest $25,000 less
D) Take on the project as it is worth the equivalent of $25,000 today
E) Not take on the project as returns do not adequately compensate investors

Question 19

Ridman Academy is considering replacing their heating, ventilation and air conditioning (HVAC) system at a cost of $245,000. Annual cash savings from the new more efficient system will be $35,000 over the next 20 years. What is the internal rate of return for the project?

A) 10%
B) 11%
C) 12%
D) 13%
E) 14%

Question 20

A carpet manufacturer, whose discount rate is 10%, can purchase texturizing equipment for $1,250,000 to process yarn. Incremental income before straight line depreciation from sales of texturized carpets is projected over the next five years as $95,000, $165,000, $357,000, $725,000 and $315,000, respectively. The company believes that the fashion will pass and demand in Year 6 will all but disappear. The machine can be sold at the end of Year 5 for $250,000. What should you advise the company to do?

A) Purchase the equipment as NPV is $86,952.
B) Not purchase the equipment as NPV is ($54,784).
C) Purchase the equipment as ARR is 10.9%.
D) Not purchase the equipment as the ARR is only 9.3%.
E) Purchase the equipment as both the NPV and ARR are negative.

Question 21

When identifying profitable project opportunities, management should

A) Focus only on cash returns and always move forward with the highest cash flow project first
B) Develop projects at the senior management level and, thus, ensure support down through the company
C) Concentrate first on the best opportunity in the strongest product category
D) First focus on opportunities that utilize the lowest amount of capital required
E) Search for opportunities that mesh with strategic plans and utilize the company's core competencies

Question 22

Ridman Academy's annual cash inflow from its $40,000 tuition per student is $5,000, net of expenses, and before amortization and interest. At a cost of $2.8 million, the Academy has acquired and refurbished an older office building to accommodate classrooms for 120 additional students. What is the expansion worth to the academy if the school expects a 9% return over the next 15 years?

A) $1,247,379
B) $1,463,971
C) $1,893,308
D) $2,036,413
E) $14,816,540

Question 23

Some high tech firms have billions of dollars of cash in the bank. What does this tell you about these firms?

A) They are charging too high a price for their products and services.
B) They have been able to cut way back on their expenses such as salaries.
C) They have been able to defer a large portion of their income taxes.
D) They are having trouble generation excellent new investment projects.
E) They are in need of better auditing because company's do not have that much cash.

Question 24

Capital rationing occurs when

A) Expected cash inflows do not materialize when the project is implemented
B) There are too few investment opportunities that can match or exceed the hurdle rate
C) Poor investment decisions cause limited resources to be spread thinly among the several projects undertaken
D) There are more investment opportunities meeting the hurdle rate than can be undertaken by the company
E) Sufficient funds for a capital investment cannot be obtained from a single source

Question 25

What type of investment opportunities are Apple Inc.'s iPod, 4G iPhone, and iPad?

A) New product development.
B) Improving existing product sales
C) Reducing costs
D) Replacement of equipment
E) Welfare and safety

Question 26

Which of the following is considered a relevant cost when undertaking an investment analysis?

A) Sunk cost.
B) Common future cost.
C) Interest payments.
D) Standard costs.
E) Opportunity cost.

Question 27

Aviation Cargo Ltd. (ACL) wants to spend $5 million to expand a runway at its air field to accommodate a new larger cargo jet. It estimates additional cash inflows of $1 million for the next ten years. What should ACL do?

A) Accept the project because the payback period is six years.
B) Accept the project because the ARR is 20%.
C) Accept the project because the IRR is 15%.
D) Accept the project because the NPV is $1, 710,000.
E) Accept the project because the the profits will increase.

Question 28

Which of the following is essential to consider when making the calculations required for NPV, IRR, PP or APP?

A) Deciding as to whether to include amortization costs or not.
B) Determining the amount of interest payments to be included in expenses.
C) Reviewing the assumptions on which the revenue forecasts are based.
D) Including the total of costs that have already been incurred.
E) Determining the extent of management's support of the project.

Question 29

When evaluating investment opportunities for a company, what is the best discount rate to use?

A) The company's hurdle rate.
B) Current interest rates.
C) The company's ROCE from the previous period.
D) The interest rate for the company's next best opportunity.
E) The published bank rate.

Question 30

An investment decision can also be assessed on the basis of the Triple Bottom Line accounting. In this methodology managers

A) Assess a project on the basis of what is referred to as People, Plant and Profit impact
B) Are responsible for accounting results, cash flow performance and balance sheet impact
C) Assess a project on the basis of its impact on future profits, present profits and any restatement of past performance that may need to be undertaken
D) Are required to focus on the impact the use of capital will have on leverage, revenue and cash flow
E) Determine the profit potential utilizing zero cost of capital, weighted average cost of capital and real cost of capital

Question 31

A customer has approached CapiCal industries with a purchase order for a specialty product it needs for the next three years. CapiCal no longer produces the product and the related fully depreciated manufacturing equipment was going to be sold for $50,000. It will take $35,000 to recondition it and approximately 155 hours employee time at $18.50 an hour to set the equipment up. Both set up and production can be incorporated in the current space and in the factory schedule without having to hire additional labour. Sales Revenue for the special order is expected to be $120,000 per year. Direct material for the special order will amount to 55% of revenue. Working capital will expand by $16,000 immediately. Allocated administration costs amount to $5,000. Interest expense is $1,400. The company uses straight-line amortization and a hurdle rate of 10%. What is the net present value (NPV) of the order?

A) $33,290
B) $70,853
C) $75,744
D) $79,393
E) $82,874

Question 32

Open Windows Corp. has the following investment goals: payback (PB) of five years, accounting rate of return (ARR) of 15%, hurdle rate of 20%. Analysis of the Great Bear Oil plant expansion shows the following results: PB is 4.5 years, ARR is 14%, IRR is 21% and NPV is ($12,500). What should Open Windows do?

A) Proceed with the expansion because the PB period is less than the goal.
B) Proceed with the expansion because the ARR is less than the goal.
C) Wait until the price of oil rises and the calculations improve.
D) Reject the expansion because the the NPV is less than zero.
E) Reject the expansion because the IRR is higher than the goal.

Question 33

A company can invest $20,000,000 for three years in Option A paying out $7,500,000, $8,500,000, and $9,500,000 respectively. For an investment of $1,500,000, Option B will pay out $650,000, $750,000, and $850,000. Where should the company invest its money given a hurdle rate of 9%?

A) Option A as it has the higher IRR.
B) Option B as it has the higher IRR.
C) The analysis does not indicate a better option.
D) Option A as it has the higher NPV.
E) Option B as it has the higher NPV.

Question 34

Sam's Super Simonizing is a small car detailer that is replacing its upholstery cleaning machine at the beginning of the next fiscal. The old one will be worthless. A used one could be purchased leaving the company as well off as before. However, the preference is for a new one for $42,000 if it can be economically justified. To make a determination, after-tax cash flows for the investment period have to be calculated. The company estimates that the machine's efficiency will contribute to an improvement to EBIT of $7,400. Straight-line amortization is used and a projected lifetime of 10 years and no salvage value is expected. The company's tax rate is 28%, has no debt and its discount rate is 12%. The machine's CCA class has a rate of 25%. What is the after-tax cash flow at the end of Year 2?

A) $6,040
B) $6,238
C) $8,469
D) $10,925
E) $12,899

Question 35

Berringer International Inc. has invested $20 million and launched its new product. The company projected sales of over the next 10 years of $500,000, $3.2 million, $6.5 million, and $7.5 million for the first four years and $11 million for the next 6 years. A capital injection of 5 million will be required in Years 5 and 7 and a residual value of $4.5 million is expected at the end. If Berringer expects a return of 18%, what is the net present value of this project?

A) ($0.5) million
B) $0.5 million
C) $5.6 million
D) $7.5 million
E) $10.4 million

Question 36

In periods of accelerating interest rates, what are the best measures to use when deciding between investment alternatives?

A) Payback
B) ARR and Payback
C) Payback and NPV
D) NPV and IRR
E) IRR

Question 37

A large cable television provider is considering getting in to the high end ice cream business. Which of the following questions is most relevant to evaluating this proposal?

A) What is the nature and purpose of the project?
B) How much financing is required and what is the cash flow pattern?
C) What other resources of the company are required for this project?
D) How long will the project last and what are its key stages?
E) Does the project align with the overall objectives of the company?

Question 38

Ballantyne Uniforms will be purchasing one or other of two models of high efficiency industrial washing machines. It will also have to purchase an extension of the racking with linen bags that move dirty laundry to the washers. The racking system should be viewed as a

A) Sunk cost
B) Common future cost
C) Opportunity cost
D) Ancillary cost
E) Variable cost

Question 39

One of the important results of the large number of companies now using post-completion audits is that

A) It is easier to discover fraudulent behaviour
B) Cost overruns on projects have been virtually eliminated
C) There is early detection of projects going wrong
D) A higher overall cash flow is being achieved
E) More realistic investment proposals are being submitted

Question 40

The Paper Euphoria Co. (PEC) has received several similar new machine investment proposals from its branches across Canada. In general the data are: cost of the new machine is $200,000; residual value after five years is $40,000; economic life is 10 years; average annual profit before depreciation is $48,000. PEC only uses the ARR to measure investment success and requires an ARR of at least 27.5%. Which of the following actions would result in the project being accepted by PEC?

A) Changing nothing from the data given and accepting the investment as is.
B) Giving away the machine after ten years instead of selling it.
C) Using the machine for seven years instead of 10.
D) Paying only $199,000 for the new machine instead of $200,000.
E) Increasing annual profit before depreciation to 48,500 instead of $48,000.

Question 41

Air Porters Inc. is considering acquiring an airplane with a new type of engine that requires more frequent maintenance. Cash flows starting now and for the first eight years are as follows: ($2,000,000); $500,000; $500,000; ($100,000); $450,000; $450,000; ($110,000); $400,000; $400,000. How many internal rates of return does this investment project have?

A) 1
B) 2
C) 3
D) 4
E) 5

Question 42

What is an advantage of the payback method?

A) It considers the timing of cash flows.
B) It considers all relevant cash flows.
C) It considers the wealth of shareholders of the business.
D) It considers the hurdle rate.
E) It is very intuitive to use.

Question 43

Calgary Cabs is considering buying 10 new taxi cabs for a total cost of $310,000. After the purchase, total cash flows will improve by $80,000. the new cabs are expected to be in service for six years. What is the internal rate of return for this investment proposal?

A) 8%
B) 10%
C) 12%
D) 14%
E) 16%

Question 44

Two years ago Red Bricks Ltd. bought a parcel of land for $200,000 and spent $40,000 laying a foundation for a new factory. Work was stopped because of a recession. Now that the economy has improved, Red Bricks is considering starting the expansion again. The latest numbers suggest it can complete construction using 1 million of its own bricks that cost $0.50 to make but could have been sold for $0.75 each. The company could use 10 of its own idle workers for 40 hours per week for 10 weeks, each earning $15 per hour. These workers would not be laid off if the firm decides against expansion. In addition, another 20 new hires would have to be done for the same period, but these employees would only earn $10 per hour. New machines costing $5,000,000 would be purchased. The new factory is expected to produce $2,000,000 cash flow per year for 10 years. What is the net present value of the project if Red Brick's hurdle rate is 14%?

A) $4.2 million
B) $5.2 million
C) $6.2 million
D) $7.2 million
E) $8.2 million