Deck 11: Capital Budgeting and Investment Analysis

Question 1

Capital budgeting is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

Answer 1

True

Question 2

A hurdle rate is the minimum acceptable rate of return for an investment.

Answer 2

True

Question 3

The net present value capital budgeting method considers all estimated cash flows for the project's expected life.

Answer 3

True

Question 4

The time value of money concept works on the principle that a dollar today is worth more than a dollar tomorrow.

Question 5

Capital budgeting decisions are not affected by return on investment considerations.

Question 6

Neither the payback period nor the accounting rate of return methods of evaluating investments considers the time value of money.

Question 7

Capital budgeting decisions that relate to investments in technology are not as risky as other types of capital budgeting decisions.

Question 8

Capital budgeting decisions are risky because the outcome is uncertain, large amounts are usually involved, the investment involves a long-term commitment, and the decision could be difficult or impossible to reverse.

Question 9

If the internal rate of return (IRR)of an investment is below the hurdle rate, the project should be accepted.

Question 10

There is only one method of evaluating capital budgeting decisions.

Question 11

Neither the net present value nor the internal rate of return methods of evaluating investments consider the time value of money.

Question 12

Three widely used methods of comparing investment alternatives are payback period, net present value, and rate of return on average investment.

Question 13

An advantage of the break-even time (BET)method over the payback period method is that it recognizes the time value of money.

Question 14

The time value of money concept works on the principle that a dollar tomorrow is worth more than a dollar today.

Question 15

For projects financed from borrowed funds, the hurdle rate must exceed the interest rate paid on these funds.

Question 16

The process of restating cash flows in terms of their present values is called discounting.

Question 17

Accounting rate of return is the simplest capital budgeting method.It gives managers an estimate of how soon they will recover their initial investment.

Question 18

All capital investment evaluation methods use the time value of money concept.

Question 19

In ranking choices with the break-even time (BET)method, the investment with the highest BET measure gets the highest rank.

Question 20

Lower-risk investments require a higher rate of return compared with higher-risk investments.

Question 21

The process of analyzing alternative investments and deciding which assets to acquire or sell is known as:

A)Planning and control.
B)Capital budgeting.
C)Variance analysis.
D)Master budgeting.
E)Managerial accounting.

Question 22

A disadvantage of an investment with a short payback period is that it will produce revenue for only a short period of time.

Question 23

The payback method, unlike the net present value method, does not ignore cash flows after the point of cost recovery.

Question 24

A minimum acceptable rate of return for an investment decision is called the:

A)Internal rate of return.
B)Average rate of return.
C)Hurdle rate of return.
D)Maximum rate of return.
E)Payback rate of return.

Question 25

The accounting rate of return uses cash flows in its calculation.

Question 26

The net cash flow of a particular investment project:

A)Does not take income taxes into consideration.
B)Equals the total of the inflows of the project.
C)Equals the total of the outflows of the project.
D)Does not include depreciation.
E)Is equal to operating income each period.

Question 27

Two investments with exactly the same payback periods are always equally valuable to an investor.

Question 28

Capital budgeting decisions usually involve analysis of:

A)Cash outflows only.
B)Short-term investments only.
C)Long-term investments only.
D)Investments with certain outcomes only.
E)Operating revenues.

Question 29

Use of the internal rate of return method cannot be used with uneven cash flows.

Question 30

Capital budgeting decisions are generally based on:

A)Tentative predictions of future outcomes.
B)Perfect predictions of future outcomes.
C)Results from past outcomes only.
D)Results from current outcomes only.
E)Speculation of interest rates and economic performance only.

Question 31

If net present values are used to evaluate two investments that have equal costs and equal total cash flows, the one with more cash flows in the early years has the higher net present value.

Question 32

The net present value decision rule is: When an asset's expected cash flows are discounted at the required rate and yield a positive net present value, the asset should be acquired.

Question 33

The payback method of evaluating an investment fails to consider how long the investment will generate cash inflows beyond the payback period.

Question 34

In calculating the rate of return on average investment, average investment should be calculated as (beginning book value + ending book value)/2.

Question 35

Which of the following is an objective of capital budgeting?

A)To eliminate all risk.
B)To discount all future and past cash flows.
C)To earn a satisfactory return on investment.
D)To reverse past decisions.
E)To reduce the number of investment activities.

Question 36

The time value of money is considered when calculating the payback period of an investment.

Question 37

The internal rate of return equals the rate that yields a net present value of zero for an investment.

Question 38

The time value of money concept:

A)Means that a dollar today is worth less than a dollar tomorrow.
B)Means that a dollar tomorrow is worth more than a dollar today.
C)Means that a dollar today is worth more than a dollar tomorrow.
D)Means that "Time is money."
E)Does not involve the concept of compound interest.

Question 39

The process of restating future cash flows in terms of their present values is called:

A)Discounting.
B)Capital budgeting.
C)Payback period.
D)Risk uncertainty.
E)Accounting rate of return.

Question 40

If two projects have the same risks, the same payback periods, and the same initial investments, they are equally attractive.

Question 41

A given project requires a $28,500 investment and is expected to generate end-of-period annual cash inflows of $12,000 for each of three years.Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below: $$\begin{array} { c c c } i = 10 \% & i = 10 \% & i = 10 \% \\n = 1 & n = 2 & n = 3 \\\hline .9091 & .8264 & .7513\end{array}$$

A)$0.00
B)$2,668.00
C)($7,461.00)
D)$1,341.60
E)$29,841.60

Question 42

A company wishes to buy new equipment for $85,000.The equipment is expected to generate an additional $35,000 in cash inflows for four years.All cash flows occur at year-end.A bank will make an $85,000 loan to the company at a 10% interest rate so that the company can purchase the equipment.Use the table below to determine break-even time for this equipment. $$\begin{array} { c c } \text { Year } & \text { Present Value } \\& \text { of 1 at } 10 \% \\0 & 1.0000 \\1 & 0.9091 \\2 & 0.8264 \\3 & 0.7513 \\4 & 0.6830\end{array}$$

A)Break-even time is longer than 4 years.
B)Break-even time is between 3 and 4 years.
C)Break-even time is between 2 and 3 years.
D)Break-even time is between 1 and 2 years.
E)This project will never break-even.

Question 43

The time expected to pass before the net cash flows from an investment would return its initial cost is called the:

A)Amortization period.
B)Payback period.
C)Interest period.
D)Budgeting period.
E)Discounted cash flow period.

Question 44

In business decision-making, managers typically examine the two fundamental factors of:

A)Risk and capital investment.
B)Risk and rate of return.
C)Capital investment and rate of return.
D)Risk and payback.
E)Payback and rate of return.

Question 45

If a manager were concerned with the time value of money, from which two capital budgeting methods should the manager choose?

A)IRR or Payback.
B)BET or IRR.
C)BET or Payback.
D)NPV or ARR.
E)NPV or Payback.

Question 46

A given project requires a $25,000 investment and is expected to generate end-of-period annual cash inflows as follows: $$\begin{array} { c c c c } \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Total } \\\hline \$ 4,000 & \$ 15,000 & \$ 6,000 & \$ 25,000\end{array}$$ Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below:
$$\begin{array} { c c c } i = 10 \% & i = 10 \% & i = 10 \% \\n = 1 & n = 2 & n = 3 \\\hline .9091 & .8264 & .7513\end{array}$$

A)$6,217.50
B)($4,459.80)
C)($6,217.50)
D)$8,275.00
E)$0.00

Question 47

A major limitation of the internal rate of return method is:

A)Failure to measure time value of money.
B)Failure to measure results as a percent.
C)Failure to consider the payback period.
D)Failure to reflect varying risk levels over project life.
E)Failure to compare dissimilar projects.

Question 48

Which methods of evaluating a capital investment project ignore the time value of money?

A)Net present value and accounting rate of return.
B)Accounting rate of return and internal rate of return.
C)Internal rate of return and payback period.
D)Payback period and accounting rate of return.
E)Net present value and payback period.

Question 49

The break-even time (BET)method is a variation of the:

A)Payback method.
B)Internal rate of return method.
C)Accounting rate of return method.
D)Net present value method.
E)Present value method.

Question 50

Which methods of evaluating a capital investment project use cash flows as a measurement basis?

A)Net present value, accounting rate of return, and internal rate of return.
B)Internal rate of return, payback period, and accounting rate of return.
C)Accounting rate of return, net present value, and payback period.
D)Payback period, internal rate of return, and net present value.
E)Net present value, payback period, accounting rate of return, and internal rate of return.

Question 51

A given project requires a $30,000 investment and is expected to generate end-of-period annual cash inflows as follows: $$\begin{array} { c c c c } \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Total } \\\hline \$ 12,000 & \$ 8,000 & \$ 10,000 & \$ 30,000\end{array}$$ Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below:
$$\begin{array} { c c c } i = 10 \% & i = 10 \% & i = 10 \% \\n = 1 & n = 2 & n = 3 \\\hline .9091 & .8264 & .7513\end{array}$$

A)$0.00
B)$21,000.00
C)($7,461.00)
D)$25,033.32
E)($4,966.68)

Question 52

Coffer Co.is analyzing two projects for the future.Assume that only one project can be selected. $\begin{array}{lrr}&\underline { \text {Project X } }&\underline { \text {Project Y } }\\ \text { Cost of } &\$ 68,000 & \$ 60,000\\ \text { machine } \\ \text { Net cash flow: } \\\text { Year 1 } & 24,000 & 4,000 \\\text { Year 2 } & 24,000 & 26,000 \\\text { Year 3 } & 24,000 & 26,000 \\\text { Year 4 } & 0 & 20,000\end{array}$ If the company is using the payback period method and it requires a payback of three years or less, which project should be selected?

A)Project Y.
B)Project X.
C)Both X and Y are acceptable projects.
D)Neither X nor Y is an acceptable project.
E)Project Y because it has a lower initial investment.

Question 53

A company wishes to buy new equipment for $85,000.The equipment is expected to generate an additional $35,000 in cash inflows for four years.All cash flows occur at year-end.A bank will make an $85,000 loan to the company at a 10% interest rate so that the company can purchase the equipment.Use the table below to determine the present value of the future cash flows and the net present value of the investment. $$\begin{array}{l}\begin{array} { c c } &\text { Present Value }\\\text { Year } & \text { of 1 at } 10 \% \\0 & 1.0000 \\1 & 0.9091 \\2 & 0.8264 \\3 & 0.7513 \\4 & 0.6830\end{array}\end{array}$$

A)$140,000 and $55,000 respectively
B)$110,942 and $25,942 respectively
C)$145,942 and $60,942 respectively
D)$145,942 and $129,432 respectively
E)$110,942 and $52,888 respectively

Question 54

A company is considering purchasing a machine for $21,000.The machine will generate an after-tax net income of $2,000 per year.Annual depreciation expense would be $1,500.What is the payback period for the new machine?

A)4 years.
B)6 years.
C)10.5 years.
D)14 years.
E)42 years.

Question 55

For purposes of applying the net present value and the internal rate of return methods, the rate chosen to measure the time adjusted value of money is known as the:

A)Internal rate.
B)Average rate.
C)Prime rate.
D)Discount rate.
E)Compound rate.

Question 56

A company wishes to buy new equipment for $9,000.The equipment is expected to generate an additional $2,800 in cash inflows for six years.All cash flows occur at year-end.A bank will make an $9,000 loan to the company at a 10% interest rate so that the company can purchase the equipment.Use the table below to determine break-even time for this equipment:

A.Break-even time is between two and three years.
B.Break-even time is between three and four years.
C.Break-even time is between four and five years.
D.Break-even time is between five and six years.
E.This project will never break-even.

Question 57

A company wishes to buy new equipment for $35,000.The equipment is expected to generate an additional $9,600 in cash inflows for seven years.All cash flows occur at year-end.A bank will make an $35,000 loan to the company at a 10% interest rate so that the company can purchase the equipment.Use the table below to determine break-even time for this equipment. $$\begin{array} { c c } & \text { Present Value } \\\text { Year } & \text { of 1 at 10\% } \\0 & 1.0000 \\1 & 0.9091 \\2 & 0.8264 \\3 & 0.7513 \\4 & 0.6830 \\5 & 0.6209 \\6 & 0.5645 \\7 & 0.5132\end{array}$$

A)Break-even time is between three and four years.
B)Break-even time is between four and five years.
C)Break-even time is between five and six years.
D)Break-even time is between six and seven years.
E)This project will never break-even.

Question 58

The calculation of the payback period for an investment when net cash flow is even (equal)is:

A)(Cost of investment)/(Annual net cash flow)
B)(Cost of investment)/(Total net cash flow)
C)(Annual net cash flow)/(Cost of investment)
D)(Total net cash flow)/(Cost of investment)
E)(Total net cash flow)/(Annual net cash flow)

Question 59

The internal rate of return method is not subject to the limitations of the net present value method when comparing projects with different amounts invested because:

A)The internal rate of return is expressed as a percent rather than the absolute dollar value of present value.
B)The internal rate of return is expressed as an absolute dollar value rather than the percent of net present value.
C)The internal rate of return reflects the time value of money rather than the absolute dollar value of present value.
D)The internal rate of return is expressed as an absolute dollar value rather than the time value of money used in net present value.
E)The internal rate of return is expressed as a percent rather than the accrual income method used in net present value.

Question 60

A given project requires a $28,000 investment and is expected to generate end-of-period annual cash inflows as follows: $$\begin{array} { c c c } \text { Year 1 } & \text { Year 2 } & \text { Year 3 } \\\hline\$ 12,000 & \$ 13,000 & \$ 12,000\end{array}$$ Assuming a discount rate of 10%, what is the net present value of this investment? Selected present value factors for a single sum are shown in the table below.
$$\begin{array} { c c c } i = 10 \% & i = 10 \% & i = 10 \% \\n = 1 & n = 2 & n = 3 \\\hline .9091 & .8264 & .7513\end{array}$$

A)$0.00
B)$2,668.00
C)($7,461.00)
D)$30,668.00
E)($4,966.68)

Question 61

A company is considering the purchase of a new machine for $48,000.Management predicts that the machine can produce sales of $16,000 each year for the next 10 years.Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year.The company's tax rate is 40%.What is the payback period for the new machine?

A)3.0 years
B)6.0 years
C)7.5 years
D)12.0 years
E)20.0 years

Question 62

A company bought a machine that has an expected life of seven years and no salvage value.Management estimates that this machine will generate annual after-tax net income of $540.If the accounting rate of return is 12%, what was the purchase price of the machine?

A)$4,500
B)$540
C)$31,500
D)$9,000
E)$2,250

Question 63

A company is considering purchasing a machine for $21,000.The machine will generate an after-tax net income of $2,000 per year.Annual depreciation expense would be $1,500.What is the approximate accounting rate of return?

A)19%
B)33%
C)17%
D)10%
E)25%

Question 64

A company is considering the purchase of a new machine for $72,000.Management predicts that the machine can produce sales of $21,000 each year for the next eight years.Expenses are expected to include direct materials, direct labor, and factory overhead totaling $5,000 per year plus depreciation of $9,000 per year.The company's tax rate is 40%.What is the payback period for the new machine?

A)5.45 years
B)17.14 years
C)10.29 years
D)4.50 years
E)6.00 years

Question 65

Beyer Corporation is considering buying a machine for $25,000.Its estimated useful life is five years, with no salvage value.Beyer anticipates annual net income after taxes of $1,500 from the new machine.What is the accounting rate of return assuming that Beyer uses straight-line depreciation and that income is earned uniformly throughout each year?

A)6.0%
B)8.0%
C)8.5%
D)10.0%
E)12.0%

Question 66

The accounting rate of return is calculated as:

A)The after-tax income divided by the total investment.
B)The after-tax income divided by the average investment.
C)The cash flows divided by the average investment.
D)The cash flows divided by the total investment.
E)The average investment divided by the after-tax income.

Question 67

The following data concerns a proposed equipment purchase: $\begin{array}{lr}\text { Cost } & \$ 58,000 \\ \text { Salvage value } & \$ 3,000 \\ \text { Estimated usefull life } & 5 \text { years } \\ \text { Annual net cash flows } & \$ 18,000\\ \text { Depreciation method}& \text { Straight-line }\\\end{array}$

Assuming that net cash flows are received evenly throughout the year, the accounting rate of return is:

A)24.13%
B)20.98%
C)22.95%
D)59.00%
E)25.45%

Question 68

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and be depreciated using the straight-line method with no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below.


$\begin{array} { l r r } \text { Sales }&&\$ 90,000\\ \text { Costs: }\\\text { Manufacturing } & \$ 52,000 \\ \text { Depreciation on machine } & 4,000 & \\ \text { Selling and administrative expenses } & \underline {30,000} & \underline { ( 86,000 ) } \\ \text { Income before taxes } & & \$ 4,000 \\ \text { Income tax } ( 50 \% ) && \underline { ( 2,000 ) } \\ \text { Net income } && \underline { \$ 2,000 } \end{array}$

-What is the payback period for this machine?

A)17.50 years
B)11.67 years
C)5.00 years
D)4.375 years
E)1 year

Question 69

A company is considering the purchase of a new machine for $48,000.Management predicts that the machine can produce sales of $16,000 each year for the next 10 years.Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year.The company's tax rate is 40%.What is the approximate accounting rate of return for the machine?

A)13%.
B)17%
C)8%
D)27%
E)10%

Question 70

After-tax net income divided by the annual average investment is the:

A)Net present value rate.
B)Payback rate.
C)Accounting rate of return.
D)Earnings from investment.
E)Profit rate.

Question 71

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and be depreciated using the straight-line method with no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below.


$\begin{array} { l r r } \text { Sales }&&\$ 90,000\\ \text { Costs: }\\\text { Manufacturing } & \$ 52,000 \\ \text { Depreciation on machine } & 4,000 & \\ \text { Selling and administrative expenses } & \underline {30,000} & \underline { ( 86,000 ) } \\ \text { Income before taxes } & & \$ 4,000 \\ \text { Income tax } ( 50 \% ) && \underline { ( 2,000 ) } \\ \text { Net income } && \underline { \$ 2,000 } \end{array}$

-What is the payback period for this machine?

A)24 years
B)12 years
C)6 years
D)4 years
E)1 year

Question 72

A disadvantage of using the payback period to compare investment alternatives is that:

A)It ignores cash flows beyond the payback period.
B)It includes the time value of money.
C)It cannot be used when cash flows are not uniform.
D)It cannot be used if a company records depreciation.
E)It cannot be used to compare investments with different initial investments.

Question 73

A company is considering the purchase of a new piece of equipment for $90,000.Predicted annual cash inflows from this investment are $36,000 (year 1); $30,000 (year 2); $18,000 (year 3); $12,000 (year 4); and $6,000 (year 5).The payback period is:

A)4.50 years
B)4.25 years
C)3.50 years
D)3.00 years
E)2.50 years

Question 74

A company buys a machine for $60,000 that has an expected life of nine years and no salvage value.The company anticipates a yearly net income of $2,850 after taxes of 30%, with the cash flows to be received evenly throughout of each year.What is the accounting rate of return?

A)2.85%
B)4.75%
C)6.65%
D)9.50%
E)42.75%

Question 75

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and be depreciated using the straight-line method with no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below.


$\begin{array} { l r r } \text { Sales }&&\$ 90,000\\ \text { Costs: }\\\text { Manufacturing } & \$ 52,000 \\ \text { Depreciation on machine } & 4,000 & \\ \text { Selling and administrative expenses } & \underline {30,000} & \underline { ( 86,000 ) } \\ \text { Income before taxes } & & \$ 4,000 \\ \text { Income tax } ( 50 \% ) && \underline { ( 2,000 ) } \\ \text { Net income } && \underline { \$ 2,000 } \end{array}$

-What is the accounting rate of return for this machine?

A)14.28%
B)17.14%
C)60.0%
D)8.57%
E)7%

Question 76

The following data concerns a proposed equipment purchase: $\begin{array}{lr}\text { Cost } & \$ 144,000 \\\text { Salvage value } & \$ 4,000 \\\text { Estimated useful life } & 4 \text { years } \\\text { Annual net cash flows } & \$ 46,100 \\\text { Depreciation method } & \text { Straight-line }\end{array}$ Assuming that net cash flows are received evenly throughout the year, the accounting rate of return is:

A)62.3%
B)32.0%
C)15.0%
D)7.7%
E)5.0%

Question 77

A company is considering the purchase of a new machine for $128,000.Management predicts that the machine can produce sales of $32,000 each year for the next eight years.Expenses are expected to include direct materials, direct labor, and factory overhead totaling $7,500 per year plus depreciation of $10,800 per year.The company's tax rate is 38%.What is the payback period for the new machine?

A)4.00 years
B)6.63 years
C)9.34 years
D)15.06 years
E)5.22 years

Question 78

Monterey Corporation is considering the purchase of a machine costing $36,000 with a six-year useful life and no salvage value.Monterey uses straight-line depreciation and assumes that the annual cash inflow from the machine will be received uniformly throughout each year.In calculating the accounting rate of return, what is Monterey's average investment?

A)$6,000
B)$7,000
C)$18,000
D)$21,000
E)$36,000

Question 79

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and be depreciated using the straight-line method with no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below.


$\begin{array} { l r r } \text { Sales }&&\$ 90,000\\ \text { Costs: }\\\text { Manufacturing } & \$ 52,000 \\ \text { Depreciation on machine } & 4,000 & \\ \text { Selling and administrative expenses } & \underline {30,000} & \underline { ( 86,000 ) } \\ \text { Income before taxes } & & \$ 4,000 \\ \text { Income tax } ( 50 \% ) && \underline { ( 2,000 ) } \\ \text { Net income } && \underline { \$ 2,000 } \end{array}$

-What is the accounting rate of return for this machine?

A)33.3%
B)16.7%
C)50.0%
D)8.3%
E)4%

Question 80

The following data concerns a proposed equipment purchase: $\begin{array}{lr}\text { Cost } & \$ 278,000 \\\text { Salvage value } & \$ 6,000 \\\text { Estimated useful life } & 8 \text { years } \\\text { Annual net cash flows } & \$ 46,360 \\\text { Depreciation method } & \text { Straight-line }\end{array}$ Assuming that net cash flows are received evenly throughout the year, the accounting rate of return is:

A)34.09%
B)32.64%
C)8.35%
D)8.70%
E)16.67%