Deck 21: Capital Budgeting and Cost Analysis

Question 1

The stage of the capital budgeting process that chooses projects for implementation is the:

A)make decisions by choosing among alternatives stage
B)make predictions stage
C)identify projects stage
D)management-control stage

Answer 1

A

Question 2

The stage of the capital budgeting process that distinguishes which types of capital expenditure projects are necessary to accomplish organization objectives is the:

A)identify projects stage
B)make predictions stage
C)obtain information stage
D)make decisions by choosing among alternatives stage

Answer 2

A

Question 3

The make decisions by choosing among alternatives stage of the capital budgeting process consists of determining which investment yields the greatest benefit and the least cost to the organization.

Answer 3

True

Question 4

The two factors capital budgeting emphasizes are:

A)qualitative and nonfinancial
B)quantitative and nonfinancial
C)quantitative and financial
D)qualitative and financial

Question 5

Explain capital budgeting and then briefly discuss each of the five stages of a capital budgeting project?

Question 6

The final activity in the capital budgeting process is to obtain funding and make the investments identified in the make decisions by choosing among alternatives stage of the process.

Question 7

The stage of the capital budgeting process that considers the expected costs and the expected benefits of alternative capital investments is the:

A)identify projects stage
B)make decisions by choosing among alternatives stage
C)obtain information stage
D)make predictions stage

Question 8

Cast Iron Stove Company wants to buy a molding machine that can be integrated into its computerized manufacturing process. It has received three bids for the machine and related manufacturer's specifications. The bids range from $3,500,000 to $3,550,000. The estimated annual savings of the machines range from $260,000 to $270,000. The payback periods are almost identical and the net present values are all within $8,000 of each other. The president just doesn't know what to do about which vendor to choose since all of the selection criteria are so close together.
Required:
What suggestions do you have for the president?

Question 9

Match each one of the examples below with one of the stages of the capital budgeting decision model.
Stages:
1. Identify Projects
2. Obtain Information
3. Make Predictions
4. Make Decisions by Choosing Among Alternatives
5. Implement the Decision, Evaluate Performance, and Learn

Question 10

The identify projects stage of capital budgeting gathers information from all parts of the value chain to evaluate alternative projects.

Question 11

The obtain information stage of capital budgeting gathers information from all parts of the value chain to evaluate alternative projects.

Question 12

The stage of the capital budgeting process during which marketing is queried for potential revenue numbers is the:

A)identify projects stage
B)obtain information stage
C)make predictions stage
D)make decisions by choosing among alternatives stage

Question 13

A capital budget spans only a one-year period.

Question 14

Explain why a corporation's customer base is considered an intangible asset.

Question 15

Which of the following involves significant financial investments in projects to develop new products, expand production capacity, or remodel current production facilities?

A)capital budgeting
B)working capital
C)master budgeting
D)project-cost budgeting

Question 16

The stage of the capital-budgeting process in which projects get underway and performance is monitored is the:

A)implement the decision, evaluate performance, and learn stage
B)make predictions stage
C)identify projects stage
D)management-control stage

Question 17

Capital budgeting is the process of making long-run planning decisions for investments in projects.

Question 18

The make predictions stage of the capital budgeting process consists of forecasting all potential net income additions that are attributable to the alternative projects.

Question 19

The accounting system that corresponds to the project dimension in capital budgeting is the:

A)net present value method
B)internal rate of return
C)accrual accounting rate of return
D)life-cycle costing

Question 20

Which of the following are NOT included in the formal financial analysis of a capital budgeting program?

A)quality of the output
B)safety of employees
C)cash flow
D)Neither A nor B are included.

Question 21

The definition of an annuity is:

A)similar to the definition of a life insurance policy
B)a series of equal cash flows at intervals
C)an investment product whose funds are invested in the stock market
D)Both A and B are correct.

Question 22

The capital budgeting method which calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time using the required rate of return is the:

A)payback method
B)accrual accounting rate-of-return method
C)sensitivity method
D)net present value method

Question 23

Answer the following questions using the information below:
Jonesville Hospital has been considering the purchase of a new x-ray machine. The existing machine is operable for five more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $90,000. The new machine will cost $650,000 and an additional cash investment in working capital of $20,000 will be required. The new machine will reduce the average amount of time required to take the x-rays and will allow an additional amount of business to be done at the hospital. The investment is expected to net $60,000 in additional cash inflows during the year of acquisition and $230,000 each additional year of use. The new machine has a five-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.
What is the net present value of the investment, assuming the required rate of return is 20%? Would the hospital want to purchase the new machine?

A)$33,910; yes
B)$(33,910); no
C)$(33,910); yes
D)$50,700; yes

Question 24

The net present value method focuses on:

A)cash inflows
B)accrual-accounting net income
C)cash outflows
D)Both A and C are correct.

Question 25

Answer the following questions using the information below:
Jonesville Hospital has been considering the purchase of a new x-ray machine. The existing machine is operable for five more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $90,000. The new machine will cost $650,000 and an additional cash investment in working capital of $20,000 will be required. The new machine will reduce the average amount of time required to take the x-rays and will allow an additional amount of business to be done at the hospital. The investment is expected to net $60,000 in additional cash inflows during the year of acquisition and $230,000 each additional year of use. The new machine has a five-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.
What is the net present value of the investment, assuming the required rate of return is 12%? Would the hospital want to purchase the new machine?

A)$(97,340); no
B)$51,430 no
C)$ 97,340; yes
D)$166,830; yes

Question 26

All of the following are methods that aid management in analyzing the expected results of capital budgeting decisions EXCEPT:

A)accrual accounting rate-of-return method
B)discounted cash-flow method
C)future-value cash-flow method
D)payback method

Question 27

Assume your goal in life is to retire with three million dollars. How much would you need to save at the end of each year if interest rates average 5% and you have a 25-year work life?

A)$ 49,110
B)$ 55,596
C)$ 62,858
D)$67,508

Question 28

Answer the following questions using the information below:
Hawkeye Cleaners has been considering the purchase of an industrial dry-cleaning machine. The existing machine is operable for three more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $120,000. The new machine will cost $400,000 and an additional cash investment in working capital of $120,000 will be required. The new machine will reduce the average amount of time required to wash clothing and will decrease labor costs. The investment is expected to net $100,000 in additional cash inflows during the year of acquisition and $300,000 each additional year of use. The new machine has a three-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.
What is the net present value of the investment, assuming the required rate of return is 24%? Would the company want to purchase the new machine?

A)$(65,600); yes
B)$(32,800); no
C)$32,800; yes
D)$65,600; no

Question 29

Assume your goal in life is to retire with two million dollars. How much would you need to save at the end of each year if interest rates average 6% and you have a 20-year work life?

A)$29,130
B)$54,369
C)$240,204
D)$752,952

Question 30

If the net present value for a project is zero or positive, this means that the:

A)project should be accepted
B)project should not be accepted
C)expected rate of return is below the required rate of return
D)Both A and C are correct.

Question 31

Which of the following results of the net present value method in capital budgeting is the LEAST acceptable?

A)$(5,000)
B)$(7,000)
C)$(15,000)
D)$0

Question 32

The stage of the capital budgeting process in which a firm obtains funding for the project is the:

A)make decisions by choosing among alternatives stage.
B)make predictions stage.
C)obtain information stage.
D)implement the decision, evaluate performance, and learn stage.

Question 33

Upper Darby Park Department is considering a new capital investment. The following information is available on the investment. The cost of the machine will be $300,000. The annual cost savings if the new machine is acquired will be $80,000. The machine will have a 5-year life, at which time the terminal disposal value is expected to be $40,000. Upper Darby Park Department is assuming no tax consequences. If Upper Darby Park Department has a required rate of return of 10%, which of the following is closest to the present value of the project?

A)$3,264
B)$24,836
C)$28,120
D)$300,000

Question 34

Discounted cash flow methods for capital budgeting focus on:

A)cash inflows
B)operating income
C)cash outflows
D)Both A and C are correct.

Question 35

Which of the following is NOT an appropriate term for the required rate of return?

A)discount rate
B)hurdle rate
C)cost of capital
D)All of these answers are correct.

Question 36

In using the net present value method, only projects with a zero or positive net present value are acceptable because:

A)the return from these projects equals or exceeds the cost of capital
B)a positive net present value on a particular project guarantees company profitability
C)the company will be able to pay the necessary payments on any loans secured to finance the project
D)Both A and B are correct.

Question 37

Which capital budgeting technique(s)measure all expected future cash inflows and outflows as if they occurred at a single point in time?

A)net present value
B)internal rate of return
C)payback
D)Both A and B are correct.

Question 38

Net present value is calculated using the:

A)internal rate of return
B)required rate of return
C)rate of return required by the investment bankers
D)None of these answers is correct.

Question 39

Answer the following questions using the information below:
Hawkeye Cleaners has been considering the purchase of an industrial dry-cleaning machine. The existing machine is operable for three more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $120,000. The new machine will cost $400,000 and an additional cash investment in working capital of $120,000 will be required. The new machine will reduce the average amount of time required to wash clothing and will decrease labor costs. The investment is expected to net $100,000 in additional cash inflows during the year of acquisition and $300,000 each additional year of use. The new machine has a three-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life.
What is the net present value of the investment, assuming the required rate of return is 10%? Would the company want to purchase the new machine?

A)$164,000; yes
B)$100,000; no
C)$(100,000); yes
D)$(164,000); no

Question 40

Assume your goal in life is to retire with 2 million dollars. How much would you need to save at the end of each year if investment rates average 9% and you have a 15-year work life?

A)$51,108
B)$ 68,118
C)$ 75,706
D)$ 82,572

Question 41

An important advantage of the net present value method of capital budgeting over the internal rate-of-return method is:

A)the net present value method is expressed as a percentage
B)the net present values of individual projects can be added to determine the effects of accepting a combination of projects
C)There is no advantage.
D)Both A and B are correct.

Question 42

The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of $475,000. The investment is expected to generate $175,000 in annual cash flows for a period of four years. The required rate of return is 14%. The old machine can be sold for $25,000. The machine is expected to have zero value at the end of the four-year period. What is the net present value of the investment? Would the company want to purchase the new machine? Income taxes are not considered.

A)$59,775; yes
B)$34,775; no
C)$509,775; yes
D)$163,375; no

Question 43

The three common discounted cash flow methods are net present value, internal rate of return, and payback.

Question 44

The Required Rate of Return (RRR)is set externally by creditors as the interest rate on long term liabilities.

Question 45

The Zeron Corporation recently purchased a new machine for its factory operations at a cost of $921,250. The investment is expected to generate $250,000 in annual cash flows for a period of six years. The required rate of return is 14%. The old machine has a remaining life of six years. The new machine is expected to have zero value at the end of the six-year period. The disposal value of the old machine at the time of replacement is zero. What is the internal rate of return?

A)15%
B)16%
C)17%
D)18%

Question 46

Crystal Manufacturing Company provides glassware machines for major department store retailers. The company has been investigating a new piece of machinery for its production department. The old equipment has a remaining life of five years and the new equipment has a value of $117,320 with a five-year life. The expected additional cash inflows are $35,000 per year. What is the internal rate of return?

A)10%
B)12%
C)15%
D)20%

Question 47

Soda Manufacturing Company provides vending machines for soft-drink manufacturers. The company has been investigating a new piece of machinery for its production department. The old equipment has a remaining life of three years and the new equipment has a value of $52,650 with a three-year life. The expected additional cash inflows are $25,000 per year. What is the internal rate of return?

A)20%
B)16%
C)10%
D)8%

Question 48

The minimum annual acceptable rate of return on an investment is the:

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

Question 49

Investment A requires a net investment of $1,600,000. The required rate of return is 12% for the four-year annuity. What are the annual cash inflows if the net present value equals 0? (rounded)

A)$378,966
B)$526,836
C)$549,696
D)$591,466

Question 50

Discounted cash flow methods focus on operating income.

Question 51

The net present value (NPV)method calculates the expected monetary gain or loss from a project by discounting all expected future cash inflows and outflows back to the present point in time using the required rate of return.

Question 52

In situations where the required rate of return is NOT constant for each year of the project, it is advantageous to use:

A)the adjusted rate-of-return method
B)the internal rate-of-return method
C)the net present value method
D)sensitivity analysis

Question 53

In capital budgeting, a project is accepted only if the internal rate of return equals or:

A)exceeds the required rate of return
B)is less than the required rate of return
C)exceeds the net present value
D)exceeds the accrual accounting rate of return

Question 54

Shirt Company wants to purchase a new cutting machine for its sewing plant. The investment is expected to generate annual cash inflows of $150,000. The required rate of return is 12% and the current machine is expected to last for four years. What is the maximum dollar amount Shirt Company would be willing to spend for the machine, assuming its life is also four years? Income taxes are not considered.

A)$263,500
B)$360,300
C)$395,870
D)$455,550

Question 55

Springtime Flower Company provides flowers and other nursery products for decorative purposes in medium to large sized restaurants and businesses. The company has been investigating the purchase of a new specially equipped van for deliveries. The van has a value of $62,755 with a seven-year life. The expected additional cash inflows are $13,750 per year. What is the internal rate of return?

A)10%
B)12%
C)15%
D)20%

Question 56

Brown Corporation recently purchased a new machine for $339,013.20 with a ten-year life. The old equipment has a remaining life of ten years and no disposal value at the time of replacement. Net cash flows will be $60,000 per year. What is the internal rate of return?

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

Question 57

Wet and Wild Water Company drills small commercial water wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below. What is the net present value of the investment? Assume there is no recovery of working capital.

A)$(124,280)
B)$20,672
C)$84,724
D)$372,672

Question 58

A "what-if" technique that examines how a result will change if the original predicted data are NOT achieved or if an underlying assumption changes is called:

A)sensitivity analysis
B)net present value analysis
C)internal rate-of-return analysis
D)adjusted rate-of-return analysis

Question 59

The capital budgeting method that calculates the discount rate at which the present value of expected cash inflows from a project equals the present value of expected cash outflows is the:

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

Question 60

Upper Darby Park Department is considering a new capital investment. The following information is available on the investment. The cost of the machine will be $432,576. The annual cost savings if the new machine is acquired will be $120,000. The machine will have a 5-year life, at which time the terminal disposal value is expected to be zero. Upper Darby Park Department is assuming no tax consequences. What is the internal rate of return for Upper Darby Park Department?

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

Question 61

The net initial investment for a piece of construction equipment is $2,000,000. Annual cash inflows are expected to increase by $400,000 per year. The equipment has an 8-year useful life. What is the payback period?

A)8 years
B)7 years
C)6 years
D)5 years

Question 62

Network Service Center is considering purchasing a new computer network for $82,000. It will require additional working capital of $13,000. Its anticipated eight-year life will generate additional client revenue of $33,000 annually with operating costs, excluding depreciation, of $15,000. At the end of eight years, it will have a salvage value of $9,500 and return $5,000 in working capital. Taxes are not considered.
Required:
a. If the company has a required rate of return of 14%, what is the net present value of the proposed investment?
b. What is the internal rate of return?

Question 63

The method that measures the time it will take to recoup, in the form of future cash inflows, the total dollars invested in a project is called:

A)the accrued accounting rate-of-return method
B)payback method
C)internal rate-of-return method
D)the book-value method

Question 64

Retail Outlet is looking for a new location near a shopping mall. It is considering purchasing a building rather than leasing, as it has done in the past. Three retail buildings near a new mall are available but each has its own advantages and disadvantages. The owner of the company has completed an analysis of each location that includes considerations for the time value of money. The information is as follows:
The owner does not understand how the location with the highest percentage return has the lowest net present value.
Required:
Explain to the owner what is (are)the probable cause(s)of the comparable differences.

Question 65

A weaknesses of the payback method is that it does not consider a project's cash flows after the payback period.

Question 66

Upper Darby Park Department is considering a new capital investment. The following information is available on the investment. The cost of the machine will be $72,096. The annual cost savings if the new machine is acquired will be $20,000. The machine will have a 5-year life, at which time the terminal disposal value is expected to be zero. Upper Darby Park is assuming no tax consequences. Upper Darby Park has a 10% required rate of return. What is the payback period on this investment?

A)3 years
B)3.6 years
C)4.2 years
D)5 years

Question 67

Unlike the net present value method and the internal rate-of-return method, the payback method does NOT distinguish between the origins of the cash flows.

Question 68

ABC Boat Company is interested in replacing a molding machine with a new improved model. The old machine has a salvage value of $10,000 now and a predicted salvage value of $4,000 in six years, if rebuilt. If the old machine is kept, it must be rebuilt in one year at a predicted cost of $20,000.
The new machine costs $80,000 and has a predicted salvage value of $12,000 at the end of six years. If purchased, the new machine will allow cash savings of $20,000 for each of the first three years, and $10,000 for each year of its remaining six-year life.
Required:
What is the net present value of purchasing the new machine if the company has a required rate of return of 14%?

Question 69

A capital budgeting project is accepted if the required rate of return equals or exceeds the internal rate of return.

Question 70

Internal rate of return is a method of calculating the expected net monetary gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time.

Question 71

The net present value method can be used in situations where the required rate of return varies over the life of the project.

Question 72

The net present value method accurately assumes that project cash flows can only be reinvested at the company's required rate of return.

Question 73

The Zero Machine Company is evaluating a capital expenditure proposal that requires an initial investment of $41,920 and has predicted cash inflows of $10,000 per year for 10 years. It will have no salvage value.
Required:
a. Using a required rate of return of 16%, determine the net present value of the investment proposal.
b. Determine the proposal's internal rate of return.

Question 74

The payback method is only useful when the expected cash flows in the later years of the project are highly uncertain.

Question 75

The payback method of capital budgeting approach to the investment decision highlights:

A)cash flow over the life of the investment
B)the liquidity of the investment
C)the tax savings of the depreciation amounts
D)having as lengthy payback time as possible

Question 76

EIF Manufacturing Company needs to overhaul its drill press or buy a new one. The facts have been gathered, and they are as follows:
Required:
Which alternative is the most desirable with a current required rate of return of 20%? Show computations, and assume no taxes.

Question 77

Springtime Flower Company provides flowers and other nursery products for decorative purposes in medium to large sized restaurants and businesses. The company has been investigating the purchase of a new specially equipped van for deliveries. The van has a value of $123,750 with a seven-year life. The expected additional cash inflows are $27,500 per year. What is the payback period on this investment?

A)3 years
B)4.5 years
C)6 years
D)NA - project not feasible

Question 78

Crystal Manufacturing Company provides glassware machines for major department store retailers. The company has been investigating a new piece of machinery for its production department. The old equipment has a remaining life of five years and the new equipment has a value of $231,000 with a five-year life. The expected additional cash inflows are $70,000 per year. What is the payback period on this investment?

A)2.5 years
B)3 years
C)3.3 years
D)5 years

Question 79

Maremount Tire Company needs to overhaul its auto lift system or buy a new one. The facts have been gathered, and they are as follows:
Required:
Which alternative is the most desirable with a current required rate of return of 15%? Show computations, and assume no taxes.

Question 80

Supply the missing data for each of the following proposals: