Deck 21: Capital Budgeting: Methods of Investment Analysis

Question 1

A capital budgeting project will have a positive net present value if its return is less than the hurdle rate.

Answer 1

False

Question 2

Identify capital expenditures relevant to accomplishing strategic goals is the first step in the capital budgeting decision process model.

Answer 2

True

Question 3

The time value of money

A) is equal to the rate of inflation.
B) includes the rate of inflation.
C) is the same value for all companies.
D) is equal to the bank prime rate.
E) is the opportunity cost of not having the money today.

Answer 3

E

Question 4

Discounted cash flow measures the cash inflows and outflows of a project as if they occurred at a single point in time in order to facilitate a proper comparison.

Question 5

Cost analysis has two dimensions, which are

A) financial and non-financial.
B) present and the future.
C) project and financial.
D) project and non-financial.
E) project and time.

Question 6

The consequences of capital expenditures are

A) quantitative and financial.
B) quantitative and qualitative.
C) qualitative and nonfinancial.
D) appropriate and inappropriate.
E) nonfinancial and irrelevant.

Question 7

The net present value method is a discounted cash flow method that concentrates only on cash flows.

Question 8

In capital budgeting decisions, revenues and costs are analyzed over the short-run.

Question 9

Discounted cash flow methods focus on operating income.

Question 10

Cost systems with an exclusive period-by-period focus are more likely to identify project costs over multiple periods.

Question 11

Which of the following is not a part of the capital budgeting decision process model?

A) establish assumptions common for each potential capital investment
B) obtain appropriate sources of financing for investments
C) identify capital expenditures relevant to accomplishing strategic goals
D) manage the control of non-quantitative factors
E) analyze the present value of future cash inflow and outflow and relevant qualitative factors

Question 12

Both financial and nonfinancial factors associated with proposed capital budgeting opportunities need to be considered as part of the capital budgeting decision process.

Question 13

The rate of return is the ratio of net future cash flows to the investment outflow.

Question 14

Accrual accounting measures income on a year-to-year basis.

Question 15

The net present value method 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 hurdle rate.

Question 16

Capital budgeting emphasizes the role of financial information in investment decisions.

Question 17

Capital budgeting focuses on projects over their entire lives to consider all the cash flows or cash savings from investing in a single project.

Question 18

Discounted cash flow methods measure all the expected future cash inflows and outflows of a project as if they occurred at equal intervals over the life of the project.

Question 19

Life cycle costing is the accounting system that corresponds to

A) the non-financial dimension of costs analysis.
B) the project dimension of costs analysis.
C) the cost dimension of costs analysis.
D) the financial dimension of costs analysis.
E) the time dimension of costs analysis.

Question 20

The required rate of return is the minimum acceptable percentage return on an investment before taking into account the risk of the investment.

Question 21

The time value of money refers to the concept that

A) saving money has value for the business.
B) both time and money are valuable resources to any organization.
C) money invested today will grow.
D) the value of a monetary unit today is worth less than the same unit in the future.
E) the value of a monetary unit today is worth more than the same unit in the future.

Question 22

What is the net present value (rounded to the nearest thousand) of the investment assuming the required rate of return is 24 percent? Would Hawkeye Cleaners want to purchase the new machine?

A) $57,000; yes
B) $(57,000); no
C) $(3,000); no
D) $29,000; yes
E) $(13,000); no

Question 23

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
What is the net present value of the investment?

A) $(25,540)
B) $39,579
C) $34,507
D) $44,000
E) $18,115

Question 24

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
Easton Ltd. is considering investing in a new piece of machinery for its factory. The machine costs $340,000 and is expected to last 7 years. It estimates that annual cash flows would be $82,000 and the equipment would have a salvage value of $13,000. The company's hurdle rate is 11%. What is the NPV of this investment? (Ignore income taxes.)

A) $87,625
B) $46,400
C) $52,660
D) $234,000
E) $247,000

Question 25

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
Investment A requires a net investment of $600,000. The required rate of return is 10 percent for the three-year annuity. What are the annual cash inflows if the net present value equals 0?

A) $184,842
B) $241,269
C) $249,791
D) $271,316
E) $360,000

Question 26

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of $950,000. The investment is expected to generate $350,000 in annual cash flows for a period of four years. The required rate of return is 14%. The old machine can be sold for $50,000. 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) $119,550; yes
B) $69,550; no
C) $1,019,550; yes
D) $326,750; no
E) $500,000; yes

Question 27

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
Project ABC is under consideration. Annual cash flows equal $50,000 per year for 5 years. During the first three years the required rate of return is 2 percent. The required rate of return for cash flows in the final two years is 10 percent. What is the present value of cash inflows?

A) $250,000
B) $247,730
C) $235,650
D) $209,391
E) $203,642

Question 28

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
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 $150,000. The annual cost savings if the new machine is acquired will be $40,000. The machine will have a 5-year life, at which time the terminal disposal value is expected to be $20,000. 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) $1,632
B) $12,418
C) $14,050
D) $150,000
E) $70,000

Question 29

The first step in the capital budgeting decision process model is to

A) establish assumptions common for each potential capital investment.
B) obtain appropriate sources of financing for investments.
C) identify capital expenditures relevant to accomplishing strategic goals.
D) manage the control of non-quantitative factors.
E) analyze the present value of future cash inflow and outflow and relevant qualitative factors.

Question 30

Which of the following statements about the net present value method is true?

A) Projects with higher net present values are preferred when all other factors are equal.
B) Projects with negative NPV are acceptable, if no positive NPV projects are available.
C) It focuses on operating income.
D) The origination of cash flows is not important in the analysis.
E) Acceptable projects are those with the highest discount rate.

Question 31

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
Wagner Ltd. is considering investing in a new piece of equipment for its factory. It estimates that annual cash flows would be $17,000 and the equipment would last for 8 years. The company's required rate of return is 12%. What is the most that the company should be willing to invest in this equipment? (Ignore income taxes.)

A) $84,450
B) $136,000
C) $61,280
D) $128,115
E) $94,580

Question 32

Shirt Company wants to purchase a new cutting machine for its sewing plant. The investment is expected to generate annual cash inflows of $300,000 recognized at the end of each year. The required rate of return is 12 percent and the new machine is expected to last for 4 years. What is the maximum dollar amount Shirt Company would be willing to spend for the machine?

A) $507,000
B) $720,600
C) $791,740
D) $911,205
E) $957,600

Question 33

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
Weston Ltd. is considering investing in a new piece of equipment for its factory. It estimates that the machine will generate an additional $120,000 per year in revenues. The contribution margin on these incremental revenues is estimated at 40%. Incremental annual fixed costs are estimated to be $8,200. The equipment would have a salvage value of $14,000 at the end of 6 years. The company's required rate of return is 13%. What is the NPV of this investment if the equipment costs $250,000? (Ignore income taxes.)

A) $2,800
B) ($51,393)
C) $204,803
D) $11,768
E) ($84,173)

Question 34

In capital budgeting analysis, opportunity considers as a minimum

A) sources of internally generated cash flow.
B) the profit gained from choosing the next best investment.
C) the profit lost from choosing the next best investment.
D) interest foregone on risk-free investments.
E) lost sales during the analysis phase.

Question 35

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) after tax cost of debt.
E) coupon interest rate on the firm's debt.

Question 36

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
Use the following information to determine which machine to purchase based on net present value. Cost of capital is 10 percent.

A) purchase machine 3
B) purchase machine 2
C) purchase machine 1
D) purchase any of the three machines
E) purchase all three machines

Question 37

What is the net present value (rounded to the nearest thousand) of the investment assuming the required rate of return is 10 percent? Would Hawkeye Cleaners want to purchase the new machine?

A) $112,000; yes
B) $52,000; yes
C) $(52,000); no
D) $(67,000); no
E) $127,000; yes

Question 38

When the net present value method is used, only projects with ________ are ________.

A) negative net present value; acceptable
B) negative net future value; not acceptable
C) positive net future value; acceptable
D) positive net present value; acceptable
E) positive net value; not acceptable

Question 39

In selecting capital projects, organizations choose

A) the alternative that matches the RRR.
B) the alternative that has revenues that exceed its costs.
C) the alternative that has the highest revenues.
D) the alternative that has the longest time horizon, but also exceeds the RRR.
E) the alternative that provides benefits that exceed predicted costs by the greatest amount.

Question 40

Which of the following results of net present value analyses is the least acceptable?

A) $(15,000)
B) $(1,000)
C) $12,000
D) $0
E) $20,000

Question 41

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 42

Projects with shorter paybacks always generate more cash flows.

Question 43

The payback method measures the time required to recoup the total dollars invested in the project through cash inflows.

Question 44

The primary advantage of the internal rate of return method is that the end result of the computation is in dollars instead of percentages.

Question 45

The net present value method is extremely useful when an organization does not require the same rate of return each year of the project.

Question 46

If the net present value analyses of a project resulted in a positive value and the company does not accept the project, it may be assumed that

A) qualitative factors outweigh the benefit of the investment.
B) An alternative project has a lower NPV.
C) the net initial investment cannot be recovered.
D) the return is greater than that required by the company.
E) quantitative factors outweigh the benefit of the investment.

Question 47

If the internal rate of return is less than the hurdle rate, the net present value of the project will be negative.

Question 48

The accrual accounting rate of return is an accounting measure of income divided by an accounting measure of investment.

Question 49

Lion Enterprises Inc. is evaluating 3 investment alternatives. Each alternative requires a cash outflow of $102,000. The cash inflows are summarized below (ignore taxes):
The company has a required rate of return of 9%.
Required:
Evaluate and rank each alternative using net present value (NPV).

Question 50

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

Question 51

Briefly describe the processes in the Capital Budgeting Decision Process Model.

Question 52

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 53

The discount rate, hurdle rate, or (opportunity) cost of capital all refer to the

A) required rate of return.
B) internal rate of return.
C) net present value.
D) discounted cash flow.
E) payback period.

Question 54

When all future cash inflows and outflows are discounted to the present using the required rate of return, the method used is

A) capital budgeting.
B) discounted cash flow.
C) net present value.
D) required rate of return.
E) payback method.

Question 55

The payback method allows for managers to highlight liquidity.

Question 56

Which of the following is not one of the methods that aid management in analyzing the expected results of capital budgeting decisions?

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

Question 57

The accrual accounting rate-of-return method has a significant weakness for use in making capital budgeting decisions because it does not track cash flows and it ignores the time value of money.

Question 58

The payback method discounts cash flows prior to the payback date.

Question 59

The net present value method can on occasion indicate erroneous decisions as it implicitly assumes that project cash flows can be reinvested at the project's rate of return.

Question 60

Explain capital budgeting, and then briefly discuss each of the six processes of the capital budgeting decision process model?

Question 61

An accounting measure of income divided by an accounting measure of investment is called

A) accrual accounting rate of return.
B) bailout payback.
C) book-value method.
D) rate of return on assets method.
E) net previous value.

Question 62

The net present value method is better than the internal rate of return because

A) managers generally find the NPV method easier to understand.
B) it always yields the same result as IRR.
C) IRR focuses more on accounting income.
D) it considers the source of cash flows.
E) the NPV's of different projects can be added together, and investments may have multiple required rates of return.

Question 63

When the present value of expected cash inflows from a project equals the present value of expected cash outflows of a project, the discount rate is the

A) universal rate.
B) internal rate of return.
C) required rate.
D) net present value rate.
E) inflation rate.

Question 64

Saturn Ltd. wants to automate one of its production processes. The new equipment will cost $180,000. In addition, Saturn will incur installation and testing costs of $5,000 and $8,500 respectively. The expected life of the equipment is 8 years and the salvage value of the equipment is estimated at $18,000. The annual cash savings are estimated at $32,000. The company's required rate of return is 14%. Ignore income taxes. What is the payback period for this investment?

A) 5.63 years
B) 5.78 years
C) 6.05 years
D) 5.26 years
E) The project does not payback.

Question 65

Alberta Ltd. is considering the purchase of new machinery which costs $147,800. The machine is expected to save $42,300 in operating costs annually for the next 7 years. By how much can the annual cost savings fall (to the nearest hundred dollars) and still provide a 16% return? Ignore income taxes.

A) $5,700
B) $36,600
C) $21,200
D) $42,300
E) $0

Question 66

Which of the following is true, concerning NPV?

A) When the NPV is positive, the sum of the cash flows from the project equal the initial investment.
B) When the NPV is negative, the sum of the cash flows from the project must also be negative
C) The project just recovers the initial investment, discounted by the hurdle rate.
D) The IRR is less than the RRR when the NPV is positive, after using the RRR as the discount rate.
E) The project recovers the initial investment and earns a return greater than the RRR.

Question 67

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

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

Question 68

In NPV analysis, if the IRR exceeds the RRR,

A) the project should be rejected.
B) the NPV will be negative (when discounted at the IRR).
C) the NPV is positive when project cash flows are discounted at the IRR.
D) the NPV is positive when project cash flows are discounted at the RRR.
E) the NPV is negative when project cash flows are discounted at the RRR.

Question 69

Saturn Ltd. wants to automate one of its production processes. The new equipment will cost $180,000. In addition, Saturn will incur installation and testing costs of $5,000 and $8,500 respectively. The expected life of the equipment is 8 years and the salvage value of the equipment is estimated at $18,000. The annual cash savings are estimated at $32,000. The company's required rate of return is 14%. Ignore income taxes. What is the net present value of this investment?

A) ($25,246)
B) $80,500
C) ($11,746)
D) ($45,056)
E) ($38,746)

Question 70

Problems encountered when the payback method is used may include

A) it is only useful when future cash flows are certain.
B) it promotes long-term projects.
C) it neglects the time value of money.
D) it emphasizes short-term projects.
E) it is easy to use.

Question 71

Which of the following is False concerning the Payback method of capital budgeting?

A) It uses the accrual accounting rate of return.
B) The payback method highlights liquidity.
C) Its major strength is that it that it is easy to use.
D) It does not project cash flows after the recovery of the initial investment.
E) Shorter payback periods give an organization more flexibility.

Question 72

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.
E) the payback method.

Question 73

A rental company replaces its heavy drilling machine every four years (no salvage value). It is contemplating acquiring a larger machine, at a cost of $70,000, which is guaranteed to last for seven years. The current machine can be traded-in for a $3,000 down payment on the new machine, and the company expects annual savings in operating costs of $15,000. What is the AARR for the new machine?

A) 2.86%
B) 6.85%
C) 7.14%
D) 20.55%
E) 21.43%

Question 74

The net initial investment for a new mainframe computer is $2,000,000. Annual cash flows are expected to increase by $800,000 per year. The equipment has a 10-year useful life. What is the payback period?

A) 4.00 years
B) 2.50 years
C) 2.00 years
D) 1.75 years
E) 0.75 years

Question 75

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
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 1 year and no sales value. The new equipment has a value of $52,650 with a three-year life. The expected additional cash inflows are $25,000 per year, end of year payments. What is the internal rate of return?

A) 24 percent
B) 20 percent
C) 16 percent
D) 12 percent
E) 8 percent

Question 76

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.
E) payback method.

Question 77

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
Brown Corporation recently purchased a new machine for $339,013.20. The new equipment has a useful life of 10 years. Net cash flows will be $60,000 per year, end of year payments. What is the internal rate of return?

A) 10 percent
B) 12 percent
C) 14 percent
D) 16 percent
E) 18 percent

Question 78

Return on investment (ROI) is also known as

A) internal rate of return.
B) accrual accounting rate of return.
C) payback.
D) net present value.
E) time-adjusted rate of return.

Question 79

Use the information below to answer the following question(s).
Wet Water Company drills residential and commercial wells. The company is in the process of analyzing the purchase of a new drill. Information on the proposal is provided below:
Note: Other than the initial investment, cash flows are end of period.
In what range is the internal rate of return?

A) 8 percent to 12 percent
B) 12 percent to 16 percent
C) 16 percent to 20 percent
D) 20 percent to 24%
E) greater than 24%

Question 80

A company is considering two different purchases from a vendor, for a high-speed photocopier. The regular model costs $4,500 and the deluxe model costs $6,100. The company has projected cash savings of $800 for the first year, and then $850 annually thereafter for the regular model, but the vendor is claiming that the deluxe model is $400 cheaper per year to operate than the regular model. What are the payback periods for the Regular and Deluxe models, respectively?

A) 4.88 years; 5.63 years
B) 5.08 years; 5.29 years
C) 5.29 years; 4.88 years
D) 5.29 years; 5.63 years
E) 5.35 years; 4.92 years