Deck 20: Capital Budgeting: Methods of Investment Analysis

Question 1

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

Answer 1

False

Question 2

Financing opportunities are always investigated prior to the formal analyses of the costs and benefits of various investments.

Answer 2

False

Question 3

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

Answer 3

True

Question 4

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

Question 5

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

Question 6

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

Question 7

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 potential capital investments that agree with the organization's strategy.
D)Manage the control of non-quantitative factors.
E)Analyze the present value of future cash inflow and outflow and relevant qualitative factors.

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 with regard to specific qualitative factors that could be considered?

Question 9

Sources of funding for capital projects include the proceeds of debt and equity securities sold in capital markets as well as internally generated cash.

Question 10

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 11

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

A)Determine which investment yields the greatest benefit and the least cost to the organization.
B)Track realized cash flows,compare against estimated numbers,and revise plans if necessary.
C)Forecast all potential cash flows attributable to the alternative projects.
D)Manage the control of non-quantitative factors.
E)Identify potential capital investments that agree with the organization's strategy.

Question 12

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 13

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

Question 14

Opportunity cost is a cost of capital for which of the following sources of funds?

A)common shares
B)short-term debt sold at a discount
C)long-term debt
D)internally generated cash flow
E)preferred shares

Question 15

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

Question 16

Explain capital budgeting,and list each of the five steps of the capital budgeting decision process model.Include both phases for step five.

Question 17

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 18

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 19

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 20

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

Question 21

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 22

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 23

Discounted cash flow methods focus on operating income.

Question 24

What is the net present value for the Wet Water Company's new drill?

A)$96,000
B)$1,722.83
C)$12,651.05
D)$23,579.26
E)$34,507.48

Question 25

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 26

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

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.The working capital is returned at the end of the investment period.
In what range is the internal rate of return for the Wet Water Company's new drill?

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 28

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 29

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

Question 30

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

Question 31

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 32

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

Question 33

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 34

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 35

The internal rate of return method may result in erroneous decisions when used to compare mutually exclusive projects with unequal lives or unequal levels of initial investment.

Question 36

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 37

An advantage of the internal rate of return method is that it can be used when the required rate of return varies over the life of the project.

Question 38

The required rate of return is the minimum acceptable percentage return on an investment and is set by the suppliers of investment funds.

Question 39

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 40

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 41

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 42

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 43

Use the information below to answer the following question(s).
Neptune Ltd.wants to expand its operations by manufacturing a new product line.New equipment will cost $225,000.Incremental sales are estimated at $150,000 per year for 6 years.Variable costs of producing the new product line are 52% of sales and incremental annual fixed costs are $25,000.The equipment can be salvaged after 6 years for 16% of its original cost.The company's required rate of return for new projects is 18%.Ignore income taxes.
What is the internal rate of return of the Neptune Ltd.investment?

A)13.62%
B)12.75%
C)10.00%
D)6.86%
E)18.00%

Question 44

Use the information below to answer the following question(s).
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 of now,it may be sold for $30,000.The new machine will cost $200,000,an additional cash investment in working capital of $60,000 will be required and will be returned at the end of the project.The machine is expected to last 3 years and has an estimated disposal value at that time of $20,000.The new machine will reduce the average amount of time required to wash clothing and will decrease labour costs.The investment is expected to net $50,000 in additional cash inflows during the year of acquisition and $150,000 each additional year of use.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.
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 45

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 46

Use the information below to answer the following question(s).
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 of now,it may be sold for $30,000.The new machine will cost $200,000,an additional cash investment in working capital of $60,000 will be required and will be returned at the end of the project.The machine is expected to last 3 years and has an estimated disposal value at that time of $20,000.The new machine will reduce the average amount of time required to wash clothing and will decrease labour costs.The investment is expected to net $50,000 in additional cash inflows during the year of acquisition and $150,000 each additional year of use.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.
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 47

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 48

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 49

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 50

Use the information below to answer the following question(s).
Neptune Ltd.wants to expand its operations by manufacturing a new product line.New equipment will cost $225,000.Incremental sales are estimated at $150,000 per year for 6 years.Variable costs of producing the new product line are 52% of sales and incremental annual fixed costs are $25,000.The equipment can be salvaged after 6 years for 16% of its original cost.The company's required rate of return for new projects is 18%.Ignore income taxes.
What is the net present value of the Neptune Ltd.investment?

A)($26,291)
B)($47,277)
C)$225,536
D)($60,613)
E)$93,000

Question 51

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 52

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 53

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 54

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 55

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 56

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)When the NPV is positive,the project recovers the initial investment and earns a return greater than the RRR.

Question 57

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.

Question 58

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 59

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 60

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 61

Toys and Junk Company is evaluating a capital expenditure proposal that requires an initial investment of $16,004 and has predicted cash inflows of $4,000 per year for 15 years.It will have no salvage value.
Required:
a.Using a required rate of return rate of 14 percent,determine the net present value of the investment proposal.
b.Determine the proposals internal rate of return.

Question 62

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 63

Anderson Equipment Manufacturing produces equipment for the natural gas industry.The company management is considering purchasing new controllers for the fabricating machines.The new controllers are expected to increase efficiency and product quality.The engineering staff estimate that annual net cash savings from increased efficiency will be $35,000 per year for four years.The existing controllers can be sold for $8,000.The new controllers have a purchase price of $75,000 and will require installation costs in the amount of $4,500.The annual software contract for the new controllers is $1,700;the controllers will be depreciated using the straight-line method.The salvage value of the new controllers at the end of four years is estimated to be $10,000.The company has a required rate of return of 15%.
Required:
a.Determine the net present value of the investment in the new controllers.
b.Calculate the internal rate of return of the investment in the new controllers.

Question 64

The Income Tax Act does not permit a company to deduct depreciation expense in the calculation of taxable income.

Question 65

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 which 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 the probable cause(s)of the comparable differences.

Question 66

Mercury Ltd.is considering purchasing laser equipment for $72,000.The machine will require additional working capital of $8,000.Its anticipated seven-year life will generate additional revenue of $31,000 annually with operating costs,excluding depreciation,of $14,000.At the end of seven years it will have a salvage value of $9,760 and return $8,000 in working capital.
Required:
a.If the company has a required rate of return of 12 percent,what is the net present value of the proposed investment?
b.What is the internal rate of return?

Question 67

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 net present value 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 68

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 69

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 70

After-tax savings from an operating cash inflow are calculated by multiplying the cash flow by (1 - t),where t = the tax rate.

Question 71

What conflicts can arise between using discounted cash flow methods for capital budgeting decisions and accrual accounting for performance

Question 72

Next Service Centre 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 73

Use the following information to determine which machines 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 machines 2 and 3
E)purchase machines 1 and 3

Question 74

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 75

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.Income taxes are not considered.What is the net present value of the investment?

A)$119,799
B)$69,799
C)$1,019,550
D)$326,750
E)$500,000

Question 76

A capital investment project typically has three categories of cash flows: (1)net initial investment; (2)cash flow from operations;and (3)terminal disposal and recovery of investment(s)
Required:
Complete the following list of components for each category:
Net initial investment
1.cost of asset acquisition
2.________
3.________
Cash flow from operations
1.________
2.________
Terminal disposal and recovery of investment(s)
1.________
2.________

Question 77

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 net present value of the project?

A)$1,632
B)$12,418
C)$14,050
D)$150,000
E)$16,050

Question 78

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 net present value of this investment? (Ignore income taxes. )

A)$87,625
B)$46,400
C)$52,662
D)$234,000
E)$247,000

Question 79

The Zero Machine Company is evaluating a capital expenditure proposal that requires an initial
investment of $20,960 and has predicted cash inflows of $5,000 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 proposals internal rate of return.

Question 80

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