Deck 21: Capital Budgeting and Cost Analysis

Question 1

Which of the following methods utilizes discounted cash flows when analyzing potential capital expenditures?
Methods:
1)Accrual accounting rate-of-return
2)Internal Rate of Return (IRR)
3)Payback Period
4)Net Present Value (NPV)

A)1 only
B)1 and 2
C)1 and 3
D)2 and 4

Answer 1

D

Question 2

Which of the following is a stage of the capital budgeting process that determines which investment
Yields the greatest benefit and the least cost to an organization?

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

Answer 2

A

Question 3

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

Answer 3

Capital budgeting is long-run planning for investment projects that usually have a life that is greater than one year.
Stage 1 of a capital budgeting project is the identify projects stage in which a firm determines which types of capital investments are necessary to accomplish organization objectives and strategies.Stage 2 is the obtain information stage in which a firm gathers information from all parts of the value chain to analyze alternative projects.Stage 3 is the make predictions stage in which the firm forecasts all potential cash flows attributable to the alternative projects.Stage 4 is the make decisions by choosing among alternatives stage in which the firm determines which investment yields the greatest benefit and the least cost to the organization.Stage 5 is the implement the decision,evaluate performance,and learn stage that is further separated into two sub stages: (1)obtain funding and make the investments selected in the stage 4 process,and (2)track the realized cash flows,compare against the forecast numbers,and revise plans if necessary.

Question 4

Which of the following is a stage of the capital budgeting process that indicates potential capital investments that agree with an organization's strategy?

A)identify projects stage
B)make predictions stage
C)obtain information stage
D)implement the decision,evaluate performance,and learn stage

Question 5

List the capital budgeting methods used to analyze financial information.

Question 6

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

A)capital budgeting
B)working capital management
C)master budgeting
D)capitalization

Question 7

Which of the following is the first stage to the capital budgeting process?

A)forecast all potential cash flows attributable to the alternative projects
B)determine which investment yields the greatest benefit and the least cost to the organization
C)obtain funding and make the investments selected
D)identify potential capital investments that agree with the organization's strategy

Question 8

In the "Identify projects" stage of capital budgeting,companies gather information from all parts of the value chain to evaluate alternative projects.

Question 9

In the "make predictions" stage of the capital budgeting process,a company forecasts all potential net income additions those are attributable to the alternative projects.

Question 10

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

Question 11

Which of the following is a stage of the capital budgeting process during which a plant manager is queried for assembly time?

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

Question 12

Which of the following is a stage of the capital budgeting process in which a firm obtains funding for the project?

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

Question 13

Capital budgeting is both a decision making and control tool.Which of the following is an example of capital budgeting as a control tool?

A)A company uses capital budgeting techniques to evaluate a group of prospective alternative projects.
B)A large manufacturer sets up a "capital relief" fund to help supplement sustainability projects that would not meet targeted rates of returns without the capital relief fund assistance.
C)When considering capital expenditures,a company looks at a minimum of six potential (alternative)projects.
D)A company's capital project is not meeting the level of profitability expected,will not meet the targeted NPV,and is abandoned.

Question 14

A capital budget spans only a one-year period.

Question 15

Which of the following is a stage of the capital budgeting process that forecasts all potential cash flows attributable to the alternative projects?

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

Question 16

In the "make decisions by choosing among alternatives" stage of the capital budgeting process,a company determines which investment yields the greatest benefit and the least cost to the organization.

Question 17

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 18

In the "obtain information" stage of capital budgeting,a company gathers information from all parts of the value chain to evaluate alternative projects.

Question 19

The accrual accounting rate-of-return method is a discounted cash flow approach to analyzing possible capital budget expenditures.

Question 20

Which of the following is a stage of the capital-budgeting process that tracks realized cash flows and compares those against estimated numbers?

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

Question 21

If the net present value for a project is positive,which of the following is true?

A)the project should be accepted because its expected rate of return is greater than the cost of capital
B)its internal rate of return is more than its cost of capital
C)its expected rate of return is below the required rate of return
D)its internal rate of return is less than its cost of capital

Question 22

Which of the following methods is described as follows: "It 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"?

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

Question 23

The net present value method focuses on ________.

A)cash flows and required rate of return
B)inventory cost and cost of capital
C)working capital and cost of capital
D)operating income and required rate of return

Question 24

Assume your goal in life is to retire with 1 million dollars.How much would you need to save at the end of each year if investment rates average 5% and you have a 16-year work life?

A)$3125
B)$42,270
C)$458,112
D)$125,000

Question 25

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)it results in high payback period

Question 26

Difend 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 $100,000.The new machine will cost $430,000 and an additional cash investment in working capital of $100,000 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 $140,000 in additional cash inflows during the first year of acquisition and $270,000 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 9%? Would the company want to purchase the new machine?

A)$(208,440);yes
B)$(134,160);no
C)$134,160;yes
D)$208,440;no

Question 27

Diemia Hospital has been considering the purchase of a new x-ray 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 $170,000.The new machine will cost $700,000 and an additional cash investment in working capital of $115,000 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 $150,000 in additional cash inflows during the year of acquisition and $180,000 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 9%? Would the hospital want to purchase the new machine?

A)$(27,510);no
B)$117,000 no
C)$27,510;yes
D)$117,000;yes

Question 28

Which of the following is another term for required rate of return?

A)hurdle rate
B)total cost rate
C)variance rate
D)predetermined overhead rate

Question 29

Assume your goal in life is to retire with $2,800,000.How much would you need to save at the end of each year if interest rates average 10% and you have a 30-year work life? (Round the final answer to the nearest whole dollar. )

A)$9333
B)$17,022
C)$186,667
D)$160,464

Question 30

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 31

Forge Company wants to purchase a new cutting machine for its sewing plant.The investment is expected to generate annual cash inflows of $140,000.The required rate of return is 10% and the current machine is expected to last for seven years.Of the following choices,which is the dollar amount the company would be willing to spend for the machine,assuming its life is also seven years? Income taxes are not considered.

A)$1,328,180
B)$882,000
C)$702,660
D)$681,520

Question 32

Diemia 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 $120,000.The new machine will cost $650,000 and an additional cash investment in working capital of $105,000 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 $130,000 in additional cash inflows during the year of acquisition and $110,000 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 16%? Would the hospital want to purchase the new machine?

A)$112,060,yes
B)-$257,620;no
C)-$257,620;yes
D)$52,360;yes

Question 33

Upon which of the following items does discounted cash flow methods for capital budgeting focus?

A)cash inflows and required rate of return
B)operating income and required rate of return
C)operating income and cost of capital
D)working capital and cost of capital

Question 34

Net present value is calculated using which of the following?

A)internal rate of return
B)required rate of return as a discount rate
C)risk-free rate
D)predetermined overhead cost rate

Question 35

Concose Park Department is considering a new capital investment.The cost of the machine is $280,000.The annual cost savings if the new machine is acquired will be $165,000.The machine will have a 3-year life and the terminal disposal value is expected to be $35,000.There are no tax consequences related to this decision.If Concose Park Department has a required rate of return of 14%,which of the following is closest to the present value of the project?

A)$190,880
B)$87,750
C)$126,755
D)$103,130

Question 36

An annuity is ________.

A)a noncash expense
B)a series of equal cash flows at equal time intervals
C)an investment product whose funds are invested in the stock market
D)a rate at which an investment's present value of all expected cash inflows equals the present value of project's expected cash outflows.

Question 37

Which of the following capital budgeting methods uses discounted cash flows?

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

Question 38

Difend 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 $170,000.The new machine will cost $360,000 and an additional cash investment in working capital of $170,000 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 $130,000 in additional cash inflows during the first year of acquisition and $290,000 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 6%? Would the company want to purchase the new machine?

A)$264,290;yes
B)$243,489.592;yes
C)$($243,489.592);no
D)$($264,290);no

Question 39

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 10-year work life?

A)$15,000
B)$1,841,740
C)$238,512
D)$600,000

Question 40

Which of the following projects is rejected on the basis of net present value method?

A)Project A with an NPV of $10,000
B)Project B with an NPV of $(15,000)
C)Project C with an NPV of $21,000
D)Project D with an NPV of $1200

Question 41

Investment A requires a net investment of $604,021 The required rate of return is 12% for the three-year annuity.What are the annual cash inflows if the net present value equals 0? (rounded)

A)$2,416,084
B)$251,466
C)$604,016
D)-$1,812,063

Question 42

Hypore Darby Park Department is considering a new capital investment.The following information is available on the investment.The cost of the machine will be $348,400.The annual cost savings if the new machine is acquired will be $80,000.The machine will have a 6-year life,at which time the terminal disposal value is expected to be zero.Hypore Park Department is assuming no tax consequences.What is the internal rate of return for Hypore Park Department?

A)5%
B)10%
C)9%
D)11%

Question 43

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 five years and the new equipment will cost $99,825 with a five-year life.The expected additional cash inflows are $25,000 per year.What is the internal rate of return?

A)8%
B)12%
C)6%
D)4%

Question 44

The net present value method assumes that project cash flows can be reinvested at the company's ________.

A)internal rate of return
B)required rate of return
C)growth rate
D)accounting rate of return

Question 45

The NPV method is the preferred method over IRR for selecting projects because ________.

A)its result is expressed in dollars and management can make an assessment as to its financial impact on the value of the business
B)it accounts for the time value of money better than IRR
C)it assumes that cash flows are reinvested at the internal rate of return for each and every year of the useful life
D)it gives a project ranking consistent with that of IRR

Question 46

The internal rate of return method assumes that project cash flows can be reinvested at the project's ________.

A)internal rate of return
B)required rate of return
C)growth rate
D)accounting rate of return

Question 47

The Comil Corporation recently purchased a new machine for its factory operations at a cost of $328,325.The investment is expected to generate $115,000 in annual cash flows for a period of four years.The required rate of return is 13%.The old machine has a remaining life of four years.The new machine is expected to have zero value at the end of the four-year period.The disposal value of the old machine at the time of replacement is zero.What is the internal rate of return?

A)12%
B)13%
C)14%
D)15%

Question 48

Diamond 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 eight years and the new equipment will cost $141,969 with a eight-year life.The expected additional cash inflows are $37,000 per year.What is the internal rate of return?

A)13%
B)15%
C)20%
D)23%

Question 49

In situations where the required rate of return is not constant for each year of the project,it is advantageous to use ________.

A)the nominal rate-of-return method
B)the internal rate-of-return method
C)the net present value method
D)the projected income method

Question 50

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 51

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 52

The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of $380,000.The investment is expected to generate $225,000 in annual cash flows for a period of four years.The required rate of return is 10%.The old machine can be sold for $30,000.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)$363,025;yes
B)$22,500;no
C)$350,000;yes
D)$375,650;no

Question 53

Which of the following is an advantage of internal rate of return method?

A)Sum of IRRs of individual projects gives an IRR of a combination or portfolio of projects.
B)The percentage returns computed under the IRR method are easy to understand and compare.
C)It can be expressed as a unique number.
D)It can be used when the required rate of return varies over the life of a project.

Question 54

A general rule in capital budgeting is that a project is accepted only if the internal rate of return equals or ________.

A)exceeds the required rate of return
B)exceeds the inflation rate
C)exceeds the risk-free rate
D)exceeds the accrual accounting rate of return

Question 55

Midize 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 will cost $61,392 with a eight-year life.The expected additional cash inflows are $16,000 per year.What is the internal rate of return?

A)17%
B)20%
C)22%
D)27%

Question 56

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 method

Question 57

Forise 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)-$188,000
B)$12,100
C)$290,000
D)$200,100

Question 58

Which of the following best describes the internal rate-of-return (IRR)method?

A)it calculates the discount rate at which an investment's present value of the total of all expected cash inflows equals the present value of its expected cash outflows.
B)it calculates the discount rate at which an investment's future value of all expected cash inflows equals the present value of its expected cash outflows.
C)it calculates the discount rate at which an investment's total of all expected cash inflows equals the present value of its expected cash outflows.
D)it calculates the discount rate at which sum of an investment's present value of all expected cash inflows equals the present value of its expected cash outflows.

Question 59

Which of the following best explains why the net present value method of capital budgeting is preferred over the internal rate-of-return method?

A)the net present value method is expressed as a percentage of initial investment
B)the net present values of individual projects can be added to determine the effects of accepting a combination of projects
C)the percentage return computed under the net present value method is very easy to compare
D)the calculation under the net present value method is easy as it does not use time value of money

Question 60

Locil Corporation recently purchased a new machine for $307,890 with a eight-year life.The old equipment has a remaining life of eight years and no disposal value at the time of replacement.Net cash flows will be $90,000 per year.What is the internal rate of return?

A)24%
B)29%
C)33%
D)37%

Question 61

Malive Park Department is considering a new capital investment.The following information is available on the investment.The cost of the machine will be $179,000.The annual cost savings if the new machine is acquired will be $35,000.The machine will have a 10-year life,at which time the terminal disposal value is expected to be zero.Malive Park is assuming no tax consequences.Malive Park has a 14% required rate of return.What is the payback period for the investment?

A)4)1 years
B)5)1 years
C)10.0 years
D)10.2 years

Question 62

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

Question 63

Discounted cash flow methods of evaluating capital expenditures focuses on the operating income as calculated under accrual accounting rules.

Question 64

Flilane 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 65

The discount rate used to calculate the NPV should be the interest rate that the company could borrow at to finance the proposed capital project.

Question 66

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 67

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 68

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 69

The Enor Machine Company is evaluating a capital expenditure proposal that requires an initial investment of $99,360 and has predicted cash inflows of $20,000 per year for 8 years.It will have no salvage value.
Required:
a.Using a required rate of return of 10%,determine the net present value of the investment proposal.
b.Determine the proposal's internal rate of return.

Question 70

If internal rate of return is less than required rate of return,the net present value is positive.

Question 71

Managers prefer projects with higher IRRs to projects with lower IRRs,if all other things are equal.

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 net initial investment for a piece of construction equipment is $2,900,000.Annual cash inflows are expected to increase by $500,000 per year.The equipment has an 10-year useful life.What is the payback period?

A)10.00 years
B)7)40 years
C)5)80 years
D)4)80 years

Question 74

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 75

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 76

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

Question 77

Which of the following methods is described as 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?

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

Question 78

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

Question 79

Discounted cash flow methods do not consider the present value of the cash flows after the recovery of the initial investment.

Question 80

The payback method of capital budgeting approach to an investment decision ________.

A)considers cash flows over the life of the investment
B)assumes that cash flows occur uniformly throughout the year
C)considers time value of money
D)ignores the initial investment