Ch 11

Question 1

Capital budgeting is used to evaluate the purchase of:

Answer 1

a machine

Question 2

List the steps involved in capital budgeting process, with the first step on top.

Answer 2

Submit proposal
Evaluate proposal
Approve or reject proposals

Question 3

All of the following are cash flows over the life of an asset except:

Answer 3

depreciation

Question 4

An investment’s … period is the expected time to recover the initial investment amount.

Answer 4

payback

Question 5

A company is considering two capital investments. Each requires an initial investment of $15,000 and has a 4 year useful life. Investment A has expected cash inflows of $5,000 each year for the 4 years for total cash inflows of $20,000. Investment B has the following expected cash flows: Year 1: $8,000; Year 2: $6,000; Year 3: $4,000; Year 4: $2,000; Total cash flows: $20,000. Calculate the payback period for Investment A.

Answer 5

3 years
Reason: $15,000 / $5,000 = 3 years.

Question 6

The process of evaluating and planning for long-term investments is called … budgeting.

Answer 6

capital

Question 7

A company is considering two capital investments. Each requires an initial investment of $15,000 and has a 4 year useful life. Investment A has expected cash inflows of $5,000 each year for the 4 years for total cash inflows of $20,000. Investment B has the following expected cash flows: Year 1: $8,000; Year 2: $6,000; Year 3: $4,000; Year 4: $2,000; Total cash flows: $20,000. Calculate the payback period for Investment B.

Answer 7

2.25 years
HOW

Question 8

Characteristics of capital budgeting include: (Check all that apply.)

Answer 8

long-term investment

large amount of money is involved

outcome is uncertain

Question 9

A company is considering two capital investments. Each requires an initial investment of $15,000 and has a 4 year useful life. Investment A has expected cash inflows of $5,000 each year for the 4 years for total cash inflows of $20,000. Investment B has the following expected cash flows: Year 1: $8,000; Year 2: $6,000; Year 3: $4,000; Year 4: $2,000; Total cash flows: $20,000. Using the payback period as the evaluation method, which investment should be chosen by management?

Answer 9

Investment B
Shortest payback

Question 10

Place the following cash flows in the order that they would occur in a capital investment:

Answer 10

Acquisition
Use
Disposal

Question 11

The formula to calculate the accounting rate of return is:

Answer 11

annual income/average investment

Question 12

The capital budgeting evaluation method that measures the expected amount of time to recover the initial investment amount is the:

Answer 12

payback period.

Question 13

Assume straight-line depreciation. A company plans to purchase machinery costing $1,000,000 with salvage value of $200,000 after 4 years. Annual income is expected to be $40,000 during the 4 years. Calculate the accounting rate of return. Round your answer to the nearest tenth of a percent.

Answer 13

6.7 %
Reason: Average investment = (1,000,000 + 200,000)/2 = 600,000. $40,000/600,000 = 6.7%

Question 14

A company is considering a capital investment of $45,000 in new equipment which will improve production and increase cash flows by $15,000 per year for 6 years. The payback period is … years.

Answer 14

3 years
45,000÷15,000

Question 15

A company is considering a capital investment of $16,000 in new equipment which will improve production and increase cash flows for the next five years at the following amounts: Year 1: $8,000; Year 2: $6,000; Year 3: $5,000; Year 4: $6,000; Year 5: $5,000. The payback period is … years.

Answer 15

2.4 years.
2+(2,000÷5,000)

Question 16

Weaknesses of the payback period as a capital budgeting evaluation method include that it: (Check all that apply.)

Answer 16

ignores time value of money.

Question 17

Weaknesses of the accounting rate of return as a capital budgeting evaluation method include that it: (Check all that apply.)

Answer 17

ignores time value of money.

does not directly consider cash flows and their timing.

Question 18

If a company uses straight-line depreciation, the average investment is calculated as: (Check all that apply.)

Answer 18

(initial investment + salvage value)/2.

(beginning book value + salvage value)/2.

Question 19

Assume straight-line depreciation and equal cash flows. A company plans to purchase equipment for $25,000. The equipment will have $0 salvage value and increase income by $7,500 annually during its 5-year life. The accounting rate of return is
…%.

Answer 19

60%
(7,500÷(25,000÷2))×100

Question 20

A company’s required rate of return computed as an average of the rate the company must pay to its lenders and investors is called:

Answer 20

hurdle rate

Question 21

A company is considering two capital investments. Each requires an initial investment of $15,000 and has a 4 year useful life. Investment A has expected cash inflows of $5,000 each year for the 4 years for total cash inflows of $20,000. Investment B has the following expected cash flows: Year 1: $8,000; Year 2: $6,000; Year 3: $4,000; Year 4: $2,000; Total cash flows: $20,000. Calculate the payback period for Investment B.

Answer 21

2.25yrs
2+(1,000÷4,000)

Question 22

The accounting rate of return:

Answer 22

does not directly consider cash flows and their timing.

Question 23

An investment that costs $30,000 will produce annual cash flows of $10,000 for 4 years. Using a required return of 8%, the investment will generate (rounded to the nearest dollar) a:

Present Value of 1

Rate

Periods

7%

8%

9%

4

0.7629

0.7350

0.7084

Present Value of an Annuity of 1

Rate

Periods

7%

8%

9%

4

3.3872

3.3121

3.2397

Answer 23

positive NPV of $3,121.
Reason: $10,000 x 3.3121=$33,121. $33,121-$30,000=$3,121.
Or. (10,000×3.3121)−30,000

Bc used pres.value of annuity

Question 24

The formula to calculate the accounting rate of return is:

Answer 24

annual income/average investment

Question 25

The decision rule for NPV includes: (Check all that apply).

Answer 25

if an asset's future net cash flows yield a positive net present value, invest. when comparing projects with similar initial investments and risk, select the one with the highest net present value.

Question 26

A company is evaluating an investment which has an initial investment of $4,000. Annual net cash flows is expected to be $2,000 over the next three years. The company requires a 10% annual return. The present value of an annuity factor for 10% and 3 periods is 2.4869. The present value of $1 factor for 10% and 3 periods is 0.7513. The net present value is $.... (round your answer to the nearest whole dollar).

Answer 26

$974 (2,000×2.4869)−4,000

Question 27

The capital investment evaluation method that subtracts the initial investment from the discounted future net cash flows from the investment at the required rate of return is the:

Answer 27

net present value

Question 28

A company is considering an investment opportunity with a cost of $5,000 that will provide future cash flows of $8,000. The cash flows for the investment for the next 4 years are: $1,000, $1,000, $2,000 and $4,000. Assume a required rate of return of 10%. The NPV is $...... (rounded to nearest dollar). Present Value of 1 Rate Periods 10% 1 0.9091 2 0.8264 3 0.7513 4 0.6830 Present Value of an Annuity of 1 Rate Periods 10% 4 3.1699

Answer 28

$970 ((1,000×0.9091)+(1,000 ×0.8264)+(2,000×0.7513) +(4,000×0.6830))−5,000

Question 29

A company is considering a capital investment of $16,000 in new equipment which will improve production and increase cash flows for the next five years at the following amounts: Year 1: $8,000; Year 2: $6,000; Year 3: $5,000; Year 4: $6,000; Year 5: $5,000. The payback period is ... years.

Answer 29

2.4 years ((16,000−8,000−6,000) ÷5,000)+2

Question 30

The formula to calculate the profitability index is:

Answer 30

present value of net cash flows/initial investment

Question 31

An investment that costs $5,000 will produce annual cash flows of $3,000 for 3 years. Using a required return of 8%, the investment will generate a NPV of $.... (rounded to nearest dollar). Present Value of 1 Rate Periods 7% 8% 9% 1 0.9346 0.9259 0.9174 2 0.8734 0.8573 0.8417 3 0.8163 0.7938 0.7722 4 0.7629 0.7350 0.7084 5 0.7130 0.6806 0.6499 Present Value of an Annuity of 1 Rate Periods 7% 8% 9% 1 0.9346 0.9259 0.9174 2 1.8080 1.7833 1.7591 3 2.6243 2.5771 2.5313 4 3.3872 3.3121 3.2397

Answer 31

2731 (3,000×2.5771)−5,000

Question 32

Consider the following projects: Project A: cost = $30,000, NPV of cash flows = $10,000; Project B: cost = $45,000, NPV of cash flows = $10,000; Project C: cost = $30,000, NPV of cash flows = $20,000; Project D: cost = $40,000, NPV of cash flows = $5,000. Using profitability index as the evaluation method, rank the projects in order of preference with the best choice on top.

Answer 32

Project C (20,000÷30,000 = 0.67) Project A (10,000÷30,000 = 0.33) Project B (10,000÷45,000 = 0.22) Project D (5,000÷40,000 = 0.125)

Question 33

A company has evaluated several projects using net present value. All projects are similar in amount invested and risk. Rank the projects in the order they should be accepted. NPV = $340 NPV = ($615) NPV = $62 NPV = $2,067

Answer 33

NPV = $340: second choice NPV = ($615): not acceptable NPV = $62: third choice NPV = $2,067: first choice

Question 34

The discount rate that results in a net present value of $0 is the:

Answer 34

internal rate of return

Question 35

A company is evaluating an investment which has an initial investment of $15,000. Expected annual net cash flows over four years is $5,000. The company would like to earn a 10% return on the investment. The present value of an annuity factor for 10% and 4 periods is 3.1699. The present value of $1 factor for 10% and 4 periods is 0.6830. The net present value is $.... (round your answer to the nearest whole dollar).

Answer 35

$850 (5,000×3.1699)−15,000

Question 36

Which of the following is the approximate internal rate of return for an investment that costs $45,880 and has net cash flows of $4,000 for 20 years? Present Value of 1 Rate Periods 5% 6% 8% 10% 20 0.3769 0.3118 0.2145 0.1486 Present Value of an Annuity of 1 Rate Periods 5% 6% 8% 10% 20 12.4622 11.4699 9.8181 8.5136

Answer 36

6% 45,880÷4,000 = 11.47 which is closest to the present value annuity rate, period 20, of Rate 6% (which is 11.4699)

Question 37

A company is considering an investment opportunity with a cost of $5,000 that will provide future cash flows of $8,000. The cash flows for the investment for the next 4 years are: $1,000, $2,000, $3,000 and $2,000. Assume a required rate of return of 10%. The NPV is $... (rounded to nearest dollar). Present Value of 1 Rate Periods 10% 1 0.9091 2 0.8264 3 0.7513 4 0.6830 Present Value of an Annuity of 1 Rate Periods 10% 4 3.1699

Answer 37

$1182 ((1,000×0.9091)+(2,000 ×0.8264)+(3,000×0.7513) +(2,000×0.6830))−5,000

Question 38

A company has a hurdle rate of 12%. Using IRR as the evaluation method, determine which projects should be accepted. Project B with IRR 12.5% Project D with IRR -12.5%

Answer 38

Project B with IRR 12.5%: accept Project D with IRR -12.5%: reject

Question 39

It is appropriate to use the profitability index to evaluate investment decisions when:

Answer 39

the amounts invested differ substantially

Question 40

Of the four capital budgeting methods, which ones reflect the time value of money? (Check all that apply).

Answer 40

net present value internal rate of return

Question 41

A company needs to choose between two investment opportunities. Project 1 has a cost of $500,000 and expected NPV of cash flows of $450,000. Project 2 has a cost of $800,000 and expected NPV of cash flows of $750,000. Using profitability index as the evaluation method, the company should choose:

Answer 41

Project 2 because it has a higher index Project 1: 450,000÷500,000 = 0.9 Project 2: 750,000÷800,000 = 0.9375

Question 42

Which of the following are correct statements about the internal rate of return (IRR)? (Check all that apply.)

Answer 42

The higher the IRR, the better. IRR uses the time value of money.

Question 43

Which of the following is the approximate internal rate of return for an investment that costs $12,680 and has net cash flows of $4,000 for 4 years? Present Value of 1 Rate Periods 8% 10% 12% 4 0.7350 0.6830 0.6355 Present Value of an Annuity of 1 Rate Period 8% 10% 12% 4 3.3121 3.1699 3.0373

Answer 43

10% 12,680÷4,000 = 3.17 which is closest to 10% pres Val annuity rate (3.1699)

Question 44

A company is considering two investment projects. Both have an initial cost of $50,000. One project has even cash flows and the other uneven cash flows. Which evaluation method would be most appropriate?

Answer 44

Net present value

Question 45

A predetermined, minimum acceptable rate of return is known as a(n):

Answer 45

hurdle rate

Question 46

A capital investment evaluation method that measures the expected time until the present value of the net cash flows equals the initial investment is:

Answer 46

break-even time

Question 47

Match the capital budgeting method to its specific characteristic. PBP: ARR: NPV: IRR:

Answer 47

PBP: ignores time value of money ARR: Uses income rather than cash flows. NPV: can reflect changes in risk over projects life. IRR: allows comparison of profess of different sizes.

Question 48

A company is evaluating an investment which has an initial investment of $4,000. Annual net cash flows are expected to be $2,000 over the next three years. The company requires a 10% annual return. The present value of $1 factor for 10% and 1 period is 0.9091; 2 periods is 0.8264; and for 3 periods is 0.7513. The break-even time is between:

Answer 48

2 and 3 years Reason: Year 1: $(4,000) - ($2,000 x 0.9091) = $(2,181.80). Year 2: $(2,181.80) - ($2,000 x .8264) = ($529). Year 3: ($529) - ($2,000 x 0.7513) = $973.60. So, they break even between years 2 and 3 at 2.35.

Question 49

Consider the following projects: Project A: cost = $30,000, NPV of cash flows = $10,000; Project B: cost = $45,000, NPV of cash flows = $10,000; Project C: cost = $30,000, NPV of cash flows = $20,000; Project D: cost = $40,000, NPV of cash flows = $5,000. Using profitability index as the evaluation method, rank the projects in order of preference with the best choice on top.

Answer 49

Project C Project A Project B Project D

Question 50

The discount rate that results in a net present value of $0 is the:

Answer 50

internal rate of return

Question 51

A company is considering two similar investment projects. One has an initial cost of $50,000 and the other an initial cost of $450,000. Which evaluation method would be most appropriate?

Answer 51

Internal rate of return

Question 52

A company is considering several investment opportunities. The investments have been evaluated using payback period and break-even time. Only one project will be chosen and time value of money is important. The company should choose the project which the:

Answer 52

shortest break-even time

Question 53

A company is considering a capital investment of $45,000 in new equipment which will improve production and increase cash flows by $15,000 per year for 6 years. The company has a hurdle rate of 10%. The break-even time is approximately: Present Value of 1 at 10%: Period 1: 0.9091; Period 2: 0.8264; Period 3: 0.7513; Period 4: 0.6830; Period 5: 0.6209; Period 6: 0.5645.

Answer 53

3.75 years Reason: ($45,000)-(15,000x.9091)=($31,363).( $31,363)-(15,000x.8264)=($18,967).( $18,967)-(15,000x.7513)=($7,697). $7,697/(15,000x.6830)=.75. 3 years +0.75=3.75 years.

Question 54

A company is evaluating an investment which has an initial investment of $4,000. Annual net cash flows are expected to be $2,000 over the next three years. The company requires a 10% annual return. The present value of $1 factor for 10% and 1 period is 0.9091; 2 periods is 0.8264; and for 3 periods is 0.7513. The break-even time is between:

Question 55

Ch 11. CV

Question 56

An investment has a cost $40,000 with net cash flows of $20,000 each year for 4 years. The company has a required rate of return of 8%. If the first four periods' discount factors, based on 8%, taken from a "present value of 1" table are 0.9259, 0.8573, 0.7938, 0.7350, what is the break-even time of the investment?

Answer 56

Between years 2 and 3

Question 57

Capital budgeting is risky because:

Answer 57

the decision is difficult to reverse

Question 58

Mint Company is considering purchasing a machine with a cost of $10,000 and a useful life of 20 years. Mint expects the machine to produce net annual cash flows of $2,000 each year. What is the cash payback period of the machine?

Answer 58

5 years 10,000÷2,000

Question 59

Jelly Company is considering purchasing a machine with a cost of $20,000 and a useful life of 10 years. Jelly expects the machine to produce net annual cash flows of $2,000 in year 1, $10,000 in year 2, $5,000 in year 3, $12,000 in year 4, and $8,000 in year 5. What is the cash payback period of the machine?

Answer 59

3.25 years ((20,000−(2,000+10,000 +5,000))÷12,000)+3

Question 60

All of the following are strengths of the payback period except:

Answer 60

it ignores the time value of money.

Question 61

Chilly Company is considering investing $110,000 in a new refrigerator, designed to keep food extra crispy. The refrigerator will have a useful life of 10 years, a salvage value of $10,000, and is expected to generate an annual income of $15,000 in each year of its useful life. Chilly will use the straight-line method of depreciation. What is the accounting rate of return?

Answer 61

25% (15,000÷((110,000 +10,000)÷2))×100

Question 62

All of the following are weaknesses of the accounting rate of return except:it is easy to compute.

Question 63

An investment has a cost of $40,000 with net cash flows of $15,000 each year for 4 years. The company has a required rate of return of 8%. If the first four periods' discount factors, based on 8%, from a "present value of 1" table are 0.9259, 0.8573, 0.7938, and 0.7350, what is the net present value of the investment?

Answer 63

$9,680 ((15,000×0.9259) +(15,000×0.8573) +(15,000×0.7938) +(15,000×0.7350)) −40,000

Question 64

If the net present value is greater than zero, the company should:

Answer 64

invest

Question 65

A company is evaluating two separate projects, both with the same $15,000 initial investment. Year Net Cash Flows Project 1 Net Cash Flows Project 2 Present Value of 1 at 10% 1 $ 10,000 $ 20,000 0.9091 2 $ 10,000 $ 7,000 0.8264 3 $ 10,000 $ 3,000 0.7513 What is the net present value of Project 1?

Answer 65

$9,868 ((10,000×0.9091)+(10,000 ×0.8264)+(10,000 ×0.7513))−15,000

Question 66

Salvage value is treated as:

Answer 66

an addition to net cash inflows at the end of the final year.

Question 67

An investment has an initial cost of $40,000, and the present value of net cash flows of $10,000. What is the profitability index?

Answer 67

0.25 10,000÷40,000

Question 68

When internal rate of return is used to evaluate a capital investment, the present value factor is computed as:

Answer 68

initial investment divided by annual net cash flows

Question 69

When internal rate of return is used to evaluate a capital investment, the present value factor is computed as:

Answer 69

initial investment divided by annual net cash flows