Deck 23: Planning for Capital Investments

Question 1

To avoid accepting projects that actually should be rejected, a company should ignore intangible benefits in calculating net present value.

Answer 1

False

Question 2

By ignoring intangible benefits, capital budgeting techniques might incorrectly eliminate projects that could be financially beneficial to the company.

Answer 2

True

Question 3

A post-audit is an evaluation of how well a project's actual performance matches the projections made when the project was proposed.

Answer 3

True

Question 4

One way of incorporating intangible benefits into the capital budgeting decision is to project conservative estimates of the value of the intangible benefits and include them in the NPV calculation.

Question 5

Sensitivity analysis uses a number of outcome estimates to get a sense of the variability among potential returns.

Question 6

Post-audits create an incentive for managers to make accurate estimates, since managers know that their results will be evaluated.

Question 7

The internal rate of return method is, like the NPV method, a discounted cash flow technique.

Question 8

The cash payback technique is a quick way to calculate a project's net present value.

Question 9

A well-run organization should perform an evaluation, called a post-audit, of its investment projects before their completion.

Question 10

The profitability index is calculated by dividing the total cash flows by the initial investment.

Question 11

The capital budgeting committee ultimately approves the capital expenditure budget for the year.

Question 12

The cost of capital is a weighted average of the rates paid on borrowed funds, as well as on funds provided by investors in the company's stock.

Question 13

The interest yield of a project is a rate that will cause the present value of the proposed capital expenditure to equal the present value of the expected annual cash inflows.

Question 14

Capital budgeting decisions usually involve large investments and often have a significant impact on a company's future profitability.

Question 15

The cash payback period is computed by dividing the cost of the capital investment by the net annual cash inflow.

Question 16

Using the net present value method, a net present value of zero indicates that the project would not be acceptable.

Question 17

The cash payback method is frequently used as a screening tool but it does not take into consideration the profitability of a project.

Question 18

For purposes of capital budgeting, estimated cash inflows and outflows are preferred for inputs into the capital budgeting decision tools.

Question 19

The profitability index allows comparison of the relative desirability of projects that require differing initial investments.

Question 20

The net present value method can only be used in capital budgeting if the expected cash flows from a project are an equal amount each year.

Question 21

Which of the following ignores the time value of money?

A)Internal rate of return
B)Profitability index
C)Net present value
D)Cash payback

Question 22

Most of the capital budgeting methods use

A)accrual accounting numbers.
B)cash flow numbers.
C)net income.
D)accrual accounting revenues.

Question 23

The capital budget for the year is approved by a company's

A)board of directors.
B)capital budgeting committee.
C)officers.
D)stockholders.

Question 24

An advantage of the annual rate of return method is that it relies on accrual accounting numbers rather than actual cash flows.

Question 25

Which of the following is a disadvantage of the cash payback technique?

A)It is difficult to calculate
B)It relies on the time value of money
C)It can only be calculated when there are equal annual net cash flows
D)It ignores the expected profitability of a project

Question 26

The corporate capital budget authorization process consists of how many steps?

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

Question 27

The first step in the capital budgeting evaluation process is to

A)request proposals for projects.
B)screen proposals by a capital budgeting committee.
C)determine which projects are worthy of funding.
D)approve the capital budget.

Question 28

All of the following are involved in the capital budgeting evaluation process except a company's

A)board of directors.
B)capital budgeting committee.
C)officers.
D)stockholders.

Question 29

The payback period is often compared to an asset's

A)estimated useful life.
B)warranty period.
C)net present value.
D)internal rate of return.

Question 30

Capital expenditure proposals are initially screened by the

A)board of directors.
B)executive committee.
C)capital budgeting committee.
D)stockholders.

Question 31

The annual rate of return method requires dividing a project's annual cash inflows by the economic life of the project.

Question 32

Capital budgeting decisions depend in part on all of the following except the

A)relationships among proposed projects.
B)profitability of the company.
C)company's basic decision making approach.
D)risks associated with a particular project.

Question 33

Which of the following is not a capital budgeting decision?

A)Constructing new studios
B)Replacing old equipment
C)Scrapping obsolete inventory
D)Remodeling an office building

Question 34

Which of the following is not a typical cash flow related to equipment purchase and replacement decisions?

A)Increased operating costs
B)Overhaul of equipment
C)Salvage value of equipment when project is complete
D)Depreciation expense

Question 35

Net annual cash flow can be estimated by

A)deducting credit sales from net income.
B)adding depreciation expense to net income.
C)deducting credit purchases from net income.
D)adding advertising expense to net income.

Question 36

Capital budgeting is the process

A)used in sell or process further decisions.
B)of determining how much capital stock to issue.
C)of making capital expenditure decisions.
D)of eliminating unprofitable product lines.

Question 37

Using the internal rate of return method, a project is rejected when the rate of return is greater than or equal to the required rate of return.

Question 38

Using the annual rate of return method, a project is acceptable if its rate of return is greater than management's minimum rate of return.

Question 39

A major advantage of the annual rate of return method is that it considers the time value of money.

Question 40

The capital budgeting decision depends in part on the

A)availability of funds.
B)relationships among proposed projects.
C)risk associated with a particular project.
D)All of these answers are correct.

Question 41

If project A has a lower payback period than project B, this may indicate that project A may have a

A)lower NPV and be less profitable.
B)higher NPV and be less profitable.
C)higher NPV and be more profitable.
D)lower NPV and be more profitable.

Question 42

If an asset costs $240,000 and is expected to have a $40,000 salvage value at the end of its ten-year life, and generates annual net cash inflows of $40,000 each year, the cash payback period is

A)7 years.
B)6 years.
C)5 years.
D)4 years.

Question 43

If a payback period for a project is greater than its expected useful life, the

A)project will always be profitable.
B)entire initial investment will not be recovered.
C)project would only be acceptable if the company's cost of capital was low.
D)project's return will always exceed the company's cost of capital.

Question 44

The cash payback technique

A)considers cash flows over the life of a project.
B)cannot be used with uneven cash flows.
C)is superior to the net present value method.
D)may be useful as an initial screening device.

Question 45

Nance Company is considering buying a machine for $90,000 with an estimated life of ten years and no salvage value. The straight-line method of depreciation will be used. The machine is expected to generate net income of $3,000 each year. The cash payback on this investment is

A)15 years.
B)10 years.
C)7.5 years.
D)6 years.

Question 46

Jordan Company is considering the purchase of a machine with the following data: $$\begin{array} { l r } \text { Initial cost } & \$ 150,000 \\\text { One-time training cost } & 12,000 \\\text { Annual maintenance costs } & 15,000 \\\text { Annual cost savings } & 75,000 \\\text { Salvage value } & 20,000\end{array}$$ The cash payback period is

A)2.70 years.
B)2.50 years.
C)2.37 years.
D)2.17 years.

Question 47

Bark Company is considering buying a machine for $240,000 with an estimated life of ten years and no salvage value. The straight-line method of depreciation will be used. The machine is expected to generate net income of $6,000 each year. The cash payback period on this investment is

A)20 years.
B)10 years.
C)8 years.
D)4 years.

Question 48

Which of the following does not consider a company's required rate of return?

A)Net present value
B)Internal rate of return
C)Annual rate of return
D)Cash payback

Question 49

The cash payback technique

A)should be used as a final screening tool.
B)can be the only basis for the capital budgeting decision.
C)is relatively easy to compute and understand.
D)considers the expected profitability of a project.

Question 50

The rate that a company must pay to obtain funds from creditors and stockholders is known as the

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

Question 51

Richman Co. purchased some equipment 3 years ago. The company's required rate of return is 12%, and the net present value of the project was $(900). Annual cost savings were: $10,000 for year 1; $8,000 for year 2; and $6,000 for year 3. The amount of the initial investment was $$\begin{array} { c c c } \text { Year } & \begin{array} { c } \text { Present Value } \\\text { of } 1 \text { at } 12 \%\end{array} & \begin{array} { c } \text { PV of an Annuity } \\\text { of } 1 \text { at } 12 \%\end{array} \\\hline 1 & .893 & .893 \\2 & .797 & 1.690 \\3 & .712 & 2.402\end{array}$$

A)$20,478.
B)$18,316.
C)$20,116.
D)$18,678.

Question 52

When using the cash payback technique, the payback period is expressed in terms of

A)a percent.
B)dollars.
C)years.
D)months.

Question 53

A company is considering purchasing a machine that costs $400,000 and is estimated to have no salvage value at the end of its 8-year useful life. If the machine is purchased, annual revenues are expected to be $100,000 and annual operating expenses exclusive of depreciation expense are expected to be $25,000. The straight-line method of depreciation would be used. The cash payback period on the machine is

A)8.0 years.
B)7.5 years.
C)6.5 years.
D)3.2 years.

Question 54

Brady Corp. is considering the purchase of a piece of equipment that costs $20,000. Projected net annual cash flows over the project's life are: $\begin{array}{cr}\text { Year } & \text { Net Annual Cash Flow } \\2 & \$ 3,000 \\2 & 8,000 \\3 & 15,000 \\4 & 9,000\end{array}$ The cash payback period is

A)2.29 years.
B)2.60 years.
C)2.40 years.
D)2.31 years.

Question 55

Use the following table, $\text { Present Value of an Annuity of } 1$
$\begin{array}{lrrr}\text { Period } & 8 \% & 9 \% & 10 \%\\1 & .926 & .917 & .909 \\2 & 1.783 & 1.759 & 1.736 \\3 & 2.577 & 2.531 & 2.487\end{array}$ A company has a minimum required rate of return of 9%. It is considering investing in a project which costs $350,000 and is expected to generate cash inflows of $140,000 at the end of each year for three years. The net present value of this project is

A)$354,340.
B)$70,000.
C)$35,436.
D)$4,340.

Question 56

Giraldi Company has identified that the cost of a new computer will be $48,000, but with the use of the new computer, net income will increase by $5,000 a year. If depreciation expense is $3,000 a year, the cash payback period is:

A)24.0 years.
B)16.0 years.
C)9.6 years.
D)6.0 years.

Question 57

A disadvantage of the cash payback technique is that it

A)ignores obsolescence factors.
B)ignores the cost of an investment.
C)is complicated to use.
D)ignores the time value of money.

Question 58

Bradshaw Inc. is contemplating a capital investment of $88,000. The cash flows over the project's four years are: $\begin{array}{ccc}\text { Expected Annual }&\text { Expected Annual }\\\text { Year } & \text { Cash Inflows } & \text { Cash Outflows } \\1 & \$ 30,000 & \$ 12,000 \\2 & 45,000 & 20,000 \\3 & 60,000 & 25,000 \\4 & 50,000 & 30,000\end{array}$ The cash payback period is

A)3.59 years.
B)3.50 years.
C)2.37 years.
D)3.20 years.

Question 59

The cash payback period is computed by dividing the cost of the capital investment by the

A)annual net income.
B)net annual cash inflow.
C)present value of the cash inflow.
D)present value of the net income.

Question 60

The discount rate is referred to by all of the following alternative names except the

A)accounting rate of return.
B)cutoff rate.
C)hurdle rate.
D)required rate of return.

Question 61

A project with a zero net present value indicates that it is

A)unacceptable.
B)profitable.
C)acceptable.
D)going to have an acceptable cash payback period.

Question 62

Sloan Inc. recently invested in a project with a 3-year life span. The net present value was $9,000 and annual cash inflows were $21,000 for year 1; $24,000 for year 2; and $27,000 for year 3. The initial investment for the project, assuming a 15% required rate of return, was $$\begin{array} { c c c } \text { Year } & \begin{array} { c } \text { Present Value } \\\text { of } 1 \text { at } 15 \%\end{array} & \begin{array} { c } \text { PV of an Annuity } \\\text { of } 1 \text { at } 15 \%\end{array} \\\hline 1 & .870 & .870 \\2 & .756 & 1.626 \\3 & .658 & 2.283\end{array}$$

A)$45,792.
B)$45,180.
C)$29,232.
D)$38,376.

Question 63

If a company's required rate of return is 10% and, in using the net present value method, a project's net present value is zero, this indicates that the

A)project's rate of return exceeds 10%.
B)project's rate of return is less than the minimum rate required.
C)project earns a rate of return of 10%.
D)project earns a rate of return of 0%.

Question 64

In capital budgeting, intangible benefits should be

A)excluded entirely.
B)included using optimistic estimated values.
C)included using conservative estimated values.
D)included only when benefits are known with certainty.

Question 65

If a project has a salvage value greater than zero, the salvage value will

A)have no effect on the net present value.
B)increase the net present value.
C)increase the payback period.
D)decrease the net present value.

Question 66

A company's discount rate is based on the

A)cost of capital and the internal rate of return.
B)cost of capital and the risk element.
C)cut-off rate and the risk element.
D)cut-off rate and the internal rate of return.

Question 67

When the annual cash flows from an investment are unequal, the appropriate table to use is the

A)future value of 1 table.
B)future value of annuity table.
C)present value of 1 table.
D)present value of annuity table.

Question 68

A negative net present value indicates that the

A)project is acceptable.
B)wrong discount rate was used.
C)project's annual rate of return exceeds the discount rate.
D)present value of the cash inflows was less than the present value of the cash out flows.

Question 69

Johnson Corp. has an 8% required rate of return. It's considering a project that would provide annual cost savings of $50,000 for 5 years. The most that Johnson would be willing to spend on this project is $\begin{array}{llr}\text { Year } & \text { Present Value } & \text { PV of an Annuity } \\&\text { of } 1 \text { at } 8 \% & \text { of } 1 \text { at } 8 \%\\1 & .926 & .926 \\2 & .857 & 1.783 \\3 & .794 & 2.577 \\4 & .735 & 3.312 \\5 & .681 & 3.993\end{array}$

A)$125,910.
B)$165,600.
C)$199,650.
D)$34,050.

Question 70

Using the profitability index method, the present value of cash inflows for Project Flower is $88,000 and the present value of cash inflows of Project Plant is $48,000. If Project Flower and Project Plant require initial investments of $90,000 and $40,000, respectively, and have the same useful life, the project that should be accepted is

A)Project Flower.
B)Project Plant.
C)Either project may be accepted.
D)Neither project should be accepted.

Question 71

Mini Inc. is contemplating a capital project costing $47,019. The project will provide annual cost savings of $18,000 for 3 years and have a salvage value of $3,000. The company's required rate of return is 10%. The company uses straight-line depreciation. $\begin{array}{llr}\text { Year } &\text { Present Value } & \text { PV of an Annuity } \\&\text { of } 1 \text { at } 10 \%&\text { of } 1 \text { at } 10 \%\\1 & .909 & .909 \\2 & .826 & 1.736 \\3 & .751 & 2.487\end{array}$ This project is

A)unacceptable because it earns a rate less than 10%.
B)acceptable because it has a positive NPV.
C)unacceptable because it has a negative NPV.
D)acceptable because it has a zero NPV.

Question 72

The primary capital budgeting method that uses discounted cash flow techniques is the

A)net present value method.
B)cash payback technique.
C)annual rate of return method.
D)profitability index method.

Question 73

A company's cost of capital refers to the

A)rate the company must pay to obtain funds from creditors and stockholders.
B)total cost of a capital project.
C)cost of printing and registering common stock shares.
D)rate of return earned on common stock.

Question 74

When a capital budgeting project generates a positive net present value, this means that the project earns a return higher than the

A)internal rate of return.
B)annual rate of return.
C)required rate of return.
D)profitability index.

Question 75

The discount rate that will result in the lowest net present value for a project is

A)any rate lower that the cost of capital.
B)any rate higher than the cost of capital.
C)the lowest rate used to evaluate the project.
D)the highest rate used to evaluate the project.

Question 76

The discount rate that will result in the highest net present value for a project is

A)any rate lower that the cost of capital.
B)any rate higher than the cost of capital.
C)the lowest rate used to evaluate the project.
D)the highest rate used to evaluate the project.

Question 77

Which of the following will increase the net present value of a project?

A)An increase in the initial investment
B)A decrease in annual cash inflows
C)An increase in the discount rate
D)A decrease in the discount rate

Question 78

Benaflek Co. purchased some equipment 3 years ago. The company's required rate of return is 12%, and the net present value of the project was $(1,800). Annual cost savings were: $20,000 for year 1; $16,000 for year 2; and $12,000 for year 3. The amount of the initial investment was $\begin{array}{llr}& \text { Present Value } & \text { PV of an Annuity } \\\text { Year } & \text { of } 1 \text { at } 12 \% & \text { of } 1 \text { at } 12 \% \\1 & .893 & .893 \\2 & .797 & 1.690 \\3 & .712 & 2.402\end{array}$

A)$40,956.
B)$36,632.
C)$40,232.
D)$37,356.

Question 79

Companies often assume that the risk element in the discount rate is

A)zero.
B)greater that zero.
C)less than zero.
D)known with certainty.

Question 80

The higher the risk element in a project, the

A)more attractive the investment.
B)higher the net present value.
C)higher the cost of capital.
D)higher the discount rate.