Deck 26: Capital Investment Decisions

Question 1

Capital budgeting is the ________.

A)process of planning for investments in long-term assets
B)preparation of the budget for operating expenses
C)process of evaluating the profitability of a business
D)process of making pricing decisions for products

Answer 1

A

Question 2

Which of the following is a capital budgeting method that ignores the time value of money?

A)payback
B)internal rate of return
C)return on assets
D)net present value

Answer 2

A

Question 3

The net present value and internal rate of return methods are appropriate for longer-term investments because they ignore the time value of money.

Answer 3

False

Question 4

The payback method provides management with valuable information about the time period in which the cash invested will be recouped.

Question 5

The payback and accounting rate of return (ARR)methods are suitable for investments with a relatively short time span.

Question 6

The last step in the capital budgeting process is control,which compares the actual results with the projected results.These comparisons are known as ________.

A)net cash inflows
B)post-audits
C)rankings
D)variance analysis

Question 7

A post-audit in capital budgeting is a comparison of the actual results of capital investments with the projected results.

Question 8

An operational asset used for a long period of time is known as a capital asset.

Question 9

List the steps of the capital budgeting process and identify actions that relate to each step.

Question 10

Which of the following best describes a capital budgeting post-audit?

A)an audit of an operating unit of a company
B)an audit performed only at the end of the project's life span
C)an analysis of an investment's cash flows prior to committing to the initial investment
D)a comparison of actual results of capital investments with projected results

Question 11

Which of the following best describes the term "capital rationing"?

A)a method of determining the period within which the cash invested is recouped
B)a process of ranking and choosing among alternative capital investments based on the availability of funds
C)a method which shows the effect of an investment on a company's accrual-based income
D)a process of controlling operating costs when adequate funds are not available

Question 12

The acquisition or construction of a capital asset is known as a capital investment.

Question 13

Two methods of analyzing potential capital investments-payback and accounting rate of return-ignore the time value of money.

Question 14

The payback and accounting rate of return methods are often used to perform an initial screening of investments.

Question 15

Capital rationing is a process adopted when a company has limited resources,and it must find ways to reduce operating expenses in all of its divisions and units.

Question 16

The accounting rate of return shows the effect of the investment on the company's accrual-based income.

Question 17

Which of the following is a capital budgeting method used to screen potential investments?

A)return on assets
B)acid test ratio
C)accounting rate of return
D)debt-to-equity ratio

Question 18

Capital budgeting involves ________.

A)budgeting for yearly operational expenses
B)preparing the sales budget for the coming year
C)evaluating various long-term investments
D)analyzing various alternatives of financing available to a company

Question 19

Which of the following is a capital budgeting method?

A)return on assets
B)net present value
C)inventory turnover
D)return on equity

Question 20

Which of the following two methods are typically used for initial screening of investments,rather than for detailed,in-depth analysis?

A)payback and accounting rate of return
B)net present value and payback
C)internal rate of return and net present value
D)accounting rate of return and net present value

Question 21

Carolina Logistics,Inc.is considering three investment opportunities with the following payback periods: $$\begin{array} { | l | c | c | c | } \hline & \text { Project } X & \text { Project } Y & \text { Project } Z \\\hline \text { Payback period } & 3 \text { years } & 2.5 \text { years } & 2.8 \text { years } \\\hline\end{array}$$ Use the decision rule for payback to rank the projects from most desirable to least desirable,all else being equal.

A)Y,Z,X
B)X,Y,Z
C)Z,Y,X
D)Y,X,Z

Question 22

Cash inflows include future cash revenue generated from an investment and any future residual value of the asset but exclude any future savings in ongoing cash operating costs resulting from the investment.

Question 23

Most capital budgeting methods focus on accrual-based income.

Question 24

Which of the following is NOT part of the capital budgeting process?

A)develop short-term operating strategies
B)identify and analyze potential capital investments
C)apply capital rationing
D)perform post-audits

Question 25

List three cash inflows and three cash outflows for capital investments.

Question 26

The payback method considers cash flows that occur both during and after the payback period.

Question 27

Cash inflows from a capital investment arise from an increase in revenues,a decrease in expenses,or both.

Question 28

All of the following are considered cash inflows except the

A)future cash revenue generated by the investment
B)future savings in ongoing cash operating costs
C)future residual value of the capital investment
D)future additional operating costs of the investment

Question 29

Both the payback and the accounting rate of return methods focus on cash flows that an asset generates.

Question 30

The following details are provided by a manufacturing company: $$\begin{array} { | l | r | } \hline \text { Investment } & \text { Product line } \\\hline \text { Useful life } & \$ 1,100,000 \\\hline \text { Estimated annual net cash inflows for first year } & 12 \text { years } \\\hline \text { Estimated annual net cash inflows for second year } & \$ 400,000 \\\hline \text { Estimated annual net cash inflows for next ten years } & \$ 390,000 \\\hline \text { Residual value } & \$ 380,000 \\\hline \text { Depreciation method } & \$ 70,000 \\\hline \text { Required rate of return } & \text { Straight-line } \\\hline\end{array}$$ Calculate the payback period for the investment.(Round your answer to two decimal places.)

A)2.75 years
B)2.82 years
C)2.55 years
D)2.77 years

Question 31

When projecting future cash flows of an investment ________.

A)cash flows include depreciation
B)cash inflows and outflows are treated separately,rather than being netted together
C)cash flows are projected by accounting personnel without considering input from other departments
D)the initial investment is a significant cash outflow that is treated separately from all other cash flows

Question 32

The payback method is a screening device and is rarely used as the sole method for deciding whether to invest in an asset.

Question 33

Which of the following is NOT a capital budgeting decision?

A)An airline updates its kiosks to allow passengers to self-check-in.
B)A convenience store decides whether to expand its operations in a new location.
C)A hospital decides whether to construct a new pediatric wing.
D)A retail company decides whether to mark down its old inventory.

Question 34

Managers generally use payback as the sole method for deciding whether to invest in an asset.

Question 35

All else being equal,investments with longer payback periods are preferable.

Question 36

Management uses several different methods in evaluating potential capital investments.Identify and briefly discuss the four methods outlined in the text.

Question 37

The payback method uses discounted cash flows to make investment decisions.

Question 38

The payback method is used only when the net cash inflows from a capital investment are the same for each period.

Question 39

Nubela Manufacturing is considering two alternative investment proposals with the following data: $$\begin{array} { | l | r | r | } \hline & \text { Proposal X } & { \text { Proposal Y } } \\\hline \text { Investment } & \$ 10,700,000 & \$ 580,000 \\\hline \text { Useful life } & 5 \text { years } & 5 \text { years } \\\hline \text { Estimated annual net cash inflows for 5 years } & \$ 2,140,000 & \$ 103,000 \\\hline \text { Residual value } & \$ 50,000 & \$ 26,000 \\\hline \text { Depreciation method } & \text { Straight-line } & \text { Straight-line } \\\hline \text { Required rate of return } & 12 \% & 13 \% \\\hline\end{array}$$ Calculate the payback period for Proposal X.

A)5 years
B)4 years
C)9 years
D)8 years

Question 40

A major criticism of the payback method is that it focuses only on the time to recover the investment and ignores profitability.

Question 41

Which capital budgeting method uses accrual accounting,rather than net cash inflows,as a basis for calculations?

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

Question 42

Tiberius Manufacturing is considering two alternative investment proposals with the following data: $$\begin{array} { | l | r | r | } \hline & \text { Proposal X } & { \text { Proposal Y } } \\\hline \text { Investment } & \$ 10,500,000 & \$ 500,000 \\\hline \text { Useful life } & 5 \text { years } & 5 \text { years } \\\hline \text { Estimated annual net cash inflows for 5 years } & \$ 2,100,000 & \$ 105,000 \\\hline \text { Residual value } & \$ 52,000 & \$ 32,000 \\\hline \text { Depreciation method } & \text { Straight-line } & \text { Straight-line } \\\hline \text { Required rate of return } & 13 \% & 12 \% \\\hline\end{array}$$ Calculate the accounting rate of return for Proposal Y.(Round any intermediate calculations and your final answer to two decimal places.)

A)13.87%
B)12.63%
C)4.29%
D)9.52%

Question 43

Dragonfly,Inc.is evaluating two possible investments in depreciable plant assets.The company uses the straight-line method of depreciation.The following information is available: $$\begin{array} { | l | r | r | } \hline & \text { Investment A } & \text { Investment B } \\\hline \text { Initial capital investment } & \$ 101,000 & \$ 151,000 \\\hline \text { Estimated useful life } & 10 \text { years } & 10 \text { years } \\\hline \text { Estimated residual value } & 0 & \$ 20,000 \\\hline \text { Estimated annual net cash inflow for 10 years } & \$ 28,000 & \$ 47,000 \\\hline \text { Required rate of return } & 12 \% & 12 \% \\\hline\end{array}$$ Calculate the payback period for Investment A.(Round your answer to two decimal places.)

A)2.22 years
B)2.89 years
C)1.00 year
D)3.61 years

Question 44

The accounting rate of return is calculated by dividing the average annual operating income by the average amount invested.

Question 45

Accelerated Finance is deciding whether to purchase new accounting software.The cost of the software package is $59,000,and its expected life is ten years.The payback for this investment is four years.Assuming equal yearly cash inflows,what are the expected annual net cash savings from the new software? (Assume the investment has no residual value.)

A)$5900
B)$44,250
C)$14,750
D)$236,000

Question 46

The accounting rate of return method focuses on operating income instead of net cash inflow generated by an asset.

Question 47

The accounting rate of return method considers the time value of money.

Question 48

The accounting rate of return also is known as the average rate of return or annual rate of return.

Question 49

The Accounting Rate of Return method evaluates the lifetime return of an investment,whereas Return on Investment evaluates the annual return of an investment.

Question 50

Gateway Graphics is considering an investment in new printing equipment costing $502,000.The equipment will be depreciated on a straight-line basis over a five-year life and is expected to generate net cash inflows of $122,000 the first year,$158,000 the second year,and $160,000 every year thereafter until the fifth year.What is the payback period for this investment? The residual value is zero.(Round your answer to two decimal places.)

A)4.30 years
B)3.39 years
C)2.80 years
D)3.11 years

Question 51

Zebulon,Inc.is evaluating two possible investments in depreciable plant assets.The company uses the straight-line method of depreciation.The following information is available:
Compute the payback period for each investment.Show your calculations and round to one decimal place.

Question 52

First Choice Carpets is considering purchasing new weaving equipment costing $730,000.The company's management has estimated that the equipment will generate cash inflows as follows: $$\begin{array} { | r | r | } \hline \text { Year 1 } & \$ 204,000 \\\hline 2 & 204,000 \\\hline 3 & 266,000 \\\hline 4 & 266,000 \\\hline 5 & 150,000 \\\hline\end{array}$$ Considering the residual value is zero,calculate the payback period.(Round your answer to two decimal places.)

A)4.61 years
B)3.21 years
C)3.42 years
D)3.70 years

Question 53

Walden Industries is considering investing in production-management software that costs $630,000,has $67,000 residual value,and leads to cost savings of $1,650,000 per year over its five-year life.Calculate the average amount invested in the asset that should be used for calculating the accounting rate of return.

A)$697,000
B)$630,000
C)$348,500
D)$67,000

Question 54

A company is evaluating three possible investments.The following information is provided by the company: $$\begin{array} { | l | r | r | r | } \hline & \text { Project A } & \text { Project B } & \text { Project C } \\\hline \text { Investment } & \$ 240,000 & \$ 54,000 & \$ 240,000 \\\hline \text { Residual value } & 0 & 18,000 & 38,000 \\\hline \text { Net cash inflows: } & & & \\\hline \text { Year 1 } & 62,000 & 34,000 & 98,000 \\\hline \text { Year 2 } & 62,000 & 25,000 & 68,000 \\\hline \text { Year 3 } & 62,000 & 21,000 & 78,000 \\\hline \text { Year 4 } & 62,000 & 18,000 & 38,000 \\\hline \text { Year 5 } & 62,000 & 0 & 0 \\\hline\end{array}$$ What is the payback period for Project A? (Assume that the company uses the straight-line depreciation method.)(Round your answer to two decimal places.)

A)2.87 years
B)1.59 years
C)3.87 years
D)5.00 years

Question 55

Under what circumstances is the investment with the shortest payback the best choice? How should managers use the payback method?

Question 56

Arrendo,Inc.is evaluating two possible investments in depreciable plant assets.The company uses the straight-line method of depreciation.The following information is available: $$\begin{array} { | l | r | r | } \hline & \text { Investment A } & \text { Investment B } \\\hline \text { Initial capital investment } & \$ 107,000 & \$ 159,000 \\\hline \text { Estimated useful life } & 10 \text { years } & 10 \text { years } \\\hline \text { Estimated residual value } & 0 & \$ 26,000 \\\hline \text { Estimated annual net cash inflow for 10 years } & \$ 28,000 & \$ 46,000 \\\hline \text { Required rate of return } & 10 \% & 14 \% \\\hline\end{array}$$ Calculate the payback period for Investment B.(Round your answer to two decimal places.)

A)3.46 years
B)1.94 years
C)2.89 years
D)3.82 years

Question 57

If the net cash inflows are unequal,how is the payback period (in years)of an investment calculated?

Question 58

Learn Safe Driving School is considering purchasing new autos costing $235,000.The company's management has estimated that the autos will generate cash inflows as follows:
Considering the residual value is zero,calculate the payback period.Round to one decimal place

Question 59

Evergreen Lawnmowers is considering the purchase of a new machine costing $814,000.The company's management is estimating that the new machine will generate additional cash inflows of $194,000 a year for ten years and have a residual value of $52,000 at the end of ten years.What is the machine's payback period? (Round your answer to two decimal places.)

A)4.20 years
B)6.37 years
C)3.33 years
D)5.22 years

Question 60

If the expected accounting rate of return meets or exceeds the required rate of return,the decision rule is to not make the investment.

Question 61

A company is evaluating an investment.The company uses the straight-line method of depreciation.Use the following information to compute the accounting rate of return.Show your calculations and round to one decimal place.

Question 62

The process for calculating present values is often called discounting future cash flows because future amounts are discounted to their present value.

Question 63

Which of the following is correct about the payback method?

A)It considers only the cash flows that occur during the payback period.
B)It considers an asset's profitability.
C)It is normally the only method used when deciding whether to invest in an asset.
D)It is difficult to calculate.

Question 64

All else being equal,the shorter the investment period,the higher the total amount of interest earned.

Question 65

The fact that invested cash earns interest over time is called the time value of money.

Question 66

Solutions Tool Co.is considering investing in specialized equipment costing $975,000.The equipment has a useful life of five years and a residual value of $75,000.Depreciation is calculated using the straight-line method.The expected net cash inflows from the investment are given below:
Compute the accounting rate of return on the investment.Show your calculations and round to two decimal places.

Question 67

Mosaic Tile Company is considering an investment in new equipment costing $858,000.The equipment will be depreciated on a straight-line basis over a five-year life and is expected to have a residual value of $62,000.The equipment is expected to generate net cash inflows of $1,002,000 in total during the five-year life.What is the accounting rate of return associated with the equipment investment? (Round your answer to two decimal places.)

A)12.36%
B)8.96%
C)45.23%
D)9.34%

Question 68

Sayer Tool Co.is considering investing in specialized equipment costing $610,000.The equipment has a useful life of five years and a residual value of $69,000.Depreciation is calculated using the straight-line method.The expected net cash inflows from the investment are given below: $$\begin{array} { | r | r | } \hline \text { Year 1 } & \$ 210,000 \\\hline 2 & 159,000 \\\hline 3 & 160,000 \\\hline 4 & 95,000 \\\hline 5 & \underline { 136,000 } \\\hline & \$ 760,000 \\\hline\end{array}$$ What is the accounting rate of return on the investment? (Round your answer to two decimal places.)

A)14.36%
B)16.19%
C)12.90%
D)6.45%

Question 69

An annuity is a stream of equal cash payments made at equal time intervals.

Question 70

Compound interest assumes that all interest earned will remain invested and earn additional interest at the same interest rate.

Question 71

Which of the following most accurately describes an annuity?

A)an investment which produces increasing cash flows over time
B)a series of unequal cash payments made at equal time intervals
C)a stream of equal cash payments made at equal time intervals
D)a term that does not apply to mortgage payable or bond payable

Question 72

Door to Door Moving Company is considering purchasing new equipment that costs $720,000.Its management estimates that the equipment will generate cash inflows as follows: $$\begin{array} { | r | c | } \hline \text { Year 1 } & \$ 218,000 \\\hline 2 & 218,000 \\\hline 3 & 258,000 \\\hline 4 & 258,000 \\\hline 5 & 150,000 \\\hline\end{array}$$ Present value of $1:
$$\begin{array} { | c | r | r | r | r | r | } \hline & 6 \% & 7 \% & 8 \% & 9 \% & 10 \% \\\hline 1 & 0.943 & 0.935 & 0.926 & 0.917 & 0.909 \\\hline 2 & 0.890 & 0.873 & 0.857 & 0.842 & 0.826 \\\hline 3 & 0.840 & 0.816 & 0.794 & 0.772 & 0.751 \\\hline 4 & 0.792 & 0.763 & 0.73 & 0.708 & 0.683 \\\hline 5 & 0.747 & 0.713 & 0.681 & 0.650 & 0.621 \\\hline\end{array}$$ The company's annual required rate of return is 8%.Using the factors in the table,calculate the present value of the cash inflows.(Round all calculations to the nearest whole dollar.)

A)$38,804
B)$774,000
C)$884,000
D)$885,326

Question 73

The following formula is used to compute the present value of a lump sum:
Future value = Present value × PV factor for i = X%,n = X periods

Question 74

The only difference between the present value and future value of a lump sum is the amount of interest that is earned in the intervening time span.

Question 75

Compound interest means that interest is calculated only on the principal amount.

Question 76

Which of the following describes the time value of money?

A)The time value of money has no effect on the timing of capital investments.
B)Money loses its purchasing power over time through inflation.
C)The fact that invested cash may not earn interest over time is called the time value of money.
D)A dollar received today is worth more than a dollar to be received in the future.

Question 77

When using the accounting rate of return,what is the rule for making the decision to make the investment?

Question 78

A company is evaluating three possible investments.Each uses the straight-line method of depreciation.Following information is provided by the company: $$\begin{array} { | l | r | r | r | } \hline & \text { Project A } & \text { Project B } & \text { Project C } \\\hline \text { Investment } & \$ 230,000 & \$ 54,000 & \$ 230,000 \\\hline \text { Residual value } & 0 & 12,000 & 36,000 \\\hline \text { Net cash inflows: } & & & \\\hline \text { Year 1 } & 56,000 & 38,000 & 94,000 \\\hline \text { Year 2 } & 56,000 & 29,000 & 64,000 \\\hline \text { Year 3 } & 56,000 & 25,000 & 74,000 \\\hline \text { Year 4 } & 56,000 & 22,000 & 34,000 \\\hline \text { Year 5 } & 56,000 & 0 & 0 \\\hline\end{array}$$ What is the accounting rate of return for Project B? (Round your answer to two decimal places.)

A)38.14%
B)26.19%
C)54.55%
D)51.83%

Question 79

Prescott Corporation is considering an investment in new equipment costing $918,000.The equipment will be depreciated on a straight-line basis over a ten-year life and is expected to have a residual value of $98,000.The equipment is expected to generate net cash inflows of $152,000 for each of the first five years and $116,000 for each of the last five years.What is the accounting rate of return associated with the equipment investment? (Round your answer to two decimal places.)

A)10.95%
B)11.34%
C)9.05%
D)10.24%

Question 80

A company is evaluating three possible investments.Each uses the straight-line method of depreciation.The following information is provided by the company: $$\begin{array} { | l | r | r | r | } \hline & \text { Project A } & \text { Project B } & \text { Project C } \\\hline \text { Investment } & \$ 240,000 & \$ 54,000 & \$ 240,000 \\\hline \text { Residual value } & 0 & 10,000 & 36,000 \\\hline \text { Net cash inflows: } & & & \\\hline \text { Year 1 } & 52,000 & 40,000 & 96,000 \\\hline \text { Year 2 } & 52,000 & 31,000 & 66,000 \\\hline \text { Year 3 } & 52,000 & 27,000 & 76,000 \\\hline \text { Year 4 } & 52,000 & 24,000 & 36,000 \\\hline \text { Year 5 } & 52,000 & 0 & 0 \\\hline\end{array}$$ What is the accounting rate of return for Project C? (Round your answer to two decimal places.)

A)12.50%
B)12.68%
C)44.44%
D)15.00%