Deck 26: Capital Budgeting

Question 1

Capital investments are difficult, if not impossible, to reverse once funds have been invested.

Answer 1

True

Question 2

To determine the average investment over the life of an asset, divide the total depreciation of the investment by two.

Answer 2

False

Question 3

The impact of a capital budgeting decision upon the environment is an example of a non financial consideration.

Answer 3

True

Question 4

The annual net cash flow of an investment refers to the excess revenue it generates over its related expenses.

Question 5

The present value of a future cash flow is the amount you would pay today for the right to receive that future amount.

Question 6

The difference between the present value and future value depends on the rate of interest and the length of time that interest accumulates.

Question 7

The residual value of an asset should be subtracted from the cost of the asset when determining the average amount invested.

Question 8

The payback period analysis fails to consider the cash flows over the entire life of the investment.

Question 9

Capital budgeting estimates often involve a considerable degree of uncertainty.

Question 10

The acquiring of a subsidiary company by a publicly traded company would be an example of a capital expenditure.

Question 11

The present value of money is always less than its future value.

Question 12

Perhaps the most important financial considerations in a capital budgeting decision are its effects upon future cash flow and future profitability.

Question 13

The payback period can be determined by multiplying the amount invested by net cash flows received annually.

Question 14

The payback period considers total profitability over the life of an investment and takes into consideration the timing of an investment's future cash flows.

Question 15

The net present value of an investment proposal is the difference between the total present value of future net cash flows and the cost of the investment.

Question 16

A failure of the return on investment method is that no consideration is given to the time value of money.

Question 17

In capital budgeting, one may use estimates in making decisions.

Question 18

Capital investment refers to large expenditures to purchase plant assets, develop new products, or sell more company stock.

Question 19

The recognition of depreciation expense often causes the annual net income of an investment to be less than the amount of its annual net cash flows.

Question 20

Non-financial factors are relevant in capital budgeting.

Question 21

To compute a future amount from a present value, we need to know:

A) The future value.
B) The interest rate.
C) The future annuity amount.
D) The present annuity amount.

Question 22

The higher the required rate of return of an investment, the less an investor will be willing to pay for the investment.

Question 23

In capital budgeting, the investment proposal with the shortest payback period always has the highest rate of return.

Question 24

The discount rate used in discounting cash flows from proposed investments is usually the rate of return required by the investor.

Question 25

The return on average investment method of evaluating investment proposals takes into consideration both the amount and the timing of future cash flows.

Question 26

Financial instruments describe all of the following except:

A) Unearned revenues.
B) Cash.
C) Equity investments.
D) Contracts that call for receipts or payments of cash.

Question 27

Capital investments decisions are not affected by:

A) Income taxes.
B) Non-financial considerations.
C) Depreciation methods.
D) Inventory levels.

Question 28

Capital budget audits are often undertaken to ensure the accuracy of cash flow estimates.

Question 29

Most capital budgeting techniques involve analysis of net operating profits.

Question 30

Investment center managers may be overly optimistic about the efficiency of the new capital investment and thus, may understate expected results.

Question 31

When straight-line depreciation is used, the average carrying value of an asset with no salvage value is equal to the asset's original cost divided by its estimated useful life.

Question 32

A weakness in the usefulness of the return on average investment is that it fails to consider the present value of an investment.

Question 33

The return on average investment computation ignores the timing of an investment's future cash flows.

Question 34

In considering investment in new plant assets, the payback period is computed without regard to the total useful life of the investment.

Question 35

Results of capital budgeting processes may have serious implications for employees.

Question 36

The future value of a future cash flow is always less than the present amount.

Question 37

A short payback period is preferred so that the investment's costs can be put to other uses.

Question 38

The minimum rate of return used by an investor to bring future cash flows to their present value is called:

A) The investment rate.
B) The prime rate.
C) The discount rate.
D) The present rate.

Question 39

Non financial considerations are not accounted for in capital budgeting decisions.

Question 40

Capital investment proposals may not be evaluated by using:

A) The payback period.
B) The return on investment method.
C) The discounted cash flow method.
D) The income statement method.

Question 41

Which of the following is not an important financial consideration in capital budgeting?

A) The timing of the investment's future cash flows.
B) The investment's future profitability.
C) The sunk costs related to the investment.
D) The initial cost of the investment and its estimated salvage value.

Question 42

The average carrying value (or average investment) of an asset with no salvage value is equal to:

A) The original cost of the asset divided by its estimated useful life.
B) The original cost of the asset divided by two.
C) The average annual net cash flow of the asset multiplied by the asset's estimated useful life.
D) The average annual net income of the asset multiplied by the asset's estimated useful life.

Question 43

The selection of an appropriate discount rate for determining net present value of a particular investment proposal does not depend upon:

A) The present value of the proposal's future cash flows.
B) Alternative investment opportunities available.
C) The nature of the investment proposal.
D) The investor's cost of capital.

Question 44

An investment cost $80,000 with no salvage value, a 5 year useful life, and had an expected annual increase in net income of $7,000. Straight line depreciation is used. What is the expected rate of return on this investment?

A) 2.8%.
B) 20%.
C) 8.8%.
D) 10.4%.

Question 45

A cost that has been incurred irrevocably by past actions is a (an):

A) Capital expenditure.
B) Incremental cost.
C) Sunk cost.
D) Fixed cost.

Question 46

Which of the following is not considered a capital investment?

A) The purchase of a large machine.
B) The development of a new product line.
C) The purchase of a large order of raw materials used in the production process.
D) The acquisition of a subsidiary company.

Question 47

When management considers an investment, they look for the payback period to be:

A) Short.
B) Long.
C) Profitable.
D) Useful.

Question 48

Which of the following is generally not considered a capital budgeting technique?

A) Payback period.
B) Return on average investment.
C) Return on stockholders' equity.
D) Discounting of future cash flows.

Question 49

When using the net present value method for evaluating an investment, an increase in the required rate of return will:

A) Make it more difficult to accept the investment.
B) Make it less difficult to accept the investment.
C) Not affect the decision if the length of the investment's benefits remain constant.
D) Not be a consideration because it is not used in the net present value method.

Question 50

The payback period:

A) Is the length of time necessary to recover the entire cost of an investment from its resulting annual net cash flow.
B) Is the length of time necessary to recover the entire cost of an investment from its resulting annual net income.
C) Takes into consideration the profitability of an investment over its entire life, but ignores the timing of its future cash flows.
D) Takes into consideration both the profitability of an investment over its entire life and the timing of its future cash flows.

Question 51

Which method of project selection gives consideration to the time value of money in a capital budgeting decision?

A) Payback method.
B) Average rate of return.
C) Net present value method.
D) Accounting rate of return.

Question 52

An investment's annual net cash flow will always be equal to its:

A) Annual revenue less its annual expenses.
B) Annual cash receipts less its annual cash disbursements.
C) Annual revenue less its annual cash disbursements.
D) Annual net income plus its annual depreciation expense.

Question 53

The present value of money is always:

A) Less than its future amount.
B) The same as its future amount.
C) More than its future amount.
D) More or less than its future amount depending upon the discount rate.

Question 54

Joseph Company is considering replacing an existing piece of machinery with newer technology. In deciding whether to replace the existing machinery, management should consider which costs as relevant?

A) Future costs which will be classified as fixed rather than variable.
B) Future costs which will be different under the two alternatives.
C) Sunk costs associated with the old machine.
D) Historical costs associated with the old machine.

Question 55

If an investment costs $140,000 with no residual value, an expected increase in net income of $35,000 and a 5 year useful life, the payback period would be:

A) 2.2 years.
B) 4 years.
C) 5 years.
D) 2 years.

Question 56

If all revenue generated by an investment is immediately received in cash, and all of the investment's expenses (other than depreciation) are immediately paid in cash, annual net cash flow of the investment may be determined by:

A) Subtracting the investment's annual depreciation expense from the annual net income earned by the investment.
B) Adding the investment's annual depreciation expense to the annual net income earned by the investment.
C) Subtracting the investment's annual expenses from the annual revenue it generates.
D) Adding the investment's annual depreciation expense to the annual revenue generated by the investment.

Question 57

Which of the following factors does the payback method does NOT ignore?

A) Total profitability of an investment.
B) The cash flows over the entire life of an investment.
C) The timing of cash flows.
D) The initial investment.

Question 58

A machine cost $46,000 and had a useful life of 4 years and a residual value of $7,000. What is the net present value of the machine if the annual cash flow is $16,000 and the company uses a discount rate of 10%? An annuity table shows the present value of $1 at 10% for 4 years to be 0.683. The present value of an ordinary annuity of $1 discounted at 10% for 4 years is 3.170.

A) $56,501.
B) $33,118.
C) $9,501.
D) $63,000.

Question 59

Of the following techniques of capital budgeting, which one explicitly incorporates an estimate of an interest rate into the basic computation?

A) Payback method.
B) Average rate of return.
C) Net present value method.
D) Accounting book value method.

Question 60

In computing the return on average investment of a particular asset, the asset's annual depreciation expense may be viewed as:

A) An increase in the average amount invested over the life of the asset.
B) An increase in the asset's carrying value each year.
C) A recovery of the amount originally invested in the asset.
D) A decrease in the asset's net cash flows.

Question 61

On the basis of the above data, which of the following is false?

A) Proposal A should be considered unacceptable.
B) Proposal C is the best alternative because it has the shortest payback period, which is the most meaningful of the capital budgeting statistics.
C) Proposal A's negative net present value indicates that this alternative will not generate management's required rate of return.
D) Although proposals B and C are each acceptable, proposal B is a better investment considering the time value of money.

Question 62

The expected rate of return on average investment in this equipment is:

A) 15%.
B) 20%.
C) 7.5%.
D) Some other percentage.

Question 63

The return on average investment for this proposed investment is:

A) 8 1/3%.
B) 50%.
C) 25%.
D) 11.1%.

Question 64

The payback period of this investment is:

A) Four years.
B) Five years.
C) Six years.
D) Over six years.

Question 65

Jericho Corporation is considering the purchase of new equipment costing initially $96,000. The equipment has an estimated life of 6 years with no salvage value. Straight-line depreciation is to be used. Net annual after tax cash flow is estimated to be $31,200 for 6 years. The payback period is:

A) 1.2300 years.
B) 3.0769 years.
C) 5.0799 years.
D) 6.0000 years.

Question 66

The management of Trylon Farms is considering the purchase of equipment costing $320,000. The equipment has a useful life of eight years, with $20,000 residual value. The use of this equipment will produce positive annual cash flow of $60,000 for eight years, as well as $20,000 from sale of the equipment at the end of the eighth year. Compute the net present value of this investment, discounted at an annual rate of 10%. (Present value of $1 due in eight years, discounted at 10%, is 0.467; present value of $1 received annually for eight years, discounted at 10%, is 5.335.)

A) $9,340.
B) $320,100.
C) $9,440.
D) $329,440.

Question 67

Kenny Company is considering the possibility of investing $1,500,000 in a special project. This venture will return $375,000 per year for 12 years in after tax cash flows. Depreciation on the project will be $187,500 per year using straight-line depreciation. The payback period for the project is:

A) 6 years.
B) 12 years.
C) 4 years.
D) 2 years.

Question 68

The management of Salem Corporation is considering the purchase of equipment costing $109,000 which has an estimated life of 3 years and no salvage value. The net after tax cash flow from the project for each of the three years is expected to be $45,000. The company's cost of capital is 10%. Compute the net present value of the equipment. (Present value of $1 due in three years, discounted at 10%, is 0.751; present value of $1 received annually for three years, discounted at 10%, is 2.487.)

A) $3,616.
B) $2,548.
C) $2,915.
D) $3,213.

Question 69

The expected rate of return on average investment of the machine is:

A) 10%.
B) 17%.
C) 18.6%.
D) 48%.

Question 70

The payback period for the investment in equipment is:

A) 5 years.
B) 1 years.
C) 2 years.
D) 2.8 years.

Question 71

The president of Nash Company is considering a proposal by the factory manager for the purchase of a machine for $72,500. The useful life would be eight years, with no residual scrap value. The use of the machine will produce a positive annual cash flow of $14,000 a year for eight years. An annuity table shows that the present value of $1 received annually for eight years and discounted at 10% is 5.335. The net present value of the proposal, discounted at 10%, is:

A) $2,190 positive.
B) Zero.
C) $3, 868 negative.
D) $3.868 positive.

Question 72

The expected rate of return on average investment will be approximately:

A) 20%.
B) 43%.
C) 23%.
D) 37 1/2%.

Question 73

Sterling Corporation has borrowed $75,000 that must be repaid in two years. This $75,000 is to be invested in an eight-year project with an estimated annual net cash flow of $15,000. The payback period for this investment is:

A) Two years.
B) Five years.
C) Eight years.
D) Indeterminable with the given information.

Question 74

Compute the net present value of this investment, using a discount rate of 12%. (An annuity table shows that the present value of $1 received annually for five years, discounted at 12%, is 3.605.)

A) $468,650.
B) $179,150.
C) $289,500.
D) $829,150.

Question 75

The above data indicate that:

A) After considering the timing of future cash flows, each of the three proposals is expected to provide a rate of return in excess of 15%.
B) Proposal A will generate net losses annually.
C) If the salvage value of proposal A were $52,000 instead of zero, proposal A would have the highest net present value.
D) The present value of proposal B's future cash flows is $2,471,600.

Question 76

The return on average investment for this investment is approximately:

A) 10%.
B) 20%.
C) 31%.
D) 50%.

Question 77

The payback period for this investment is approximately:

A) 4.7 years.
B) 9.4 years.
C) 8.75 years.
D) 5 years.

Question 78

The payback period for this proposed investment is:

A) 4.5 years.
B) Twelve years.
C) Six years.
D) Two years.

Question 79

The payback period of the machine is approximately:

A) Four years.
B) Eight years.
C) Five years.
D) Ten years.

Question 80

Compute the net present value of this proposed investment, using a discount rate of 12%. (An annuity table shows that the present value of $1 received annually for six years, discounted at 12%, is 4.111.)

A) $105,600.
B) ($41,078).
C) $369,600.
D) $434,121.