Question 1

The length of time required to recover the initial investment in a capital asset is known as the:

Accepted Answer

The length of time required to recover the initial investment in a capital asset is known as the payback period. This is the time it takes for the cash inflows from the asset to equal the initial investment. It is an important metric for businesses to determine whether an investment is worth making, as a shorter payback period is generally better. The other choices, rate of return, investment period, and present value period, are all related to investment analysis but do not specifically refer to the time it takes to recover the initial investment.

Question 2

Which method for evaluating capital investment proposals deducts the present value of cash outflows from the present value of cash inflows?

Accepted Answer

The method that deducts the present value of cash outflows from the present value of cash inflows is the net present value (NPV) method. This method takes into account the time value of money and provides a more accurate picture of the profitability of a capital investment proposal. Option A, the payback method, only considers the time it takes to recover the initial investment without considering the profitability of the investment. Option B, internal rate of return, uses a similar approach as NPV but only calculates the rate of return, not the actual value of the investment. Option D, the unadjusted rate of return, does not take into account the time value of money and therefore, can provide an inaccurate picture of the profitability of the investment.

Question 3

Young Corporation is considering purchasing equipment that costs $80,000 and is expected to provide the following cash inflows over its five-year useful life:  What is the payback period of this investment project (rounded to the nearest year)?

Accepted Answer

11ea7feb_d160_69db_a768_51bcc45fe623_TB3570_00_TB3570_00_TB3570_00 The investment in the project is fully recovered in the 4th year.

Question 4

The difference between an ordinary annuity and an annuity due is:

Accepted Answer

When equal cash inflows occur at the end of the accounting period, this distribution is called an ordinary annuity. On the other hand, when equal cash inflows occur at the beginning of the accounting period, this distribution is called an annuity due.

Question 5

The time value of money concept recognizes that a dollar today is worth more than a dollar tomorrow. Which of the following is not a factor in causing the present value of cash inflows to diminish over time?

Accepted Answer

First, you could deposit today's dollar in a savings account to earn interest that increases its total value. If you wait for your money, you lose the opportunity to earn interest. Second, the expectation of receiving a future dollar carries an element of risk. Changed conditions may result in the failure to collect. Finally, inflation diminishes the buying power of the dollar.

Question 6

Which of the following statements is incorrect?

Accepted Answer

When a company invests in capital assets, it sacrifices current dollars for the opportunity to receive future dollars.

Question 7

Which of the following is not a criterion that is used to determine whether a project is acceptable under the net present value method?

Accepted Answer

The net present value decision rule states that, if the net present value is equal to or greater than zero, accept the investment opportunity.

Question 8

A series of equal cash flows at fixed intervals is termed a(n):

Accepted Answer

A series of equal cash flows at fixed intervals is referred to as an annuity.

Question 9

Which of the following statements about postaudits is correct?

Accepted Answer

The postaudit of a capital investment project should be made using the same analytical technique that was used in deciding to make the investment. This ensures consistency and accuracy in evaluating the project's success and determining any deviations from expected results. A postaudit can be conducted at any time after a capital investment is made, not necessarily at the time of purchase. Postaudits are not specifically aimed at improving cost-volume-profit analysis, but rather at evaluating the actual performance of a capital investment project. While expected cash flows and the company's cost of capital may be used in the analysis, they are not the only factors considered.

Question 10

Joan Osborne is evaluating a potential capital investment. She has calculated the net present value using a minimum rate of return of 10%. Using this rate, the net present value is negative. What does this tell her about the rate of return expected for the project?

Accepted Answer

A positive net present value indicates the investment will yield a rate of return higher than the required rate of return. The negative net present value in this situation suggests the investment will earn a rate of return of less than 10%.

Question 11

Which method of evaluating capital investment decisions uses the concept of present value to compute a rate of return?

Accepted Answer

The Internal Rate of Return (IRR) method uses the concept of present value to compute a rate of return by finding the discount rate that makes the net present value of all cash flows from a particular project equal to zero.

Question 12

Cash inflows generated by capital investments include all of the following except:

Accepted Answer

Cash inflows generated from capital investments come from four basic sources. Incremental revenue refers to the additional cash inflows from operating activities generated by using additional capital assets. A second type of cash inflow results from cost savings. An investment's salvage value provides a third source of cash inflows. A fourth type of cash inflow is a reduction in the amount of working capital required. Cash outflows fall into three primary categories. One category consists of outflows for the initial investment. A second category of cash outflows may result from increases in operating expenses. Third, increases in working capital commitments result in cash outflows.

Question 13

Which of the following are not present value methods of analyzing capital investment proposals?

Accepted Answer

Several techniques for evaluating capital investment proposals ignore the time value of money. The payback method shows how long it will take to recover the initial cash outflow (the cost) of an investment. The unadjusted rate of return method is another common evaluation technique. This method does not adjust investment cash flows to reflect the time value of money.

Question 14

The present value index indicates the:

Accepted Answer

To compare different size investment alternatives, management can compute a present value index by dividing the present value of the cash inflows by the present value of the cash outflows. The higher the ratio, the higher the rate of return per dollar invested in the proposed project.

Question 15

Seth Morrison is considering alternative proposals that involve different amounts of investments. To compare different size investment proposals, it may be helpful for Seth to prepare a relative ranking of the proposals by using a(n):

Accepted Answer

To compare different size investment alternatives, management can compute a present value index by dividing the present value of the cash inflows by the present value of the cash outflows. The higher the ratio, the higher the rate of return per dollar invested in the proposed project.

Question 16

Cash outflows generated by capital investments include all of the following except:

Accepted Answer

Cash inflows generated from capital investments come from four basic sources. Incremental revenue refers to the additional cash inflows from operating activities generated by using additional capital assets. A second type of cash inflow results from cost savings. An investment's salvage value provides a third source of cash inflows. A fourth type of cash inflow is a reduction in the amount of working capital required. Cash outflows fall into three primary categories. One category consists of outflows for the initial investment. A second category of cash outflows may result from increases in operating expenses. Third, increases in working capital commitments result in cash outflows.

Question 17

Butch's Barbecue thinks that offering delivery will increase their sales. Butch's is considering whether to purchase a used delivery truck costing $12,000. Additional net income from the delivery service will be $1,400 per year. The truck will last approximately 5 years. What is the unadjusted rate of return based on the average investment?

Accepted Answer

Unadjusted rate of return (based on average investment) = Average incremental increase in annual net income ÷ (Net cost of original investment ÷ 2)
Unadjusted rate of return (based on average investment) = $1,400 ÷ ($12,000 ÷ 2) = 0.233 = 23.3%

Question 18

Findell Corporation is considering two projects, A and B, and it has gathered the following estimates for the project:  What is the present value index for project A?

Accepted Answer

Present value index = Present value of cash inflows ÷ Present value of cash outflows
Present value index = $84,360 ÷ $77,000 = 1.096

Question 19

Capital investment decisions involve all of the following, except:

Accepted Answer

Purchases of long-term operational assets are capital investments.

Question 20

The process by which management evaluates long-term investment decisions involving long term operational assets is called:

Accepted Answer

The process described in the question is capital investment analysis, which involves evaluating long-term investment decisions that involve operational assets. Activity based management refers to managing activities and processes to improve efficiency, strategic business analysis is a broad term that could refer to various types of analysis, and fixed cost analysis focuses specifically on evaluating fixed costs.

Quiz 16: Planning for Capital Investments