Question 1

Why does a company use its cost of capital as the minimum required rate of return for its capital investment decisions?

Accepted Answer

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Question 2

If the net present value for a capital investment is equal to zero,the internal rate of return for the investment is equal to the required rate of return.

Accepted Answer

When the net present value (NPV) of a capital investment is zero, it means that the investment is expected to generate just enough cash flows to cover the cost of the initial investment and the required rate of return. This is also referred to as the breakeven point. At this point, the internal rate of return (IRR) of the investment is equal to the required rate of return, since the cash flows generated by the investment are exactly enough to cover the cost of capital. Therefore, the statement is true.

Question 3

Generally,the unadjusted rate of return should be calculated based on the average investment rather than the amount of the original investment in a depreciable asset such as equipment.

Accepted Answer

The unadjusted rate of return should be based on the average investment over the asset's useful life, as this provides a more accurate representation of the return on investment. Calculating the return based on the original investment amount would not take into account any changes in the investment over time due to maintenance, repair, or replacement.

Question 4

The amount of the depreciation tax shield can be calculated by multiplying the amount of depreciation expense by the tax rate.

Accepted Answer

The depreciation tax shield is the amount of tax savings that result from deducting depreciation expenses on an asset. It can be calculated by multiplying the amount of depreciation expense by the tax rate. Therefore, the statement is true.

Question 5

The unadjusted rate of return is found by dividing the average incremental increase in annual operating income by the cost of the investment.

Accepted Answer

This statement correctly defines the unadjusted rate of return calculation.

Question 6

Why is the time value of money often taken into account in analyzing a capital investment?

Accepted Answer

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Question 7

What is the reinvestment assumption,and how does the assumption affect capital investment analyses?

Accepted Answer

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Question 8

The payback method of evaluating capital investments measures the recovery of the investment,but it does not measure profitability.

Accepted Answer

The payback method only measures the length of time it takes to recover the initial investment, without considering the profitability of the investment.

Question 9

If a company has to pay a given amount of income taxes over the life of a capital investment,managers of the company should seek to pay the taxes as early as possible in the investment's life.

Accepted Answer

Managers of the company should aim to defer income tax payments for as long as possible in the investment's life. By doing so, the company can use the funds that would otherwise be paid in taxes to invest in its operations and generate more profits. Additionally, deferring taxes can result in a lower present value of tax payments due to inflation and the time value of money.

Question 10

Depreciation on a capital investment (such as equipment)has the effect of decreasing the amount of income taxes that the company owning the asset must pay.

Accepted Answer

This is true because depreciation is a non-cash expense that can be deducted from the company's taxable income, therefore reducing the amount of income taxes owed. It allows the company to spread the cost of the asset over its useful life, rather than taking a one-time deduction in the year of purchase.

Question 11

Describe what is meant by the time value of money.

Accepted Answer

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Question 12

When the effect of income taxes is considered in a capital budgeting analysis,the amount of depreciation expense must be added back to after-tax income to calculate the annual cash inflow.

Accepted Answer

Depreciation expense is a non-cash expense that reduces taxable income and therefore reduces the amount of income taxes paid. When considering the effect of income taxes on capital budgeting analysis, depreciation expense must be added back to after-tax income to calculate the annual cash inflow.

Question 13

When a capital investment is expected to provide unequal annual cash inflows,the payback period can be calculated by accumulating the incremental cash inflows until the sum equals the amount of the original investment.

Accepted Answer

This is a correct statement. The payback period is a method of evaluating the profitability of a capital investment by calculating the time period required to recover the initial investment. If the cash inflows are not equal, the incremental cash inflows are accumulated until they add up to the original investment amount, which is used to determine the payback period.

Question 14

The payback method shows how long will be required to recover the cost of an investment in a capital asset.

Accepted Answer

The payback method is a capital budgeting technique that calculates the length of time it takes to recover the cost of an investment. Therefore, the statement is true.

Question 15

A capital investment with an internal rate of return equal to or greater than the required rate of return is considered to be an acceptable investment.

Accepted Answer

This statement is true. An investment's internal rate of return measures the expected rate of return for the investment and if it is equal to or greater than the required rate of return, then the investment is considered acceptable.

Question 16

A postaudit should be performed at the end of a capital investment project to determine whether the expected results were actually achieved.

Accepted Answer

A postaudit is a review conducted after the completion of a project to evaluate whether the planned objectives and projected benefits have been achieved. Therefore, it is true that a postaudit should be performed at the end of a capital investment project to determine whether the expected results were actually achieved.

Question 17

Cash inflows from a capital investment may include the salvage value of capital assets and increases in revenues.

Accepted Answer

Cash inflows from a capital investment may include the salvage value of capital assets, which is the estimated value of the assets at the end of their useful life. In addition, capital investments may also result in increases in revenues due to improved efficiency, higher production capacity, or other factors. Therefore, both salvage value and increased revenues can be sources of cash inflows from a capital investment.

Question 18

Generally,a company should use the MACRS method to calculate depreciation on its income tax return,due to the effects of the time value of money.

Accepted Answer

MACRS (Modified Accelerated Cost Recovery System) takes into account the time value of money by allowing for larger deductions in earlier years of an asset's useful life, ultimately resulting in a larger tax savings over time.

Question 19

When a capital investment is expected to provide unequal annual cash inflows,the payback period cannot be calculated.

Accepted Answer

The payback period can still be calculated for investments with unequal annual cash inflows by summing the cash inflows year by year until the initial investment is recovered.

Question 20

Sources of cash outflows from capital investments include incremental expenses and installation costs.

Accepted Answer

Incremental expenses and installation costs are both forms of cash outflows from capital investments.

Quiz 10: Planning for Capital Investments