Question 1

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total income over the life of the machine is estimated to be $12,000. The machine will generate cash flows per year of $6,000. The payback period for the machine is 4 years.

Accepted Answer

The answer of A company is planning to purchase a...

Question 2

The process by which management allocates available investment funds among competing capital investment proposals is termed present value analysis.

Accepted Answer

The process described is termed capital budgeting. Present value analysis is a technique used within capital budgeting to evaluate the desirability of investments or projects.

Question 3

In calculating the present value of an investment in equipment, the present value of the terminal residual value should be added to the cash inflows.

Accepted Answer

The present value of the terminal residual value represents the estimated value of the equipment at the end of its useful life, and it is a cash inflow that occurs at that time. Therefore, it should be added to the forecasted cash inflows during the investment horizon to estimate the total net present value of the investment.

Question 4

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total income over the life of the machine is estimated to be $12,000. The machine will generate cash flows per year of $6,000. The payback period for the machine is 12 years.

Accepted Answer

The payback period for the machine is actually 4 years ($24,000 initial cost / $6,000 cash flows per year).

Question 5

Net present value and the payback period are examples of discounted cash flow methods used in capital budgeting decisions.

Accepted Answer

Net present value (NPV) is a discounted cash flow method used in capital budgeting to evaluate the profitability of an investment or project. However, the payback period is not a discounted cash flow method; it simply calculates the time required for the cash inflows from a project to repay the initial investment, without considering the time value of money.

Question 6

A qualitative characteristic that may impact upon capital investment analysis is manufacturing control.

Accepted Answer

Manufacturing control is a qualitative characteristic that can impact capital investment analysis. It refers to the level of control a company has over its manufacturing processes and the ability to manage costs and minimize waste. A company with strong manufacturing control may be able to improve its return on investment when investing in new capital projects.

Question 7

A company is considering the purchase of a new piece of equipment for $90,000. Predicted annual cash inflows from the investment are $36,000 (year 1), $30,000 (year 2), $18,000 (year 3), $12,000 (year 4), and $6,000 (year 5). The average income from operations over the 5-year life is $20,400. The payback period is 3.5 years.

Accepted Answer

To calculate the payback period, we need to add up the cash inflows until they equal the initial investment of $90,000.

Year 1: $36,000
Year 2: $30,000
Year 3: $18,000
Year 4: $12,000
Year 5: $6,000
Total cash inflows after 3 years: $84,000

Therefore, the payback period is between 3 and 4 years. Since the cash inflows in year 4 and 5 are not needed to reach the initial investment, they do not affect the payback period.

The average income from operations is not relevant to the payback period calculation.

Question 8

A company is planning to purchase a machine that will cost $24,000, have a six-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total income over the life of the machine is estimated to be $12,000. The machine will generate cash flows per year of $6,000. The accounting rate of return for the machine is 16.7%.

Accepted Answer

The answer of A company is planning to purchase a...

Question 9

The accounting rate of return method of analyzing capital budgeting decisions measures the average rate of return from using the asset over its entire life.

Accepted Answer

The accounting rate of return method calculates the average annual accounting profit generated by a project as a percentage of the average investment in the project. It does not take into account the time value of money or the cash flows generated by the project over its entire life.

Question 10

A company is considering purchasing a machine for $21,000. The machine will generate income from operations of $2,000; annual cash flows from the machine will be $3,500. The payback period for the new machine is 10.5 years.

Accepted Answer

The payback period is calculated by dividing the initial investment by the annual cash flows, not including income from operations. Therefore, the payback period for this machine would actually be 6 years ($21,000 ÷ $3,500).

Question 11

The payback method can be used only when net cash inflows are the same for each period.

Accepted Answer

The payback method can be used even when net cash inflows are not the same for each period. However, it may not provide a comprehensive picture of the profitability of a project.

Question 12

A company is considering purchasing a machine for $21,000. The machine will generate income from operations of $2,000; annual cash flows from the machine will be $3,500. The payback period for the new machine is 6 years.

Accepted Answer

To calculate payback period, we divide the initial investment by the annual cash flows generated by the investment.

Payback period = Initial investment / Annual cash flows

In this case, payback period = $21,000 / $3,500 = 6

Since the calculated payback period matches the given payback period of 6 years, the answer is true.

Question 13

The accounting rate of return is a measure of profitability computed by dividing the average annual cash flows from an asset by the average amount invested in the asset.

Accepted Answer

The definition given in the statement is of the simple rate of return, while the accounting rate of return is calculated by dividing the average annual net income or profit by the average investment in the asset.

Question 14

A company is considering the purchase of a new machine for $48,000. Management expects that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. All revenues and expenses except depreciation are on a cash basis. The payback period for the machine is 6 years.

Accepted Answer

The payback period for the machine is calculated as the initial investment divided by the net annual cash inflow. In this case, the net annual cash inflow is the sales revenue of $16,000 minus expenses of $8,000, which equals $8,000. Therefore, the payback period is $48,000 initial investment divided by $8,000 net annual cash inflow, which equals 6 years.

Question 15

A company is considering the purchase of a new machine for $48,000. Management expects that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. All revenues and expenses except depreciation are on a cash basis. The payback period for the machine is 12 years.

Accepted Answer

The payback period for the machine is actually 3 years, not 12. To calculate the payback period, we divide the initial cost ($48,000) by the net cash inflows per year ($16,000 - $8,000 = $8,000) which gives us 6 years. However, we also need to factor in the annual depreciation of $4,000 which reduces the net investment to $44,000 ($48,000 - $4,000). Dividing this by the net cash inflows per year gives us a payback period of 5.5 years. Therefore, the statement that the payback period is 12 years is false.

Question 16

A qualitative characteristic that may impact upon capital investment analysis is manufacturing productivity.

Accepted Answer

Manufacturing productivity can impact the capital investment analysis as it influences the amount of output that can be produced with the given resources, resulting in increased profitability and return on investment. Therefore, it is a relevant qualitative characteristic to consider in the analysis.

Question 17

The time expected to pass before the net cash flows from an investment would return its initial cost is called the amortization period.

Accepted Answer

The time expected to pass before the net cash flows from an investment would return its initial cost is called the payback period, not the amortization period.

Question 18

In calculating the net present value of an investment in equipment, the required investment and its terminal residual value should be subtracted from the present value of all future cash inflows.

Accepted Answer

The answer of In calculating the net present value of...

Question 19

A qualitative characteristic that may impact upon capital investment analysis is employee morale.

Accepted Answer

Employee morale can impact the productivity and efficiency of a company, which in turn can impact the outcome of capital investment analysis. For example, if employee morale is low, it may affect the quality of output and cause a decline in customer satisfaction and revenue, ultimately affecting the success of the investment. Therefore, considering employee morale as a qualitative characteristic in capital investment analysis can provide valuable insights into the potential risks and rewards of the investment.

Question 20

The process by which management allocates available investment funds among competing capital investment proposals is termed capital rationing.

Accepted Answer

Capital rationing is the process of allocating limited resources (such as investment funds) among different investment opportunities or projects. Therefore, the statement is true.

Quiz 25: Capital Investment Analysis