Question 1

The methods of evaluating capital investment proposals can be grouped into two general categories: (1) methods that ignore present values and (2) methods that use present values.

Accepted Answer

This statement is true. The two general categories of evaluating capital investment proposals are methods that ignore present values (such as the payback period method) and methods that use present values (such as the net present value method and internal rate of return method).

Question 2

For years one through five, a proposed expenditure of $250,000 for a fixed asset with a 5-year life has expected net income of $40,000, $35,000, $25,000, $25,000, and $25,000, respectively, and net cash flows of $90,000, $85,000, $75,000, $75,000, and $75,000, respectively. The cash payback period is 2.5 years.

Accepted Answer

The cash payback period is calculated by summing the net cash flows until the initial investment is recovered. In this case, $90,000 in year 1 and $85,000 in year 2 total $175,000, which does not recover the $250,000 initial investment. By adding part of year 3's cash flow, the total exceeds $250,000, indicating the payback period is longer than 2.5 years.

Question 3

The excess of cash flowing in from revenues over the cash flowing out for expenses is termed net cash flow.

Accepted Answer

Net cash flow is the difference between cash inflows and cash outflows. If cash inflows exceed cash outflows, it results in positive or net cash flow.

Question 4

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and a $40,000 residual value, is expected to yield total net income of $500,000 for 5 years. The expected average rate of return is 50%.

Accepted Answer

The expected average rate of return is calculated as (Annual Net Income / Initial Investment) * 100. The annual net income can be estimated by subtracting the residual value from the total net income over the useful life, then dividing by the useful life. However, the provided statement does not correctly calculate the average rate of return based on the given figures.

Question 5

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and a $40,000 residual value, is expected to yield total net income of $200,000 for 5 years. The expected average rate of return on investment is 18.2%.

Accepted Answer

The expected average rate of return on investment can be calculated using the formula: [(Total net income - Residual value) / Initial investment] / Useful life. Plugging in the given values, we get [(200,000 - 40,000) / 400,000] / 5 = 0.036 or 3.6%. However, this is not the expected average rate of return on investment mentioned in the statement. Therefore, the statement is true.

Question 6

The excess of cash flowing in from revenues over the cash flowing out for expenses is termed net discounted cash flow.

Accepted Answer

The excess of cash flowing in from revenues over the cash flowing out for expenses is termed as net cash flow. Net discounted cash flow takes into account the time value of money and involves discounting future cash flows back to their present value.

Question 7

Average rate of return equals estimated average annual income divided by average investment.

Accepted Answer

This is the correct formula for calculating the average rate of return.

Question 8

The computations required for the net present value method are less than those the computation required for the average rate of return method.

Accepted Answer

The net present value (NPV) method involves more complex computations, including discounting future cash flows to their present value, which is more computationally intensive than calculating the average rate of return (ARR), which typically involves simpler arithmetic operations based on average annual profit and initial investment.

Question 9

A company should purchase an asset when the minimum rate of return exceeds its average rate of return.

Accepted Answer

A company should consider purchasing an asset when its average rate of return exceeds the minimum rate of return, indicating the investment is expected to perform above the minimum acceptable threshold.

Question 10

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is expected to yield total net income of $300,000 for 5 years. The expected average rate of return is 30%.

Accepted Answer

The expected average rate of return is calculated as follows:
Annual net income = $300,000/5 = $60,000
Average rate of return = Annual net income / Initial investment = $60,000 / $400,000 = 0.15 or 15%
Since the expected average rate of return is actually 30% (given in the question), the investment is expected to yield more than the required rate of return, making it a profitable investment. Therefore, the statement is true.

Question 11

The methods of evaluating capital investment proposals can be grouped into two general categories: (1) average rate of return method and (2) cash payback method.

Accepted Answer

The methods of evaluating capital investment proposals can be grouped into more than two categories, including not only the average rate of return method and the cash payback method but also the net present value method, the internal rate of return method, and others.

Question 12

The computations required for the net present value method are more than the computation required for the average rate of return method.

Accepted Answer

The net present value method requires discounting future cash flows to their present value, which involves more computation than the average rate of return method that only requires dividing average annual profit by the initial investment.

Question 13

The process by which management plans, evaluates, and controls long- term investment decisions involving fixed assets is called cost-volume-profit analysis.

Accepted Answer

The process described in the statement is actually capital budgeting, not cost-volume-profit analysis.

Question 14

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is expected to yield total net income of $200,000 for 5 years. The expected average rate of return on investment computed is 20%.

Accepted Answer

The expected average rate of return on investment is computed by dividing the total net income by the initial cost of the asset, and then multiplying by 100 to get a percentage. In this case, the total net income for 5 years is $200,000, and the initial cost of the asset is $400,000, so the expected average rate of return is:

($200,000 / $400,000) x 100 = 50%

Since the question states that the expected average rate of return is 20%, the statement is false. However, if the question were to state that the expected average rate of return is 50%, then the statement would be true.

Question 15

When evaluating a proposal by use of the net present value method, if there is a deficiency of the present value of future cash inflows over the amount to be invested, the proposal should be accepted.

Accepted Answer

If the present value of future cash inflows is less than the amount to be invested, the proposal should be rejected. The net present value of a project should be positive for it to be considered acceptable.

Question 16

Care must be taken while making capital investment decisions since it involves a long-term commitment of funds and affects operations for several years.

Accepted Answer

Capital investment decisions involve a significant amount of funds and have an impact on the business's operations for a long time. Therefore, caution and careful consideration must be exercised while making such decisions.

Question 17

Average rate of return equals average investment divided by estimated average annual income.

Accepted Answer

The average rate of return is calculated by dividing the total earnings from an investment by the initial amount invested, expressed as a percentage. It does not take into consideration the estimated average annual income.

Question 18

If the average rate of return on an asset exceeds the minimum rate of return for investments, the asset should be purchased.

Accepted Answer

If the average rate of return on an asset exceeds the minimum rate of return for investments, it means that the asset is generating more return than what is required. Therefore, it would be profitable to purchase such an asset.

Question 19

If a proposed expenditure of $80,000 for a fixed asset with a 4-year life has an annual expected net cash flow and net income of $32,000 and $12,000, respectively, the cash payback period is 2.5 years.

Accepted Answer

Cash Payback Period = Initial Investment / Annual Net Cash Flow = $80,000 / $32,000 = 2.5 years. The net income is not relevant in the calculation of cash payback period.

Question 20

The process by which management plans, evaluates, and controls long-term investment decisions involving fixed assets is called capital investment analysis.

Accepted Answer

This is a correct statement. Capital investment analysis refers to the process of decision-making regarding the allocation of funds for long-term assets, and involves planning, evaluating, and controlling investment decisions in fixed assets.

Quiz 15: Capital Investment Analysis