Question 1

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

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered, so they are not relevant to future decision-making. The timing of the investment's future cash flows, the investment's future profitability, and the initial cost of the investment and its estimated salvage value are all important financial considerations in capital budgeting.

Question 2

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

Accepted Answer

The average carrying value of an asset with no salvage value is calculated as the original cost of the asset divided by two. This is because the asset depreciates linearly over its useful life to a value of zero, making the average value half of its original cost.

Question 3

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

Accepted Answer

The discount rate is used to calculate the present value of future cash flows, not the other way around. It is determined by factors such as alternative investment opportunities, the nature of the investment, and the investor's cost of capital.

Question 4

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?

Accepted Answer

- The annual net income increase of $7,000 is a cash inflow, so it is considered in the calculation of the expected rate of return.
- Straight line depreciation is used, meaning that the depreciation expense is the same each year.
- The depreciation expense can be calculated as the cost of the investment divided by its useful life:
$80,000 / 5 years = $16,000 per year
- The total annual cash inflow is therefore:
$7,000 + $16,000 = $23,000 per year
- The expected rate of return can now be calculated as:
($23,000 / $80,000) x 100% = 28.75%
- Rounding this to one decimal place gives an expected rate of return of 28.8%, which is closest to choice C (8.8%). Therefore, choice C is the best answer.

Question 5

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

Accepted Answer

A sunk cost is a cost that has already been incurred and cannot be recovered regardless of future actions. It is therefore irrelevant in decision making because it cannot be changed or undone. Capital expenditure, incremental cost, and fixed cost do not necessarily have to be sunk costs.

Question 6

Which of the following is not considered a capital investment?

Accepted Answer

The purchase of a large order of raw materials used in the production process is not considered a capital investment as it is a current expense rather than a long-term investment in an asset or capability. The other options are all capital investments as they involve the acquisition or development of assets or capabilities for the purpose of generating future profits.

Question 7

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

Accepted Answer

Management typically wants a short payback period so that they can see a return on their investment quickly and use the funds for other projects or purposes. A longer payback period may be seen as a higher risk investment as it may take longer to recoup the initial investment and may also be subject to more market volatility or uncertainty. Profitability and usefulness are also important factors, but a short payback period is typically a key consideration in investment decision-making.

Question 8

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

Accepted Answer

Return on stockholders' equity is not considered a capital budgeting technique. It is a measure of a company's profitability and is used to assess how effectively it is using the shareholders' investments. The other options, payback period, return on average investment, and discounting of future cash flows, are all methods used in capital budgeting to evaluate the potential profitability of an investment.

Question 9

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

Accepted Answer

An increase in the required rate of return means that the investor will require a higher return on their investment to justify the risk. This will cause the present value of future cash flows to decrease, making it more difficult to accept the investment.

Question 10

The payback period:

Accepted Answer

The payback period is the length of time required to recover the entire cost of an investment from its resulting annual net cash flow. It does not consider the profitability of an investment over its entire life or the timing of its future cash flows.

Question 11

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

Accepted Answer

The net present value (NPV) method considers the time value of money by discounting all future cash flows back to their present value. This takes into account the fact that money received in the future is worth less than money received today, due to inflation and the opportunity cost of investing the money elsewhere. The payback method and the accounting rate of return do not consider the time value of money, while the average rate of return uses an average of profits rather than the actual cash flows. Therefore, the NPV method is the most appropriate choice for capital budgeting decisions.

Question 12

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

Accepted Answer

Annual net cash flow is the amount of cash that remains after subtracting annual cash disbursements from annual cash receipts. Option B correctly captures this calculation. Options A, C and D include non-cash items such as expenses, revenue and depreciation which do not directly impact annual net cash flow.

Question 13

The present value of money is always:

Accepted Answer

The present value of money is always less than its future amount because money loses value over time due to inflation and the opportunity cost of not investing it elsewhere. Therefore, we need to discount future cash flows to calculate their present value.

Question 14

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?

Accepted Answer

In deciding whether to replace the existing machinery, management should consider future costs which will be different under the two alternatives. Sunk costs (choice C) and historical costs (choice D) are not relevant as those costs are already incurred in the past and cannot be changed by the current decision. Future costs that will be classified as fixed rather than variable (choice A) are not particularly relevant in this instance as both the old and new machinery will likely have fixed costs associated with them. Therefore, the best choice is B as it directly pertains to the decision at hand.

Question 15

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:

Accepted Answer

The answer of If an investment costs $140,000 with no...

Question 16

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:

Accepted Answer

Depreciation is a non-cash expense, so it is added back to net income to calculate net cash flow.

Question 17

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

Accepted Answer

The payback method considers the initial investment as it calculates the time required to recover it from the cash inflows.

Question 18

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.

Accepted Answer

The net present value (NPV) is calculated by finding the present value of the cash flows and subtracting the initial investment. The present value of the annual cash flows is $16,000 * 3.170 = $50,720. The present value of the residual value is $7,000 * 0.683 = $4,781. Subtracting the initial cost of $46,000 gives an NPV of $50,720 + $4,781 - $46,000 = $9,501.

Question 19

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

Accepted Answer

The net present value method explicitly incorporates an estimate of an interest rate into the basic computation by discounting the cash flows of a project at a specified rate, which reflects the time value of money and the risk associated with the project. The other methods do not explicitly consider an interest rate in their calculations.

Question 20

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

Accepted Answer

Depreciation expense is considered a recovery of the amount originally invested in the asset over its useful life, as it allocates the asset's cost over its expected period of use.

Quiz 26: Capital Budgeting