Deck 14: Capital Investment Decisions

Question 1

A disadvantage of the payback period is that it ignores the time value of money.

Answer 1

True

Question 2

Projects that do not affect the cash flows of other projects are called mutually exclusive projects.

Answer 2

False

Question 3

One way to use the payback period is to set a maximum payback period for all projects and to reject any project that exceeds this level.

Answer 3

True

Question 4

In capital investment decision making,it is usually assumed that managers should select projects that attempt to maximize the wealth of the owners of the firm.

Question 5

Sometimes firms require riskier projects to have longer payback periods.

Question 6

Projects that if accepted preclude the acceptance of all other competing projects are called mutually exclusive projects.

Question 7

The two major categories of capital investment decision models are independent and mutually exclusive.

Question 8

In practice,managers often choose a discount rate that is higher than the cost of capital.

Question 9

Two discounting models for capital investment decision making are net present value and internal rate of return.

Question 10

Companies considering projects with shorter lives are interested in longer payback periods.

Question 11

The process of planning,setting goals and priorities,arranging financing,and using certain criteria to select long-term assets is called capital investment decisions.

Question 12

The minimum acceptable rate of return for a project is the required rate of return.

Question 13

Taxes are important consideration in forecasting cash flows.

Question 14

Only accounting rate of return ignores the time value of money.

Question 15

A disadvantage of the payback period is that it ignores a project's total profitability.

Question 16

In order to use the payback period model,the proposed investment must have even cash inflows.

Question 17

If cash flows are uneven,the payback period assumes that the inflows during the last fraction of a year occur evenly.

Question 18

The difference between the present value of the cash inflows and outflows associated with a project is the internal rate of return model.

Question 19

Before-tax cash flows must be forecasted and used in capital investment decision making.

Question 20

The payback period considers the profitability of a project over its entire life span.

Question 21

The internal rate of return is the most widely used of the capital investment techniques.

Question 22

Because of the postaudit,managers are more likely to make capital investment decisions in the best interests of the firm.

Question 23

Postaudits ensure that resources are used wisely by evaluating profitability.

Question 24

Companies that perform postaudits of capital projects experience a number of benefits.

Question 25

The interest rate that sets the present value of a project's cash inflows equal to the present value of the project's cost is called the internal rate of return.

Question 26

The internal audit staff is usually the best choice for performing a postaudit of a capital investment.

Question 27

A key element in the capital investment process is called a postaudit.

Question 28

A postaudit evaluates the overall outcome of the investment and proposes corrective action if needed.

Question 29

A disadvantage of postaudits is that they are costly.

Question 30

Net present value analysis and internal rate of return analysis can sometimes produce erroneous choices because they ignore the time value of money.

Question 31

Suppose that the actual cost of capital is 10 percent,but the firm chooses a discount rate of 18 percent.Managers of that company will be more likely to choose relatively short term investments.

Question 32

For independent projects,net present value analysis and internal rate of return analysis yield the same decision.

Question 33

Less objective results are obtainable if an independent party performs the postaudit of a capital investment.

Question 34

Postaudits supply feedback to managers that should help improve future decision making.

Question 35

One drawback to the internal rate of return model is that cash inflows must occur evenly over the life of the investment.

Question 36

A postaudit is an analysis of a capital project before it is implemented.

Question 37

The internal rate of return is the least widely used of the capital investment techniques.

Question 38

An obvious problem with postaudits is that the assumptions driving the original analysis may often be invalidated by changes in the actual operating environment.

Question 39

In general,it is best if postaudits are done by company management,since they understand the actual operating conditions.

Question 40

If the net present value of an investment is zero,the investment earns less than the minimum required rate of return.

Question 41

The ______________ is the time required for a firm to recover its original investment.

Question 42

_______________________ ignore the time value of money.

Question 43

_____________________ explicitly consider the time value of money.

Question 44

If the internal rate of return (IRR)is less than the required rate of return,the project is __________.

Question 45

The _______________________ is defined as the interest rate that sets the present value of a project's cash inflows equal to the present value of the project's cost.
or
or

Question 46

The two types of capital budgeting projects are ________________ and _______________.
or

Question 47

The internal rate of return model does not consistently result in choices that maximize firm wealth.

Question 48

If the internal rate of return (IRR)is greater than the required rate,the project is deemed ___________.

Question 49

_______________________ are the future cash flows expressed in terms of their present value.

Question 50

The major disadvantage of a postaudit is that it is ____________.

Question 51

The amount that must be invested now to produce a future value is known as the ____________ of the future amount.

Question 52

The process of making capital investment decisions often is referred to as ________________.

Question 53

The _________________________ measures the return on a project in terms of income.
or
or

Question 54

When choosing among competing alternatives the ________________ model may choose an inferior project.
or
or

Question 55

______________________ are projects that,if accepted or rejected,do not affect the cash flows of other projects.

Question 56

The difference between the present value of the cash inflows and the outflows associated with a project is known as the ___________________.

Question 57

_______________________ are concerned with the process of planning,setting goals and priorities,arranging financing,and using certain criteria to select long-term assets.

Question 58

When choosing among competing projects,the ___________________ model correctly identifies the best investment alternative.

Question 59

The ___________________ is the minimum acceptable rate of return.
or
or
or

Question 60

A key element in the capital investment process is a follow-up analysis of a capital project once it is implemented; this analysis is a called a _____________.

Question 61

Elena Wallace invested $150,000 in a project that pays her an even amount per year for 10 years.The payback period is 6 years.What are Elena's yearly cash inflows from the project?

A)$150,000
B)$15,000
C)$25,000
D)$90,000
E)cannot be determined from this information

Question 62

Which of the following is true of capital investment decision making?

A)It is used only for independent projects.
B)It is used only for mutually exclusive projects.
C)It requires that funding for a project must come from sources with the same opportunity cost of funds.
D)It is used to determine whether or not a firm should accept a special order.
E)None of these.

Question 63

In general terms,a sound capital investment will earn

A)back its original capital outlay.
B)a return greater than existing capital investments.
C)back its original capital outlay and provide a reasonable return on the original investment.
D)back its original capital outlay by the midpoint of its useful life.
E)none of these.

Question 64

Buster Evans is considering investing $20,000 in a project with the following annual cash revenues and expenses: Depreciation will be $4,000 per year.
What is the accounting rate of return on the investment?

A)15%
B)35%
C)70%
D)75%
E)none of these

Question 65

Which of the following is a drawback of the payback period?

A)It ignores a project's total profitability.
B)It uses a set discount rate.
C)It considers total profitability,requiring the forecasting of all future cash flows.
D)It uses before-tax cash flows rather than after-tax cash flows.
E)It uses operating income rather than cash flows.

Question 66

If the cash flows of a project are received evenly over the life of the project,the formula for the calculating the payback period is

A)original investment/annual cash flow.
B)original investment ´ annual cash flow.
C)original investment + annual cash flow.
D)original investment - annual cash flow.
E)(original investment + annual cash flow)/annual cash flow.

Question 67

The payback period provides information to managers that can be used to help

A)control the risks associated with the uncertainty of future cash flows.
B)minimize the impact of an investment on a firm's liquidity problems.
C)control the risk of obsolescence.
D)control the effect of the investment on performance measures.
E)all of these.

Question 68

Carol Harrison is considering an investment in a retail shopping mall.The initial investment is $400,000.She expects to receive cash income of $80,000 a year.What is the payback period?

A)4 year
B)3.5 years
C)5 years
D)2.5 years
E)6 years

Question 69

When the risk of obsolescence is high,managers will want

A)a shorter payback period.
B)a longer payback period.
C)a payback period equal to the life of the investment.
D)all of these.
E)none of these.

Question 70

One disadvantage of the payback period is that

A)it is sometimes used as a crude measure of risk.
B)managers may choose investments with quick payback periods to maximize short term criteria on which their own bonuses,etc.may be based.
C)it cannot be used for investments with unequal cash inflows.
D)it cannot be used if the entire cost of the investment does not occur immediately.
E)all of these.

Question 71

An investment of $5,000 provides an average net cash flows of $320 with zero salvage value.Depreciation is $35 per year.The accounting rate of return using the original investment is

A)4.0%
B)5.1%
C)5.7%
D)3.2%
E)2.4%

Question 72

Tessa Wilson invested in a project with a payback period of 6 years.The project brings $18,000 per year for a period of 9 years.What was the initial investment?

A)$108,000
B)$107,500
C)$162,000
D)$240,000
E)cannot be determined from this information

Question 73

Greg Moss has just invested $120,000 in a coffee shop.He expects to receive cash income of $15,000 a year.What is the payback period?

A)5 years
B)7.7 years
C)4.5 years
D)6.5 years
E)8 years

Question 74

Managers may use the accounting rate of return to evaluate potential investment projects because

A)debt contracts require that a firm maintain certain ratios that are affected by income and long-term asset levels.
B)it serves as a screening measure to insure that new investments do not affect key financial ratios.
C)bonuses to managers may be based on accounting income and/or return on assets.
D)it can be tied to the manager's personal income.
E)all of these.

Question 75

A formula for the accounting rate of return is

A)average income/initial investment.
B)initial investment/annual cash flow.
C)annual cash flow/initial investment.
D)initial investment/average income.
E)(average income + initial investment)/initial investment.

Question 76

A division manager was considering a project that required a significant initial investment.If accepted,the project could have a negative impact on certain financial ratios that the firm was required to maintain to satisfy debt contracts.To ensure that the ratios would not be adversely affected by the investment,the manager would use which of the following capital investment models?

A)Payback period
B)Accounting rate of return
C)Net present value
D)Internal rate of return
E)None of these

Question 77

Neil Morrison has just invested $130,000 in a restaurant.He expects to receive income of $24,000 a year,and to have the investment for 8 years.What is the accounting rate of return?

A)5.60%
B)18.46%
C)14.52%
D)12.41%
E)4.50%

Question 78

The time required for a firm to recover its original investment is the

A)internal rate of return.
B)net present value.
C)life of the project.
D)accounting rate of return.
E)payback period.

Question 79

The value of an investment at the end of its life is called its ________________.

Question 80

To make a capital investment decision,a manager must estimate the

A)quantity of cash flows.
B)timing of cash flows.
C)risk of the investment.
D)impact of the investment on the firm's profitability.
E)all of these.