Deck 13: Planning for Capital Investments

Question 1

The profitability index allows comparison of the relative desirability of projects that require differing initial investments.

Answer 1

True

Question 2

The cash payback period is calculated by dividing the cost of the capital investment by the annual cash inflow.

Answer 2

True

Question 3

Sensitivity analysis uses a number of outcome estimates to get a sense of the variability among potential returns.

Answer 3

True

Question 4

By ignoring intangible benefits, capital budgeting techniques might incorrectly eliminate projects that could be beneficial to the company.

Question 5

A well-run organization should perform an evaluation, called a post-audit, of its investment projects before their completion.

Question 6

The interest yield of a project is a rate that will cause the present value of the proposed capital expenditure to equal the present value of the expected annual cash inflows.

Question 7

The cost of capital is a weighted average of the rates paid on borrowed funds, as well as on funds provided by investors in the company's shares.

Question 8

The net present value method can only be used in capital budgeting if the expected cash flows from a project are an equal amount each year.

Question 9

The capital budgeting committee ultimately approves the capital expenditure budget for the year.

Question 10

One way of incorporating intangible benefits into the capital budgeting decision is to project conservative estimates of the value of the intangible benefits and include them in the NPV calculation.

Question 11

The cash payback method is frequently used as a screening tool but it does not take into consideration the profitability of a project.

Question 12

Post-audits create an incentive for managers to make accurate estimates, since managers know that their results will be evaluated.

Question 13

Using the net present value method, a net present value of zero indicates that the project would not be acceptable.

Question 14

The internal rate of return method is, like the NPV method, a discounted cash flow technique.

Question 15

The cash payback technique is a quick way to calculate a project's net present value.

Question 16

The profitability index is calculated by dividing the total cash flows by the initial investment.

Question 17

Capital budgeting decisions usually involve large investments and often have a significant impact on a company's future profitability.

Question 18

To avoid accepting projects that actually should be rejected, a company should ignore intangible benefits in calculating net present value.

Question 19

A post-audit is an evaluation of how well a project's actual performance matches the projections made when the project was proposed.

Question 20

For purposes of capital budgeting, estimated cash inflows and outflows are preferred for inputs into the capital budgeting decision tools.

Question 21

Which of the following represents a cash outflow?

A)overhaul of equipment
B)increased cash received from customers
C)reduced cash flows for operating costs
D)salvage value of equipment when project is completed

Question 22

If an asset costs $60,000 and is expected to have a $5,000 salvage value at the end of its nine-year life, and generates annual net cash inflows of $10,000 each year, the cash payback period is

A)6.5 years.
B)6 years.
C)5.5 years.
D)9 years.

Question 23

The higher the risk element in a project, the

A)more attractive the investment.
B)higher the net present value.
C)higher the cost of capital.
D)higher the discount rate.

Question 24

When using the cash payback technique, the payback period is expressed in terms of

A)a percent.
B)dollars.
C)years.
D)months.

Question 25

The cash payback period is calculated by dividing the cost of the capital investment by the

A)annual net income.
B)net annual cash inflow.
C)present value of the cash inflow.
D)present value of the net income.

Question 26

Bark Company is considering buying a machine for $120,000 with an estimated life of ten years and no salvage value.The straight-line method of depreciation will be used.The machine is expected to generate net income of $8,000 each year.The cash payback period on this investment is

A)15 years.
B)10 years.
C)6 years.
D)3 years.

Question 27

The capital budgeting decision depends in part on the

A)availability of funds.
B)relationships among proposed projects.
C)risk associated with a particular project.
D)all of these.

Question 28

The discount rate is referred to by all of the following alternative names except the

A)cost of capital.
B)cutoff rate.
C)hurdle rate.
D)required rate of return.

Question 29

The capital budget for the year is approved by a company's

A)board of directors.
B)capital budgeting committee.
C)officers.
D)shareholders.

Question 30

The annual rate of return method requires dividing a project's annual cash inflows by the economic life of the project.

Question 31

The rate that a company must pay to obtain funds from creditors and shareholders s known as the

A)hurdle rate.
B)cost of capital.
C)cutoff rate.
D)all of these.

Question 32

Which of the following represents a cash inflow?

A)the initial investment
B)sale of old equipment
C)repairs and maintenance
D)increased operating costs

Question 33

A disadvantage of the cash payback technique is that it

A)ignores obsolescence factors.
B)ignores the cost of an investment.
C)is complicated to use.
D)ignores the time value of money.

Question 34

If a payback period for a project is greater than its expected useful life, the

A)project will always be profitable.
B)entire initial investment will not be recovered.
C)project would only be acceptable if the company's cost of capital was low.
D)project's return will always exceed the company's cost of capital.

Question 35

The cash payback technique

A)should be used as a final screening tool.
B)can be the only basis for the capital budgeting decision.
C)is relatively easy to calculate and understand.
D)considers the expected profitability of a project.

Question 36

A major advantage of the annual rate of return method is that it considers the time value of money.

Question 37

Which of the following describes the capital budgeting evaluation process?

A)The capital budget committee submits its proposals to the officers of the company who choose which projects will be forwarded to the shareholders for ultimate approval.
B)The officiers of the company submit their proposals to the capital budget committee who choose which projects will be forwarded to the shareholders for ultimate approval.
C)The officiers of the company submit their proposals to the capital budget committee who choose which projects will be forwarded to the board of directors for ultimate approval.
D)The capital budget committee submits its proposal to the officers of the company who choose which projects will be forwarded to the board of directors for ultimate approval.

Question 38

Using the annual rate of return method, a project is acceptable if its rate of return is greater than management's minimum rate of return.

Question 39

Capital budgeting is the process

A)used in sell or process further decisions.
B)of determining how many common shares to issue.
C)of making capital expenditure decisions.
D)of eliminating unprofitable product lines.

Question 40

Using the internal rate of return method, a project is rejected when the rate of return is greater than or equal to the required rate of return.

Question 41

Post-audits of capital projects

A)are usually foolproof.
B)are done using different evaluation techniques than were used in making the original capital budgeting decision.
C)provide a formal mechanism by which the company can determine whether existing projects should be supported or terminated.
D)all of these.

Question 42

In evaluating high-tech projects

A)only tangible benefits should be considered.
B)only intangible benefits should be considered.
C)both tangible and intangible benefits should be considered.
D)neither tangible nor intangible benefits should be considered.

Question 43

Intangible benefits in capital budgeting

A)should be ignored because they are difficult to determine.
B)include increased quality or employee loyalty.
C)are not considered because they are usually not relevant to the decision.
D)have a rate of return in excess of the company's cost of capital.

Question 44

Intangible benefits in capital budgeting would include all of the following except increased

A)product quality.
B)employee loyalty.
C)salvage value.
D)product safety.

Question 45

If a company uses a 12% discount rate with the net present value method, and then does the same analysis, but with a 15% discount rate, which of the following is likely to occur?

A)The 12% rate will show the project is more profitable than the 15% rate.
B)The 15% rate will show the project is more profitable than the 12% rate.
C)Both rates will produce the same net present value.
D)The relative profitability of the two studies depends only on the timing of the cash flows, not on the discount rate.

Question 46

The following information is available for a potential investment for Panda Company: The potential investment's profitability index is

A)4.00.
B)2.85.
C)2.50.
D)1.45.

Question 47

The capital budgeting method that takes into account both the size of the original investment and the discounted cash flows is the

A)cash payback method.
B)internal rate of return method.
C)net present value method.
D)profitability index.

Question 48

An approach that uses a number of outcome estimates to get a sense of the variability among potential returns is

A)the discounted cash flow technique.
B)the net present value method.
C)risk analysis.
D)sensitivity analysis.

Question 49

A post-audit should be performed using

A)a different evaluation technique than that used in making the original decision.
B)the same evaluation technique used in making the original decision.
C)estimated amounts instead of actual figures.
D)an independent advisor.

Question 50

The capital budgeting method that allows comparison of the relative desirability of projects that require differing initial investments is the

A)cash payback method.
B)internal rate of return method.
C)net present value method.
D)profitability index.

Question 51

The profitability index is calculated by dividing the

A)total cash flows by the initial investment.
B)present value of cash flows by the initial investment.
C)initial investment by the total cash flows.
D)initial investment by the present value of cash flows.

Question 52

The profitability index

A)does not take into account the discounted cash flows.
B)is calculated by dividing total cash flows by the initial investment.
C)allows comparison of the relative desirability of projects that require differing initial investments.
D)will never be greater than 1.

Question 53

If a company's required rate of return is 10% and, in using the net present value method, a project's net present value is zero, this indicates that the

A)project's rate of return exceeds 10%.
B)project's rate of return is less than the minimum rate required.
C)project earns a rate of return of 10%.
D)project earns a rate of return of 0%.

Question 54

A thorough evaluation of how well a project's actual performance matches the projections made when the project was proposed is called a

A)pre-audit.
B)post-audit.
C)risk analysis.
D)sensitivity analysis.

Question 55

If a company's required rate of return is 9%, and in using the profitability index method, a project's index is greater than 1, this indicates that the project's rate of return is

A)equal to 9%.
B)greater than 9%.
C)less than 9%.
D)unacceptable for investment purposes.

Question 56

All of the following statements about intangible benefits in capital budgeting are correct except that they

A)include increased quality and employee loyalty.
B)are difficult to quantify.
C)are often ignored in capital budgeting decisions.
D)cannot be incorporated into the NPV calculation.

Question 57

When the annual cash flows from an investment are unequal, the appropriate table to use is the

A)future value of 1 table.
B)future value of annuity table.
C)present value of 1 table.
D)present value of annuity table.

Question 58

Which of the following assumptions is made in order to simplify the net present value method?

A)All cash flows come at the end of the year.
B)All cash flows are immediately reinvested at the best rate available at the time.
C)All cash flows come at the beginning of the year.
D)All cash flows are not reinvested.

Question 59

Using the profitability index method, the present value of cash inflows for Project Flower is $88,000 and the present value of cash inflows of Project Plant is $48,000.If Project Flower and Project Plant require initial investments of $90,000 and $40,000, respectively, and have the same useful life, the project that should be accepted is

A)Project Flower.
B)Project Plant.
C)Either project may be accepted.
D)Neither project should be accepted.

Question 60

Using a number of outcome estimates to get a sense of the variability among potential returns is

A)financial analysis.
B)post-audit analysis.
C)sensitivity analysis.
D)outcome analysis.

Question 61

All of the following statements about the internal rate of return method are correct except that it

A)recognizes the time value of money.
B)is widely used in practice.
C)is easy to interpret.
D)can be used only when the cash inflows are equal.

Question 62

In using the internal rate of return method, the internal rate of return factor was 4.0 and the equal annual cash inflows were $16,000.The initial investment in the project must have been

A)$8,000.
B)$16,000.
C)$64,000.
D)$32,000.

Question 63

What is the main disadvantage of the annual rate of return method?

A)It is only valid for investments with a one year time perspective.
B)It incorporates depreciation into the calculations, which increases the uncertainty of the calculations associated with estimating the life and salvage value of the investment.
C)No consideration is given as to when the cash inflows occur.
D)It does not consider the time value of money.

Question 64

The annual rate of return method is also referred to as:

A)simple rate of return method.
B)accounting rate of return method.
C)unadjusted rate of return method.
D)all of the above.

Question 65

Use the following table for questions .
A company has a minimum required rate of return of 9% and is considering investing in a project that costs $50,000 and is expected to generate cash inflows of $30,000at the end of each year for two years.The net present value of this project is

A)$20,000.
B)$10,000.
C)$6,920.
D)$2,770.

Question 66

Use the following information for questions
Carr Company is considering two capital investment proposals.Estimates regarding each project are provided below: The company requires a 10% rate of return on all new investments.
The internal rate of return for Project Nuts is approximately

A)10%.
B)11%.
C)12%.
D)9%.

Question 67

Use the following information for questions
Carr Company is considering two capital investment proposals.Estimates regarding each project are provided below: The company requires a 10% rate of return on all new investments.
The annual rate of return for Project Soup is

A)13.3%.
B)10%.
C)33.3%.
D)30%.

Question 68

Use the following table for questions .
A company has a minimum required rate of return of 9% and is considering investing in a project that costs $50,000 and is expected to generate cash inflows of $20,000 at the end of each year for three years.The profitability index for this project is

A).99.
B)1.00.
C)1.01.
D)1.20.

Question 69

Use the following information for questions
Carr Company is considering two capital investment proposals.Estimates regarding each project are provided below: The company requires a 10% rate of return on all new investments.
The cash payback period for Project Soup is

A)13.5 years.
B)5 years.
C)3.9 years.
D)3 years.

Question 70

Use the following information for questions
Carr Company is considering two capital investment proposals.Estimates regarding each project are provided below: The company requires a 10% rate of return on all new investments.
The net present value for Project Nuts is

A)$618,410.
B)$182,912.
C)$100,000.
D)$18,410.

Question 71

Performing a post-audit is important because

A)managers will be more likely to submit reasonable data when they make investment proposals if they know their estimates will be compared to actual results.
B)it provides a formal mechanism by which the company can determine whether existing projects should be terminated.
C)it improves the development of future investment proposals because managers improve their estimation techniques by evaluating their past successes and failures.
D)all of these.

Question 72

Use the following information for questions
A company projects an increase in net income of $40,000 each year for the next five years if it invests $500,000 in new equipment.The equipment has a five-year life and an estimated salvage value of $50,000.The company uses the straight-line method of depreciation.
What is the net annual cash flow?

A)$40,000
B)$90,000
C)$130,000
D)$140,000

Question 73

Use the following table for questions .
A company has a minimum required rate of return of 10% and is considering investing in a project that requires an investment of $68,000 and is expected to generate cash inflows of $30,000 at the end of each year for 3 years.The present value of future cash inflows for this project is

A)$68,000.
B)$74,610.
C)$7,930.
D)$6,610

Question 74

A capital budgeting method that takes into consideration the time value of money is the

A)annual rate of return method.
B)return on shareholders' equity method.
C)cash payback technique.
D)internal rate of return method.

Question 75

Use the following information for questions
A company is considering purchasing factory equipment that costs $400,000 and is estimated to have no salvage value at the end of its 5-year useful life.If the equipment is purchased, annual revenues are expected to be $150,000 and annual operating expenses exclusive of depreciation expense are expected to be $25,000.The straight-line method of depreciation would be used.
If the equipment is purchased, the annual rate of return expected on this equipment is

A)37.5%.
B)31.25%.
C)11.25%.
D)6.25%.

Question 76

The annual rate of return method is based on

A)accounting data.
B)the time value of money data.
C)market values.
D)cash flow data.

Question 77

The capital budgeting technique that finds the interest yield of the potential investment is the

A)annual rate of return method.
B)internal rate of return method.
C)net present value method.
D)profitability index method.

Question 78

Use the following information for questions
A company is considering purchasing factory equipment that costs $400,000 and is estimated to have no salvage value at the end of its 5-year useful life.If the equipment is purchased, annual revenues are expected to be $150,000 and annual operating expenses exclusive of depreciation expense are expected to be $25,000.The straight-line method of depreciation would be used.
The cash payback period on the equipment is

A)8.89 years.
B)5.0 years.
C)3.2 years.
D)2.67 years.

Question 79

Use the following table for questions .
A company has a minimum required rate of return of 8% and is considering investing in a project that costs $67,145 and is expected to generate cash inflows of $27,000 each year for three years.The approximate internal rate of return on this project is

A)8%.
B)10%.
C)9%.
D)less than the required 8%.

Question 80

The internal rate of return is the interest rate that results in a

A)positive NPV.
B)negative NPV.
C)zero NPV.
D)positive or negative NPV.