Deck 13: Planning for Capital Investments

Question 1

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

Answer 1

True

Question 2

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

Answer 2

True

Question 3

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

Answer 3

False

Question 4

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

Question 5

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 6

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

Question 7

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

Question 8

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

Question 9

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

Question 10

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

Question 11

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

Question 12

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

Question 13

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

Question 14

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

Question 15

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 16

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

Question 17

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

Question 18

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

Question 19

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 20

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 21

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 22

An advantage of the annual rate of return method is that it relies on accrual accounting numbers rather than actual cash flows.

Question 23

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 officers 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 officers 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 24

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 25

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 26

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

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

Question 29

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 30

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

Question 31

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

Question 32

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 33

Carr Company is considering two capital investment proposals.Estimates regarding each project are provided below: $\begin{array}{ccc}&\text { Project Soup }& \text { Project Nuts }\\\text { Initial investment } & \$ 270,000 & \$ 600,000 \\\text { Annual net income } & 27,000 & 45,000 \\\text { Net annual cash inflow } & 90,000 & 142,000 \\\text { Estimated useful life } & 5 \text { years } & 6 \text { years } \\\text { Salvage value } & -0- & -0-\end{array}$ The cash payback period for Project Soup is

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

Question 34

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 35

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 36

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 37

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 38

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 39

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

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

Question 40

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 41

The major difficulty of the cash payback method is

A)it ignores any salvage values at the end of a project.
B)it ignores the time value of money in the calculations.
C)it ignores the overall cash flow of the project.
D)it ignores the overall profitability of the project.

Question 42

Cleaners, Inc.is considering purchasing equipment costing $30,000 with a 6-year useful life.The equipment will provide cost savings of $7,300 and will be depreciated straight-line over its useful life with no salvage value.Cleaners, Inc.requires a 10% rate of return.What is the approximate net present value of this investment? $\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\text { Present Value of an Annuity of } 1$
$\begin{array}{llcc}\underline{\text { Period }} &\underline{8 \%}&\underline{9 \%} & \underline{10 \%}&\underline{11 \%} &\underline{12 \%}& \underline{15 \%}\\6&4.623&4.486&4.355&4.231&4.111&3.784\end{array}$

A)$13,800
B)$1,792
C)$886
D)$2,748

Question 43

Doris Co.is considering purchasing a new machine which will cost $200,000, but which will decrease costs each year by $50,000.The useful life of the machine is 10 years.The machine would be depreciated straight-line with no residual value over its useful life at the rate of $20,000/year.The payback period is

A)5.0 years.
B)4.5 years.
C)4.0 years.
D)10.0 years.

Question 44

Tammy Co.is considering purchasing a machine that will produce annual savings of $22,000 at the end of the year.Tammy requires a 12% rate of return and the asset has a 5-year useful life.What is the maximum Tammy would be willing to pay for this machine? $\begin{array}{c}\begin{array}{lll}\underline{\text { Present Value of Annuity of } 1}&\\\underline{\text { Period }}&\underline{12 \%}\\5&3.605\end{array}\begin{array}{lll}\underline{\text { Present Value of } 1}\\\underline{\text { Period }}&\underline{12 \%}\\5&.567\end{array}\end{array}$

A)$43,386
B)$79,310
C)$110,000
D)$62,370

Question 45

Carr Company is considering two capital investment proposals.Estimates regarding each project are provided below: $\begin{array}{ccc}&\text { Project Soup }& \text { Project Nuts }\\\text { Initial investment } & \$ 270,000 & \$ 600,000 \\\text { Annual net income } & 27,000 & 45,000 \\\text { Net annual cash inflow } & 90,000 & 142,000 \\\text { Estimated useful life } & 5 \text { years } & 6 \text { years } \\\text { Salvage value } & -0- & -0-\end{array}$
$\text { The company requires a } 10 \% \text { rate of return on all new investments. }$
$\begin{array}{lllll}\begin{array}{c}\quad\quad\quad\underline{\text { Present Value of an Annuity of } 1}\\\end{array}\\\begin{array}{c}\underline{\text { Periods} } & \underline{9 \%} & \underline{10 \%} & \underline{11 \%} &\underline{ 12 \%}\\5 & 3.890 & 3.791 & 3.696 & 3.605 \\6 & 4486 & 4.355 & 4231 & 4111\end{array} \end{array}$ The net present value for Project Nuts is

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

Question 46

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 47

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 48

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 cash payback period?

A)12.5 years
B)5.56 years
C)3.85 years
D)3.57 years

Question 49

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 50

The cash payback method is useful because

A)it gives a broad indication when outlays will be recovered by the firm.
B)it gives a specific date as to when outlays will be recovered by the firm.
C)it avoids using complicated accounting data in capital budgeting decisions.
D)it is easy to communicate the relation between cash received and ultimate profitability of a project to everyone in the organization.

Question 51

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 52

Capital budgeting relies on cash inflows and outflows as preferred inputs for calculations because

A)managers prefer to use cash figures rather than accounting figures.
B)GAAP does not apply to capital budgeting decisions.
C)projects require cash paid out and firms want to know when cash will be returned.
D)cash figures are easier to calculate than accounting figures.

Question 53

Vault Company wants to purchase an asset with a 3-year useful life, which is expected to produce cash inflows of $10,000 each year for two years, and $15,000 in year 3.Vault has a 14% cost of capital, and uses the following factors.What is the present value of these future cash flows? $\text { Present Value of } 1$
$\begin{array}{ll}\text { Period }&14\%\\1 & .88 \\2 & .77 \\3 & .67\end{array}$

A)$30,800
B)$30,400
C)$26,550
D)$34,750

Question 54

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 55

Which of the following would NOT be considered as an input into a capital budgeting decision?

A)scrap value of equipment sold at the end of a project
B)labour savings as a result of mechanization of a process
C)cost outlays many years after the project has started
D)amortization on a straight line basis

Question 56

When the annual cash flows from an investment are unequal, the appropriate table to use is in the calculation of net present value 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 57

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 58

Mystery Co.is considering purchasing a new piece of equipment that will cost $600,000.The equipment has an estimated useful life of 8 years and no salvage value.The equipment will produce cash inflows of $215,000 per year and net income of $90,000 per year.Mystery requires a 10% rate of return.What is the payback period for this equipment?

A)8.0 years
B)3.75 years
C)2.79 years
D)6.67 years

Question 59

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 60

When evaluating a project, companies should always use

A)the Bank of Canada rate of interest.
B)the rate that is currently charged at its bank.
C)the current corporate borrowing rate.
D)the corporate borrowing rate adjusted for any perceived risk of the project.

Question 61

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 62

Peanut Co.is planning on investing in a new 2-year project, Project Jelly.Project Jelly is expected to produce cash flows of $100,000 and $120,000 in each of the 2 years, respectively.Peanut requires an internal rate of return of 15%.What is the maximum amount that Peanut should invest immediately in Project Jelly? $\begin{array}{c}\begin{array}{lll}\underline{\text { Present Value of } 1}&\\\underline{\text { Period }}&\underline{15 \%}\\1&.870\\2&.758\end{array}\begin{array}{lll}\underline{\text { Future Value of } 1}\\\underline{\text { Period }}&\underline{15 \%}\\1&1.150\\2&1.323\end{array}\end{array}$

A)$191.400
B)$177,720
C)$220,000
D)$273,760

Question 63

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 64

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 65

An intangible benefit of a project would best be described as

A)goodwill will be increased on the balance sheet as a result of the project.
B)the company's bankers may offer a lower rate of interest for certain projects.
C)the company's presence in its market is enhanced by the project which may result in additional sales of the company's other product lines.
D)the company may be allowed deferred income tax payment terms as a result of the project.

Question 66

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 67

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 68

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 69

Sensitivity analysis on a potential project

A)is only useful to perform when there are firm calculations on the project available.
B)is useful to perform when uncertainty exists and calculations are based on estimates.
C)is designed to ensure that management is aware of all possible outcomes of the project.
D)is designed to provide an escape-hatch for management should the project not succeed.

Question 70

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 71

Cleaners, Inc.is considering purchasing equipment costing $30,000 with a 6-year useful life.The equipment will provide cost savings of $7,300 and will be amortized using the straight-line method over its useful life with no salvage value.Cleaners, Inc.requires a 10% rate of return.What is the approximate profitability index associated with this equipment? $\quad$$\quad$$\quad$$\quad$$\quad$$\quad$$\text { Present Value of an Annuity of } 1$$\begin{array}{llcc}\underline{\text { Period }} &\underline{8 \%}&\underline{9 \%} & \underline{10 \%}&\underline{11 \%} &\underline{12 \%}& \underline{15 \%}\\6&4.623&4.486&4.355&4.231&4.111&3.784\end{array}$

A)1.23
B)1.03
C)1.06
D)73

Question 72

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 73

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 74

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 75

When accepting large capital projects, a company should

A)pay strict attention to what the numbers indicate and accept or reject a project accordingly.
B)pay close attention to trends in the marketplace before accepting or rejecting a project.
C)assess the numbers on the project and then go with management's best judgment.
D)assess the numbers on the project then review the intangible benefits before accepting or rejecting a project

Question 76

The major difference between the Net Present Value method and the Annual Rate of Return method in evaluating a capital project is

A)the ARR method is easier for accountants to justify than the NPV method.
B)the NPV method is easier for managers to justify than the ARR method.
C)the ARR method focuses on overall profitability of a project.
D)the NPV method focuses on the overall profitability of a project.

Question 77

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 78

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 79

The following information is available for a potential investment for Panda Company: $\begin{array}{lr}\text { Initial investment } & \$ 40,000 \\\text { Net annual cash inflow } & 10,000 \\\text { Net present value } & 18,112 \\\text { Salvage value } & 5,000 \\\text { Useful life } & 10 \text { yrs. }\end{array}$ The potential investment's profitability index is

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

Question 80

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.