Deck 14: Capital Budgeting Decisions

Question 1

The internal rate of return is the rate of return of an investment project over its useful life.

Answer 1

True

Question 2

When the net cash inflow is the same every year for a project after the initial investment, the internal rate of return of a project can be determined by dividing the initial investment required in the project by the annual net cash inflow. This computation yields a factor that can be looked up in a table of present values of annuities to find the internal rate of return.

Answer 2

True

Question 3

The minimum required rate of return is the discount rate that makes the net present value of the project equal to zero.

Answer 3

False

Question 4

The payback method is most appropriate for projects whose cash flows do not extend far into the future.

Question 5

The internal rate of return method assumes that the cash flows generated by the project are immediately reinvested elsewhere at a rate of return that equals the company's cost of capital.

Question 6

Discounted cash flow techniques automatically take into account recovery of the initial investment.

Question 7

An investment project with a profitability index of 0.04 has an internal rate of return that is less than the discount rate.

Question 8

Neither the net present value method nor the internal rate of return method can be used as a screening tool in capital budgeting decisions.

Question 9

The net present value method assumes that cash flows from a project are immediately reinvested at a rate of return equal to the internal rate of return.

Question 10

The cost of capital is the average rate of return that the company earns on its investments.

Question 11

The salvage value of new equipment should not be considered when using the internal rate of return method to evaluate a project.

Question 12

A shorter payback period does not necessarily mean that one investment is more desirable than another.

Question 13

If the salvage value of equipment at the end of a project is highly uncertain, the salvage value should be ignored in capital budgeting decisions.

Question 14

When a company is cash poor, a project with a short payback period but a low rate of return may be preferred to a project with a long payback period and a high rate of return.

Question 15

If the internal rate of return is less than the required rate of return for a project, then the net present value of that project is positive.

Question 16

In calculating the payback period where new equipment is replacing old equipment, any salvage value to be received on disposal of the old equipment should be deducted from the cost of the new equipment.

Question 17

An increase in the expected salvage value at the end of a capital budgeting project will increase the internal rate of return for that project.

Question 18

The internal rate of return is computed by finding the discount rate that equates the present value of a project's cash outflows with the present value of its cash inflows.

Question 19

When discounted cash flow methods of capital budgeting are used, the working capital required for a project is ordinarily counted as a cash outflow at the beginning of the project and as a cash inflow at the end of the project.

Question 20

The required rate of return is the maximum rate of return that an investment project must yield to the acceptable.

Question 21

If investment funds are limited, the net present value of one project should not be compared directly to the net present value of another project unless the initial investments in these projects are equal.

Question 22

The simple rate of return focuses on cash flows rather than on accounting net operating income.

Question 23

The present value of a cash flow increases as it moves further into the future.

Question 24

The present value of a given future cash flow will decrease as the discount rate decreases.

Question 25

A capital budgeting project's incremental net income computation for purposes of determining incremental tax expense includes investments in working capital.

Question 26

The investment in working capital at the start of an investment project can be deducted from revenues when computing taxable income.

Question 27

When the internal rate of return method is used to rank investment proposals, the higher the internal rate of return, the more desirable the investment.

Question 28

The higher the discount rate, the higher the present value of a given future cash flow.

Question 29

All cash inflows are taxable.

Question 30

Depreciation expense is not included in the computation of incremental net income when determining the income tax expense associated with a capital budgeting project.

Question 31

When computing the profitability index of an investment project, the investment required should exclude any investment made in working capital at the beginning of the project.

Question 32

In calculating the "investment required" for the profitability index, the amount invested should not be reduced by any salvage recovered from the sale of old equipment.

Question 33

The simple rate of return is computed by dividing the annualincremental net operating income generated by a project by the initial investment in the project.

Question 34

In preference decisions, the profitability index and internal rate of return methods will rank projects in the same order of preference.

Question 35

The present value of an amount to be received in five years is exactly twice as large as the present value of an equal amount to be received in ten years.

Question 36

When a company invests in equipment, it is not ordinarily allowed to immediately expense the entire cost of the equipment when computing taxable income.

Question 37

Income taxes have no effect on whether a capital budgeting project should or should not be accepted in a for-profit company.

Question 38

Under the simplifying assumptions made in the text, to calculate the amount of income tax expense associated with an investment project, first calculate the incremental net cash inflow during each year of the project and then multiply each year's incremental net cash inflow by the tax rate.

Question 39

A capital budgeting project's incremental net income computation for purposes of determining incremental tax expense includes immediate cash outflows for initial investments in equipment.

Question 40

The present value of a cash flow will never be greater than the future dollar amount of the cash flow.

Question 41

The management of Lanzilotta Corporation is considering a project that would require an investment of $218,000 and would last for 6 years. The annual net operating income from the project would be $106,000, which includes depreciation of $31,000. The scrap value of the project's assets at the end of the project would be $26,000. The cash inflows occur evenly throughout the year. The payback period of the project is closest to (Ignore income taxes.): (Round your answer to 1 decimal place.)

A) 1.6 years
B) 2.1 years
C) 1.3 years
D) 2.8 years

Question 42

Ataxia Fitness Center is considering an investment in some additional weight training equipment. The equipment has an estimated useful life of 11 years with no salvage value at the end of the 11 years. Ataxia's internal rate of return on this equipment is 6%. Ataxia's discount rate is also 6%. The payback period on this equipment is closest to (Ignore income taxes.):Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.

A) 11 years
B) 7.887 years
C) 6 years
D) 8.987 years

Question 43

An investment project requires an initial investment of $100,000. The project is expected to generate net cash inflows of $28,000 per year for the next five years. These cash inflows occur evenly throughout the year. Assuming a 12% discount rate, the project's payback period is (Ignore income taxes.):

A) 0.28 years
B) 3.36 years
C) 3.57 years
D) 1.40 years

Question 44

The profitability index and the internal rate of return:

A) will always result in the same preference ranking for investment projects.
B) will sometimes result in different preference rankings for investment projects.
C) are less dependable than the payback method in ranking investment projects.
D) are less dependable than net present value in ranking investment projects.

Question 45

A company with $810,000 in operating assets is considering the purchase of a machine that costs $86,000 and which is expected to reduce operating costs by $18,000 each year. These reductions in cost occur evenly throughout the year. The payback period for this machine in years is closest to (Ignore income taxes.): (Round your answer to 1 decimal place.)

A) 4.8 years
B) 9.4 years
C) 0.21 years
D) 45 years

Question 46

The assumption that the cash flows from an investment project are reinvested at the company's discount rate applies to:

A) both the internal rate of return and the net present value methods.
B) only the internal rate of return method.
C) only the net present value method.
D) neither the internal rate of return nor net present value methods.

Question 47

A preference decision in capital budgeting:

A) is concerned with whether a project clears the minimum required rate of return hurdle.
B) comes before the screening decision.
C) is concerned with determining which of several acceptable alternatives is best.
D) involves using market research to determine customers' preferences.

Question 48

The internal rate of return method assumes that a project's cash flows are reinvested at the:

A) internal rate of return.
B) simple rate of return.
C) required rate of return.
D) payback rate of return.

Question 49

The Zingstad Corporation is considering an investment with the following data (Ignore income taxes.): Cash inflows occur evenly throughout the year. The payback period for this investment is:

A) 3.0 years
B) 3.5 years
C) 4.0 years
D) 4.5 years

Question 50

Rennin Dairy Corporation is considering a plant expansion decision that has an estimated useful life of 20 years. This project has an internal rate of return of 15% and a payback period of 9.6 years. How would a decrease in the expected salvage value from this project in 20 years affect the following for this project?

A) Choice A
B) Choice B
C) Choice C
D) Choice D
E) Choice E

Question 51

Buy-Rite Pharmacy has purchased a small auto for delivering prescriptions. The auto was purchased for $31,000 and will have a 6-year useful life and a $4,300 salvage value. Delivering prescriptions (which the pharmacy has never done before) should increase gross revenues by at least $32,300 per year. The cost of these prescriptions to the pharmacy will be about $25,600 per year. The pharmacy depreciates all assets using the straight-line method. The payback period for the auto is closest to (Ignore income taxes.): (Round your answer to 1 decimal place.)

A) 4.6 years
B) 4 years
C) 5.3 years
D) 3.8 years

Question 52

If the net present value of a project is zero based on a discount rate of 16%, then the internal rate of return is:

A) equal to 16%.
B) less than 16%.
C) greater than 16%.
D) cannot be determined from this data.

Question 53

Olinick Corporation is considering a project that would require an investment of $329,000 and would last for 8 years. The incremental annual revenues and expenses generated by the project during those 8 years would be as follows (Ignore income taxes.): The scrap value of the project's assets at the end of the project would be $25,000. The cash inflows occur evenly throughout the year. The payback period of the project is closest to: (Round your answer to 1 decimal place.)

A) 3.2 years
B) 5.4 years
C) 4.3 years
D) 2.8 years

Question 54

Jarvey Corporation is studying a project that would have a ten-year life and would require a $450,000 investment in equipment which has no salvage value. The project would provide net operating income each year as follows for the life of the project (Ignore income taxes.): The company's required rate of return is 12%. The payback period for this project is closest to:

A) 3 years
B) 2 years
C) 4.28 years
D) 9 years

Question 55

The management of Lanzilotta Corporation is considering a project that would require an investment of $263,000 and would last for 8 years. The annual net operating income from the project would be $66,000, which includes depreciation of $31,000. The scrap value of the project's assets at the end of the project would be $15,000. The cash inflows occur evenly throughout the year. The payback period of the project is closest to (Ignore income taxes.):

A) 3.8 years
B) 2.6 years
C) 2.7 years
D) 4.0 years

Question 56

Olinick Corporation is considering a project that would require an investment of $343,000 and would last for 8 years. The incremental annual revenues and expenses generated by the project during those 8 years would be as follows (Ignore income taxes.): The scrap value of the project's assets at the end of the project would be $23,000. The cash inflows occur evenly throughout the year. The payback period of the project is closest to:

A) 3.0 years
B) 5.1 years
C) 3.2 years
D) 4.8 years

Question 57

A company has unlimited funds to invest at its discount rate. The company should invest in all projects having:

A) an internal rate of return greater than zero.
B) a net present value greater than zero.
C) a simple rate of return greater than the discount rate.
D) a payback period less than the project's estimated life.

Question 58

A company with $500,000 in operating assets is considering the purchase of a machine that costs $60,000 and which is expected to reduce operating costs by $15,000 each year. These reductions in cost occur evenly throughout the year. The payback period for this machine in years is closest to (Ignore income taxes.):

A) 0.25 years
B) 8.3 years
C) 4 years
D) 33.3 years

Question 59

Some investment projects require that a company increase its working capital. Under the net present value method, the investment and eventual recovery of working capital should be treated as:

A) an initial cash outflow.
B) a future cash inflow.
C) both an initial cash outflow and a future cash inflow.
D) irrelevant to the net present value analysis.

Question 60

Buy-Rite Pharmacy has purchased a small auto for delivering prescriptions. The auto was purchased for $24,000 and will have a 6-year useful life and a $6,000 salvage value. Delivering prescriptions (which the pharmacy has never done before) should increase gross revenues by at least $28,000 per year. The cost of these prescriptions to the pharmacy will be about $22,000 per year. The pharmacy depreciates all assets using the straight-line method. The payback period for the auto is closest to (Ignore income taxes.):

A) 2 years
B) 1.8 years
C) 4 years
D) 1.2 years

Question 61

Moates Corporation has provided the following data concerning an investment project that it is considering: Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.The net present value of the project is closest to:

A) $378,963
B) $(31,037)
C) $410,000
D) $58,000

Question 62

Byerly Corporation has provided the following data concerning an investment project that it is considering: Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.The working capital would be released for use elsewhere at the end of the project. The net present value of the project is closest to:

A) $(151,658)
B) $(105,847)
C) $11,000
D) $(44,847)

Question 63

Haroldsen Corporation is considering a capital budgeting project that would require an initial investment of $350,000. The investment would generate annual cash inflows of $133,000 for the life of the project, which is 4 years. At the end of the project, equipment that had been used in the project could be sold for $32,000. The company's discount rate is 14%. The net present value of the project is closest to:Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.

A) $214,000
B) $37,429
C) $56,373
D) $406,373

Question 64

Fossa Road Paving Corporation is considering an investment in a curb-forming machine. The machine will cost $240,000, will last 10 years, and will have a $40,000 salvage value at the end of 10 years. The machine is expected to generate net cash inflows of $60,000 per year in each of the 10 years. Fossa's discount rate is 18%. The net present value of the proposed investment is closest to (Ignore income taxes.):Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.

A) $5,840
B) $37,280
C) $(48,780)
D) $69,640

Question 65

Respass Corporation has provided the following data concerning an investment project that it is considering: Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.The net present value of the project is closest to:

A) $67,000
B) $160,516
C) $516
D) $(5,776)

Question 66

Charlie Corporation is considering buying a new donut maker. This machine will replace an old donut maker that still has a useful life of 6 years. The new machine will cost $3,740 a year to operate, as opposed to the old machine, which costs $4,150 per year to operate. Also, because of increased capacity, an additional 21,400 donuts a year can be produced. The company makes a contribution margin of $0.10 per donut. The old machine can be sold for $8,400 and the new machine costs $31,400. The incremental annual net cash inflows provided by the new machine would be (Ignore income taxes.):

A) $2,550
B) $410
C) $2,140
D) $6,260

Question 67

Moates Corporation has provided the following data concerning an investment project that it is considering: Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.The net present value of the project is closest to: (Round your intermediate calculations and final answer to the nearest whole dollar amount.)

A) $280,000
B) $134,592
C) $(152,000)
D) $(134,592)

Question 68

Puello Corporation has provided the following data concerning an investment project that it is considering: Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.The life of the project is 4 years. The company's discount rate is 8%. The net present value of the project is closest to:

A) $480,000
B) $480,240
C) $100,000
D) $240

Question 69

Stomberg Corporation has provided the following data concerning an investment project that it is considering: Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.The life of the project is 4 years. The company's discount rate is 10%. The net present value of the project is closest to:

A) $184,000
B) $579,982
C) $29,982
D) $20,420

Question 70

Dowlen, Incorporated, is considering the purchase of a machine that would cost $150,000 and would last for 6 years. At the end of 6 years, the machine would have a salvage value of $23,000. The machine would reduce labor and other costs by $36,000 per year. Additional working capital of $6,000 would be needed immediately. All of this working capital would be recovered at the end of the life of the machine. The company requires a minimum pretax return of 12% on all investment projects. The net present value of the proposed project is closest to (Ignore income taxes.):Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.

A) $9,657
B) $(2,004)
C) $6,699
D) $13,223

Question 71

Charlie Corporation is considering buying a new donut maker. This machine will replace an old donut maker that still has a useful life of 6 years. The new machine will cost $3,600 a year to operate, as opposed to the old machine, which costs $3,800 per year to operate. Also, because of increased capacity, an additional 20,000 donuts a year can be produced. The company makes a contribution margin of $0.10 per donut. The old machine can be sold for $7,000 and the new machine costs $30,000. The incremental annual net cash inflows provided by the new machine would be (Ignore income taxes.):

A) $2,200
B) $200
C) $2,000
D) $5,000

Question 72

Jark Corporation has invested in a machine that cost $76,000, that has a useful life of eight years, and that has no salvage value at the end of its useful life. The machine is being depreciated by the straight-line method, based on its useful life. It will have a payback period of five years. Given these data, the simple rate of return on the machine is closest to (Ignore income taxes.): (Round your answer to 1 decimal place.)

A) 3.9%
B) 5.0%
C) 7.5%
D) 32.5%

Question 73

In an effort to reduce costs, Pontic Manufacturing Corporation is considering an investment in equipment that will reduce defects. This equipment will cost $420,000, will have an estimated useful life of 10 years, and will have an estimated salvage value of $50,000 at the end of 10 years. The company's discount rate is 22%. What amount of cost savings will this equipment have to generate per year in each of the 10 years in order for it to be an acceptable project? (Ignore income taxes.).Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.(Round your intermediate calculations to 3 decimal places.)

A) $50,690 or more
B) $41,315 or more
C) $105,315 or more
D) $94,316 or more

Question 74

The management of Penfold Corporation is considering the purchase of a machine that would cost $440,000, would last for 7 years, and would have no salvage value. The machine would reduce labor and other costs by $102,000 per year. The company requires a minimum pretax return of 16% on all investment projects. The net present value of the proposed project is closest to (Ignore income taxes.):Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.

A) $(28,022)
B) $96,949
C) $(79,196)
D) $274,000

Question 75

The following data pertain to an investment proposal (Ignore income taxes.): Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.The net present value of the proposed investment is closest to: (Round your intermediate calculations and final answer to the nearest whole dollar amount.)

A) $2,687
B) $4,859
C) $2,172
D) $21,000

Question 76

Ataxia Fitness Center is considering an investment in some additional weight training equipment. The equipment has an estimated useful life of 10 years with no salvage value at the end of the 10 years. Ataxia's internal rate of return on this equipment is 8%. Ataxia's discount rate is also 8%. The payback period on this equipment is closest to (Ignore income taxes.):Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.

A) 10 years
B) 6.71 years
C) 5 years
D) 7.81 years

Question 77

Parks Corporation is considering an investment proposal in which a working capital investment of $10,000 would be required. The investment would provide cash inflows of $2,000 per year for six years. The working capital would be released for use elsewhere when the project is completed. If the company's discount rate is 10%, the investment's net present value is closest to (Ignore income taxes.):Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.

A) $1,290
B) $(1,290)
C) $2,000
D) $4,350

Question 78

Jark Corporation has invested in a machine that cost $60,000, that has a useful life of six years, and that has no salvage value at the end of its useful life. The machine is being depreciated by the straight-line method, based on its useful life. It will have a payback period of four years. Given these data, the simple rate of return on the machine is closest to (Ignore income taxes.):

A) 8.3%
B) 7.2%
C) 9.5%
D) 25%

Question 79

Penniston Corporation is considering a capital budgeting project that would require an initial investment of $630,000 and working capital of $73,000. The working capital would be released for use elsewhere at the end of the project in 3 years. The investment would generate annual cash inflows of $228,000 for the life of the project. At the end of the project, equipment that had been used in the project could be sold for $29,000. The company's discount rate is 12%. The net present value of the project is closest to:Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided.

A) $(134,696)
B) $(82,720)
C) $(9,720)
D) $54,000

Question 80

The management of Penfold Corporation is considering the purchase of a machine that would cost $410,000, would last for 7 years, and would have no salvage value. The machine would reduce labor and other costs by $67,000 per year. The company requires a minimum pretax return of 7% on all investment projects.Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using the tables provided. The net present value of the proposed project is closest to (Ignore income taxes.): (Round your intermediate calculations and final answer to the nearest whole dollar amount.)

A) $(48,937)
B) $(8,937)
C) $(73,857)
D) $(24,017)