Deck 12: Capital Expenditure Decisions

Question 1

A capital expenditure decision is a _____________decision on whether or not to make an investment at the time of the decision in order to obtain future net cash receipts totalling more than the investment.

Answer 1

long-term

Question 2

Because proposals to invest cash involve ____________ cash receipts and payments over several years, capital expenditure decisions are sometimes referred to as cash budgeting decisions.

Answer 2

estimated

Question 3

Many institutional investors are now screening investments using some _________________ criteria.

Answer 3

sustainability

Question 4

A capital expenditure proposal is acceptable to a business when its _________________ ____ ______________ is greater than the cost to the business of providing the cash to make the investment.

Question 5

The ______________cost is the expected cash payment to be made to put the capital budget proposal into operation.

Question 6

An example of an investment involving future cash receipts only is when a business buys ___________ of another business to receive dividends.

Question 7

_________________ cash flows are future cash flows that differ, either in amount or in timing, as a result of accepting a capital expenditure proposal.

Question 8

Choosing ____________________ alternative does not change a business' cash flows.

Question 9

A business' cut-off rate that is used in evaluating whether capital expenditure proposals will benefit the business is referred to as the business' _____________ _________ ____ ________.

Question 10

A business' ______________ __ _________ is the weighted-average cost it must pay to all sources of capital.

Question 11

A business receives its capital from short-term borrowing, long-term borrowing and _________________________.

Question 12

The ________________ __________ ________ of a capital expenditure proposal is the present value of its future net cash receipts and payments minus the expected initial cash payment.

Question 13

When the net present value of a proposal is ________________ the proposal is acceptable as the rate of return on the proposal is greater than the required rate of return.

Question 14

When the net present value of a proposal is ________________ the proposal is not acceptable as the rate of return on the proposal is less than the required rate of return.

Question 15

The dividend growth model is a formula that can be used to estimate the __________ ________ at any point in time.

Question 16

The ____________ ____________ ____ ___________ is an indicator of the efficiency or quality of an investment as opposed to net present value which indicates value or magnitude.

Question 17

The _______________ _________ is the length of time required for a return of the initial investment.

Question 18

The _______________ _________ ___ _________ is a measure of return on investment calculated by dividing the average net income from an asset by the average investment in the asset.

Question 19

_______________ ____________ occurs when a business cannot obtain sufficient cash to make all of the investments that it would like to make.

Question 20

The value of projects and initiatives driven by ___________ ___________ _________ thinking are often not captured in long term planning.

Question 21

A capital expenditure decision is a short-term decision in which a business determines whether or not to make an investment.

Question 22

Capital expenditure decisions are sometimes referred to as capital budgeting decisions.

Question 23

As a general rule, a capital expenditure proposal is acceptable to a business when its return on investment is greater than the cost to the business of providing cash to make the investment.

Question 24

The 'initial cost' of a capital expenditure proposal is the expected cash payment to be made to put the proposal into operation.

Question 25

If the cost of a machine is $40 000, machine transportation costs are $3200, the machine installation costs are $1600 and the annual insurance costs for the machine are $1000 then the 'initial cost' of the machine is $45 800.

Question 26

The 'working capital' of a capital expenditure proposal is the expected cash payment to be made to put the proposal into operation.

Question 27

The 'sunk cost' of a capital expenditure proposal is the expected cash payment to be made to put the proposal into operation.

Question 28

Future cash receipts may come in three forms; future cash receipts only, future cash receipts that are more than future cash payments, or savings of future cash payments.

Question 29

Some investments do not involve increasing future cash receipts but instead involve reducing future cash payments.

Question 30

Future cash flows that differ, either in amount or timing, as a result of accepting a capital expenditure proposal are called relevant cash flows.

Question 31

Capital expenditure alternatives such as not buying a machine or not expanding a factory are referred to as the 'do-nothing' alternative.

Question 32

Long-term capital expenditure proposals never have any relevant cash inflows at the end of their useful life.

Question 33

A capital expenditure analysis of the purchase of a new machine should estimate the present value of all depreciation charges.

Question 34

When the net present value of a project is zero or positive then the project should be rejected.

Question 35

The internal rate of return is the rate of return at which the net present value of a project is zero.

Question 36

A project may have a short payback period for a return of the investment but not contribute to the overall profitability of the business.

Question 37

The accounting rate of return method of evaluating capital expenditure projects is conceptually superior to the net present value method and the payback period method.

Question 38

If faced with mutually exclusive capital expenditure proposals, a business will choose the alternative with the highest net present value.

Question 39

If faced with mutually exclusive capital expenditure proposals where one proposal must be selected, a business will choose the alternative with the highest net present value, even if it is a negative net present value.

Question 40

In making capital expenditure decisions businesses need to consider all relevant factors, even the difficult-to-measure ones.

Question 41

Capital expenditure is a:

A) short-term investment made by a business to obtain future net cash receipts totalling more than the investment.
B) long-term investment made by a business to obtain future net cash receipts totalling more than the investment.
C) short-term investment made by a business to obtain profit totalling more than the investment.
D) long-term investment made by a business to obtain assets totalling more than the investment.

Question 42

Which of the following is NOT one of the steps a manager must complete to determine whether a capital expenditure proposal is acceptable?

A) Determining the initial cash payment needed to make the investment.
B) Estimating the future cash receipt and payments (cash flows) expected from the investment.
C) Determining the cost of providing the cash to make the investment.
D) Determining sunk costs.

Question 43

A business is evaluating a potential investment in a new machine that it will use for six years. The quoted price is $10 000. The business expects to pay transportation costs of $800 to get the machine to its factory, and an additional $400 to install the machine. What is the initial cost of this proposal?

A) $10 000
B) $10 400
C) $11 200
D) $10 800

Question 44

A business is evaluating a potential investment in a training program for employees that will cost $45 000 today. The training is expected to save $15 000 every year for the next 5 years. What cash flows would be evaluated for capital expenditure analysis?

A) Initial cash flow of $45 000 only.
B) Outflows of $15 000 every year for the next 5 years only.
C) Initial cash flow of $45 000 plus inflow of $15 000 every year for the next 5 years.
D) None, as this is an operating expenditure analysis, not a capital expenditure analysis

Question 45

Future cash flows that differ either in amount or timing depending upon which decision alternative is chosen, are:

A) relevant cash flows.
B) sunk cash flows.
C) mutually exclusive cash flows.
D) non-relevant cash flows.

Question 46

Which of the following is ignored in capital expenditure analysis computations?

A) Annual net cash inflows.
B) Depreciation expense.
C) Cost of the investment under consideration.
D) Residual value.

Question 47

The rate that measures a business' cost of obtaining cash for investments, and is used as a cut off to distinguish between acceptable and unacceptable investment proposals, is called the business':

A) average rate of return.
B) discount rate.
C) internal rate of return.
D) cost of capital.

Question 48

A business' cost of capital is the ____________________ it must pay to all sources of capital.

A) fixed-average cost of capital
B) variable-average cost of capital
C) weighted-average cost of capital
D) none of the options given

Question 49

A proposal with an initial investment of $1 million and a net present value of $1.2 million should be:

A) accepted as the proposal rate of return must be greater than the required rate of return.
B) accepted as the initial cost is positive.
C) rejected as the proposal rate of return is not high enough.
D) rejected as the proposal rate of return is less than the required rate of return.

Question 50

Which of the following is NOT a valid method of assessing a capital investment in shares?

A) Zero dividend growth
B) Negative dividend growth
C) Constant dividend growth
D) Non-constant dividend growth

Question 51

A drill press costing $100 000, with a $10 000 residual value and a 10-year useful life, will reduce operating cash outflows by $25 000 per year. The payback period for the drill press is:

A) 4 years.
B) 5 years.
C) 6.25 years.
D) 3.6 years.

Question 52

Which of the following is NOT a limitation of the payback period method?

A) The time value of money is ignored.
B) Cash flows after the payback period are ignored.
C) The return on investment is ignored.
D) Highlights risk.

Question 53

The net present value method is conceptually superior to the payback method because the payback method:

A) is easy to calculate
B) ignores the time value of money.
C) highlights risk.
D) is based on cash flows.

Question 54

Example 12.1
Use the information below to answer the following questions.
The Schroeder Business has identified the investment proposals shown below as acceptable.
\begin{array} { c c c } \begin{array} { c } \text { Investment } \\\text { Proposal }\end{array} & \begin{array} { c } \text { Required } \\\text { Investment }\end{array} & \begin{array} { c } \text { Net Present } \\\text { Value }\end{array} \\\hline\text { A } & \$ 20000 & \$ 10000\\\text { B } & 50000 & 16000 \\\text { C } & 30000 & 8000 \\\text { D } & 30000 &7000 \\\\text { E } & 20000 &11000 \\end{array}

-Refer to Example 12.1. Assuming the proposals are mutually exclusive, which proposal should be chosen?

A) Proposal A
B) Proposal B
C) Proposal C
D) Proposal E.

Question 55

Example 12.1
Use the information below to answer the following questions.
The Schroeder Business has identified the investment proposals shown below as acceptable.
\begin{array} { c c c } \begin{array} { c } \text { Investment } \\\text { Proposal }\end{array} & \begin{array} { c } \text { Required } \\\text { Investment }\end{array} & \begin{array} { c } \text { Net Present } \\\text { Value }\end{array} \\\hline\text { A } & \$ 20000 & \$ 10000\\\text { B } & 50000 & 16000 \\\text { C } & 30000 & 8000 \\\text { D } & 30000 &7000 \\\\text { E } & 20000 &11000 \\end{array}

-Refer to Example 12.1. Assuming the business can invest up to a maximum of $100 000, which proposals should be chosen?

A) Proposals A, B, and C
B) Proposals A, C, D, and E
C) Proposals B, C, and E
D) Proposals A, B, and E.

Question 56

Due to a legal requirement, a business must upgrade its manufacturing equipment, so must select only one of several machines that can be used in its manufacturing process. Investment proposals of this type are often called:

A) operating investment proposals.
B) capital rationing investment proposals.
C) mutually exclusive capital investment proposals.
D) do nothing alternative proposals.

Question 57

Where a business cannot obtain sufficient cash to make all of the desired investments this is known as:

A) capital investment.
B) capital rationing.
C) capital appraisal.
D) capital apportionment.

Question 58

The Spicket Business has the following three investment proposals available:
$\begin{array}{ccc}& \text { initial investment } & \text { net present } \\\text { Proposal } & \text { Required } & \text { Value } \\\hline \text { A } & \$ 20000 & \$ 5000 \\\text { B } & 30000 & 8000 \\\text { C } & 50000 & 14000\end{array}$ Assuming Spicket has $50 000 cash available and uses the maximum net present value method to evaluate investments, Spicket should select:

A) proposal A.
B) proposal B.
C) proposal C.
D) any of the three proposals, as all have positive net present values.

Question 59

The value of proposals and initiatives drive by triple bottom line thinking are:

A) often not captured in long term planning.
B) associated with easily measurable short-term returns.
C) non-financial and thus should be ignored.
D) never successfully integrated into capital budgeting.

Question 60

Briefly explain the nature and purpose of capital expenditure decisions.

Question 61

Atlas Tyres is considering purchasing an electronic tyre-balancing machine. The machine will cost $15 000, will reduce operating cash outflows by $5 000 per year for its entire 4-year useful life, and will have no residual value at the end of its life. The business' minimum acceptable rate of return is 12%.
Required:
Calculate the net present value of the investment in the machine.

Question 62

Bill's Burgers is considering purchasing a new, environmentally friendly freezer costing $12 000 to replace an existing freezer which cost $8 000 five years ago. The new freezer will reduce operating cash outflows by $3 000 per year for its entire 4-year useful life, and will have a residual value of $4 000 at the end of its life. The business' minimum acceptable rate of return is 8%.
Required:
Calculate the net present value of the investment in the freezer.

Question 63

Harglo Construction is considering purchasing a radio antenna for broadcasting to service trucks over the airwaves rather than using telephone lines. The antenna is expected to reduce cash operating costs by $2000 the first year, $2500 the second year, and $3000 the third year. The antenna will cost $6000, will last 3 years (due to technological advances), and will have no residual value at the end of its life. Harglo's minimum acceptable rate of return is 8%.
Required:
(1) Calculate the net present value of the investment in the antenna.
(2) If Harglo's cost of capital was 12%, would this proposal be acceptable?

Question 64

The Sloopy Jeans is considering the purchase of a machine that would increase the business' cash inflows by $12 000 per year for 6 years. Operation of the machine would increase the business' cash payments by $400 in each of the first 3 years, $800 the fourth year, and $1000 in the fifth and sixth years. The machine costs $50 000 and would have a residual value of $2000 at the end of the sixth year.
Required:
(1) Calculate the payback period for this machine.
(2) Calculate the net present value of the investment in the machine, assuming a minimum acceptable rate of return of 16%.

Question 65

The Meriweather Company is considering a proposal that would require a $9000 investment now, and a $4000 additional investment at the end of Year 4 that has not been included in the computation of the future net cash inflows shown below. Net cash inflows expected from the project are as follows:
$$\begin{array} { l r r r } \text { Year 1 } & \$ 2000 & \text { Year 5 } & \$ 1000 \\\text { Year 2 } & 0 & \text { Year 6 } & 6000 \\\text { Year 3 } & 4000 & \text { Year 7 } & 2000 \\\text { Year 4 } & 2000 & \text { Year 8 } & 2000\end{array}$$ Required:
(1) Calculate the project's payback period.
(2) If Meriweather's cost of capital is 12%, calculate the project's net present value.

Question 66

Sipton Tea is considering the purchase of equipment for an additional processing line. The equipment will increase revenues by $20 000 per year, but additional cash operating expenses would be $5000 per year. The equipment would cost $40 000 and have a 10-year life, with no residual value projected.
Required:
(1) If Sipton's cost of capital is 12%, calculate the net present value of the investment.
(2) Should the proposal be accepted or rejected at a cost of capital of 12%? Why?

Question 67

Multichoice Company has three mutually exclusive proposals from which to choose. One must be selected. The following information about the three proposals is available:
$\begin{array}{cccc}& \text { Investment } & \text { Annual Net } & \text { Expected } \\ \underline{\text { Proposal }} & \underline{\text { Required} } & \underline{ \text { Cash Inflows }} & \underline{ \text { Life} }\\\mathrm{X} & \$ 48000 & \$ 8000 & 10 \text { yrs. } \\\mathrm{Y} & 50000 & 8000 & 10 \text { yrs. } \\\mathrm{Z} & 86000 & 15000 & 10 \text { yrs. }\end{array}$
Required:
(1) Using the payback period, rank order the three proposals from most attractive to least attractive.
(2) Order the proposals from most attractive to least attractive using the net present value method. Assume the business' cost of capital is 12%.
(3) Which method, payback period or net present value, would you recommend using?

Question 68

The Somewhat Limited Company has $60 000 of cash available for investment during 2015. The business has the following five investment proposals available to choose from:
$\begin{array}{ccc}& \text { Investment } & \text { Net Present } \\ \underline{\text { Proposal }} & \underline{\text { Required }} & \underline{\text { Value }}\\\mathrm{A} & \$ 20000 & \$ 15000 \\\text { B } & 10000 & 6000 \\\text { C } & 10000 & 8000 \\\text { D } & 20000 & 5000 \\\text { E } & 40000 & 20000\end{array}$
Required:
Determine which proposals the Somewhat Limited Company should choose using the maximum net present value approach.

Question 69

The Tearess Company can accept either Proposal A or Proposal B (but not both), or it can reject both investment proposals. Proposal A requires an investment of $7000 and promises increased net cash inflows of $2600 for 5 years. Proposal B requires an investment of $7000 and promises increased net cash inflows of $3000 in each of the first 3 years, $2000 in the fourth year and $2200 in the fifth year. The business' minimum acceptable rate of return is 20%.
Required:
Prepare an analysis to determine which (if either) of the proposals should be selected for investment.

Question 70

The Able Company has identified the investment proposals shown below as acceptable. However, only $30 000 can be made available for investment.
$\begin{array}{ccc}& \text { Investment } & \text { Net Present } \\ \underline{\text { Proposal }} & \underline{\text { Required }} & \underline{\text { Value }}\\\mathrm{A} & \$ 10000 & \$ 5000 \\\text { B } & 20000 & 8000 \\\text { C } & 20000 & 7000 \\\text { D } & 10000 & 4000 \\\text { E } & 10000 &30000\end{array}$

Required:
Determine the combination of proposals to be selected using the maximum net present value approach.

Question 71

The Ike Company is considering the purchase of a high-quality paint coating system at a cost of $40 000 that will provide increased net cash flows of $11 000 per year. The machine would be depreciated using the straight-line method and is expected to have a residual value of $1000 after seven years. Ike's minimum acceptable rate of return on investment is 16%.
Required:
(1) Calculate the payback period for the investment.
(2) Calculate the net present value of the investment.