Deck 14: Capital Investment Decisions

Question 1

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

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

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

Answer 3

True

Question 4

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.

Question 5

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

Question 6

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

Question 7

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

Question 8

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

Question 9

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

Question 10

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 11

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

Question 12

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

Question 13

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 14

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

Question 15

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

Question 16

Sometimes firms require riskier projects to have longer payback periods.

Question 17

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

Question 18

Taxes are important consideration in forecasting cash flows.

Question 19

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

Question 20

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

Question 21

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

Question 22

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

Question 23

A disadvantage of postaudits is that they are costly.

Question 24

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

Question 25

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

Question 26

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

Question 27

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

Question 28

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

Question 29

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

Question 30

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

Question 31

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 32

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

Question 33

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

Question 34

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

Question 35

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 36

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

Question 37

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

Question 38

Postaudits ensure that resources are used wisely by evaluating profitability.

Question 39

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

Question 40

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

Question 41

Match each item with the correct statement below.
a.Payback period
b.Accounting rate of return
c.Net present value
d.Internal rate of return
e.Discount rate
f.Annuity
g.Post-audit
h.Compounding of interest
can be used to determine whether or not an investment will negatively affect key financial ratios

Question 42

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

Question 43

Match each item with the correct statement below.
a.Payback period
b.Accounting rate of return
c.Net present value
d.Internal rate of return
e.Discount rate
f.Annuity
g.Post-audit
h.Compounding of interest
is the best method discounting model to use for mutually exclusive competing projects

Question 44

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

Question 45

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

Question 46

Match each item with the correct statement below.
a.Payback period
b.Accounting rate of return
c.Net present value
d.Internal rate of return
e.Discount rate
f.Annuity
g.Post-audit
h.Compounding of interest
earning of interest on interest

Question 47

_______________________ ignore the time value of money.

Question 48

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

Question 49

Match each item with the correct statement below.
a.Payback period
b.Accounting rate of return
c.Net present value
d.Internal rate of return
e.Discount rate
f.Annuity
g.Post-audit
h.Compounding of interest
a series of equal future cash flows

Question 50

Match each item with the correct statement below.
a.Payback period
b.Accounting rate of return
c.Net present value
d.Internal rate of return
e.Discount rate
f.Annuity
g.Post-audit
h.Compounding of interest
assumes that all future cash inflows earn the minimum rate of return

Question 51

Match each item with the correct statement below.
a.Payback period
b.Accounting rate of return
c.Net present value
d.Internal rate of return
e.Discount rate
f.Annuity
g.Post-audit
h.Compounding of interest
interest rate used to discount future cash flows

Question 52

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

Question 53

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

Question 54

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

Question 55

Match each item with the correct statement below.
a.Payback period
b.Accounting rate of return
c.Net present value
d.Internal rate of return
e.Discount rate
f.Annuity
g.Post-audit
h.Compounding of interest
can be used as a rough measure of risk and liquidity

Question 56

Match each item with the correct statement below.
a.Payback period
b.Accounting rate of return
c.Net present value
d.Internal rate of return
e.Discount rate
f.Annuity
g.Post-audit
h.Compounding of interest
assumes that all future cash inflows earn the same rate of return as the project itself

Question 57

Match each item with the correct statement below.
a.Payback period
b.Accounting rate of return
c.Net present value
d.Internal rate of return
e.Discount rate
f.Annuity
g.Post-audit
h.Compounding of interest
comparison of actual benefits and costs of a project with the expected benefits and costs

Question 58

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

Question 59

_____________________ explicitly consider the time value of money.

Question 60

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

Question 61

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 62

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 63

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 64

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 65

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 66

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.

Question 67

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

Question 68

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

Question 69

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

Question 70

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

Question 71

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 72

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 73

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 74

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 75

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

Question 76

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

Question 77

The ___________________ is the minimum acceptable rate of return.

Question 78

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

Question 79

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 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.