Deck 15: Capital Investment Analysis

Question 1

The methods of evaluating capital investment proposals can be grouped into two general categories: (1) methods that ignore present values and (2) methods that use present values.

Answer 1

True

Question 2

For years one through five, a proposed expenditure of $250,000 for a fixed asset with a 5-year life has expected net income of $40,000, $35,000, $25,000, $25,000, and $25,000, respectively, and net cash flows of $90,000, $85,000, $75,000, $75,000, and $75,000, respectively. The cash payback period is 2.5 years.

Answer 2

False

Question 3

The excess of cash flowing in from revenues over the cash flowing out for expenses is termed net cash flow.

Answer 3

True

Question 4

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and a $40,000 residual value, is expected to yield total net income of $500,000 for 5 years. The expected average rate of return is 50%.

Question 5

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and a $40,000 residual value, is expected to yield total net income of $200,000 for 5 years. The expected average rate of return on investment is 18.2%.

Question 6

The excess of cash flowing in from revenues over the cash flowing out for expenses is termed net discounted cash flow.

Question 7

Average rate of return equals estimated average annual income divided by average investment.

Question 8

The computations required for the net present value method are less than those the computation required for the average rate of return method.

Question 9

A company should purchase an asset when the minimum rate of return exceeds its average rate of return.

Question 10

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is expected to yield total net income of $300,000 for 5 years. The expected average rate of return is 30%.

Question 11

The methods of evaluating capital investment proposals can be grouped into two general categories: (1) average rate of return method and (2) cash payback method.

Question 12

The computations required for the net present value method are more than the computation required for the average rate of return method.

Question 13

The process by which management plans, evaluates, and controls long- term investment decisions involving fixed assets is called cost-volume-profit analysis.

Question 14

The anticipated purchase of a fixed asset for $400,000, with a useful life of 5 years and no residual value, is expected to yield total net income of $200,000 for 5 years. The expected average rate of return on investment computed is 20%.

Question 15

When evaluating a proposal by use of the net present value method, if there is a deficiency of the present value of future cash inflows over the amount to be invested, the proposal should be accepted.

Question 16

Care must be taken while making capital investment decisions since it involves a long-term commitment of funds and affects operations for several years.

Question 17

Average rate of return equals average investment divided by estimated average annual income.

Question 18

If the average rate of return on an asset exceeds the minimum rate of return for investments, the asset should be purchased.

Question 19

If a proposed expenditure of $80,000 for a fixed asset with a 4-year life has an annual expected net cash flow and net income of $32,000 and $12,000, respectively, the cash payback period is 2.5 years.

Question 20

The process by which management plans, evaluates, and controls long-term investment decisions involving fixed assets is called capital investment analysis.

Question 21

The internal rate of return method of analyzing capital investment proposals uses the present value concept to compute the rate of return expected from the proposals.

Question 22

Internal rate of return is often called the payback rate of return.

Question 23

If a proposed expenditure of $400,000 for a fixed asset with a 4-year life has an annual expected net cash flow and net income of $160,000 and $60,000, respectively, the cash payback period is 2.5 years.

Question 24

When evaluating a proposal by use of the net present value method, if the present value is less than the amount to be invested, the rate of return on the proposal is more than the rate used in the analysis.

Question 25

Qualitative considerations are best evaluated using present value methods such as internal rate of return.

Question 26

A present value index can be used to rank competing capital investment proposals when the net present value method is used.

Question 27

A qualitative characteristic that influences capital investment analysis is manufacturing productivity.

Question 28

The expected period of time that will elapse between the date of a capital investment and the complete recovery in cash of the amount invested is called the cash payback period.

Question 29

The expected period of time that will elapse between the date of a capital investment and the complete recovery in cash of the amount invested is called the discount period.

Question 30

Qualitative considerations in capital investment decisions are most appropriate for strategic investments or those that are designed to affect a company's long-term ability to generate profits.

Question 31

When evaluating a proposal by use of the cash payback method, if net cash flows exceed the capital investment within the time deemed acceptable by management, the proposal should be accepted.

Question 32

When evaluating a proposal by use of the net present value method, if there is an excess of the present value of future cash inflows over the amount to be invested, the rate of return on the proposal exceeds the rate used in the analysis.

Question 33

The anticipated purchase of a fixed asset for $400,000 with a useful life of 5 years and no residual value is expected to yield total income of $150,000 (recognition is given to the effect of straight-line depreciation on the investment). The expected average rate of return is 15%.

Question 34

Methods that ignore present value in capital investment analysis include the cash payback method.

Question 35

In net present value analysis for a proposed capital investment, the expected future net cash flows are reduced to their present values.

Question 36

The average rate of return method of capital investment analysis gives consideration to the present value of future cash flows.

Question 37

For years one through five, a proposed expenditure of $400,000 for a fixed asset with a 5-year life has expected net income of $50,000, $40,000, $20,000, $20,000, and $20,000, respectively, and net cash flows of $130,000, $120,000, $100,000, $100,000, and $100,000, respectively. The cash payback period is 3.5years.

Question 38

When evaluating a proposal by use of the net present value method, if there is an excess of the present value of future cash inflows over the amount to be invested, the rate of return on the proposal is less than the rate used in the analysis.

Question 39

A series of unequal cash flows at fixed intervals is termed an annuity.

Question 40

One of the qualitative characteristics that influence capital investment analysis is product quality.

Question 41

The process by which management allocates available investment funds among competing capital investment proposals is termed present value analysis.

Question 42

Leasing assets may be a favorable alternative to purchasing assets if the asset has a high risk of becoming obsolete.

Question 43

Using the following partial table of present value of $1 at compound interest, compute the present value of $20,000 (rounded to nearest dollar) to be received one year from today, assuming an earnings rate of 15%. $$\begin{array} { |l | l | l | l | } \hline 20 \% & 15 \% & 10 \% & \text { Year } \\\hline 0.833 & 0.870 & 0.909 & 1 \\\hline 0.694 & 0.756 & 0.826 & 2 \\\hline 0.579 & 0.659 & 0.751 & 3 \\\hline 0.482 & 0.572 & 0.683 & 4 \\\hline 0.402 & 0.497 & 0.621 & 5 \\\hline 0.335 & 0.473 & 0.564 & 6 \\\hline 0.279 & 0.376 & 0.513 & 7 \\\hline & & & \\\hline\end{array}$$

A) $17,400
B) $17,000
C) $20,000
D) $15,451

Question 44

In general, present value methods of analyzing capital investments are more desirable than methods ignoring present values because:

A) the calculations in methods that ignore present value are more complex than those in methods using present value.
B) the present value methods consider that a dollar today is worth more than a dollar in the future due to the potential earning power of that dollar.
C) the calculations in methods that consider present value are less complex than those methods ignoring present value.
D) the present value methods consider that a dollar in the future is worth more than a dollar today due to the potential earning power of that dollar.

Question 45

Which of the following can be used to place capital investment proposals involving different amounts of investment on a comparable basis for purposes of net present value analysis?

A) Price-level index
B) Present value factor
C) Annuity
D) Present value index

Question 46

By converting dollars to be received in the future into current dollars, the present value methods take into consideration that money:

A) has an international rate of exchange.
B) is the language of business.
C) is the measure of assets, liabilities, and stockholders' equity on financial statements.
D) has a time value.

Question 47

When several alternative investment proposals of the same amount are being considered, the one with the largest net present value is the most desirable. If the alternative proposals involve different amounts of investment, it is useful to prepare a relative ranking of the proposals by using a(n):

A) average rate of return.
B) cash payback period.
C) present value index.
D) price-level index.

Question 48

In capital rationing, alternative proposals are initially screened by establishing minimum standards using the cash payback and the average rate of return methods.

Question 49

The primary advantages of the average rate of return method of analyzing a capital investment proposal are its ease of computation and the fact that:

A) it emphasizes the amount of income earned over the life of the proposal.
B) there is less possibility of loss from changes in economic conditions and obsolescence when the commitment is short-term.
C) it is especially useful to managers whose primary concern is liquidity.
D) it considers the time value of money.

Question 50

The process by which management allocates available investment funds among competing capital investment proposals is termed capital rationing.

Question 51

A capital expenditures budget summarizes the decisions made for the acquisition of fixed assets.

Question 52

An analysis of a proposal by the net present value method indicated that the present value exceeded the amount to be invested. Which of the following statements best describes the results of this analysis?

A) The proposal is desirable and the rate of return expected from the proposal exceeds the minimum rate used for the analysis.
B) The proposal is desirable and the rate of return expected from the proposal is less than the minimum rate used for the analysis.
C) The proposal is undesirable and the rate of return expected from the proposal is less than the minimum rate used for the analysis.
D) The proposal is undesirable and the rate of return expected from the proposal exceeds the minimum rate used for the analysis.

Question 53

Decisions to install new equipment, replace old equipment, and purchase or construct a new building are examples of:

A) sales mix analysis.
B) variable cost analysis.
C) cost-volume-profit analysis.
D) capital investment analysis.

Question 54

Using the following partial table of present value of $1 at compound interest, determine the present value of $20,000 to be received four years hence with earnings at the rate of 12% a year: $$\begin{array} { | l | l | l | l | } \hline 12 \% & 10 \% & 6 \% & \text { Year } \\\hline 0.893 & 0.909 & 0.943 & 1 \\\hline 0.797 & 0.826 & 0.890 & 2 \\\hline 0.712 & 0.751 & 0.840 & 3 \\\hline 0.636 & 0.683 & 0.792 & 4 \\\hline & & &\end{array}$$

A) $13,660
B) $15,840
C) $12,720
D) $10,400

Question 55

An anticipated purchase of equipment for $1,200,000, with a useful life of 8 years and no residual value, is expected to yield the following annual net incomes and net cash flows: $$\begin{array}{l}\text { Net Cash}& \text {Net Income Flow}&\text { Year}\\\$ 330,000 & \$ 180,000&1 \\320,000 & 170,000&2 \\780,000 & 130,000&3 \\770,000 & 120,000&4 \\200,000 & 50,000 &5\\200,000 & 50,000&6 \\200,000 & 50,000 &7\\200,000 & 50,000&8\end{array}$$ What is the cash payback period?

A) 5 years
B) 4 years
C) 6 years
D) 3 years

Question 56

Which method of evaluating capital investment proposals uses the concept of present value to compute a rate of return?

A) Average rate of return
B) Internal rate of return
C) Cash payback period
D) Accounting rate of return

Question 57

When evaluating two competing proposals with unequal lives, management should give greater consideration to the investment with the longer life because the asset will be useful to the company for a longer period of time.

Question 58

The rate of return is 10% and the cash to be received in one year is $10,000. Determine the present value amount, using the following partial table of present value of $1 at compound interest: $$\begin{array} { | l | l | l | l | } \hline 12 \% & 10 \% & 6 \% & \text { Year } \\\hline 0.893 & 0.909 & 0.943 & 1 \\\hline 0.797 & 0.826 & 0.890 & 2 \\\hline 0.712 & 0.751 & 0.840 & 3 \\\hline 0.636 & 0.683 & 0.792 & 4 \\\hline & & &\end{array}$$

A) $8,930
B) $9,000
C) $9,430
D) $9,090

Question 59

The process by which management plans, evaluates, and controls long-term investment decisions involving fixed assets is called:

A) absorption cost analysis.
B) variable cost analysis.
C) capital investment analysis.
D) cost-volume-profit analysis.

Question 60

Which of the following are present value methods of analyzing capital investment proposals?

A) Internal rate of return and average rate of return
B) Average rate of return and net present value
C) Net present value and internal rate of return
D) Net present value and cash payback

Question 61

The management of Hence Corporation is considering the purchase of a new machine costing $200,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 90,000 & \$ 50,000 & 1 \\\hline 10,000 & 20,000 & 2 \\\hline 50,000 & 10,000 & 3 \\\hline 45,000 & 5,000 & 4 \\\hline 45,000 & 5,000 & 5 \\\hline\end{array}$
The average rate of return for this investment is:

A) 18%.
B) 16%.
C) 58%.
D) 20%.

Question 62

The management of London Corporation is considering the purchase of a new machine costing $750,000. The company's desired rate of return is 6%. The present value factors for $1 at compound interest of 6% for 1 through 5 years are 0.943, 0.890, 0.840, 0.792, and 0.747, respectively. In addition to this information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 187,500 & \$ 37,500 & 1 \\\hline 187,500& 37,500 & 2 \\\hline187,500& 37,500 & 3 \\\hline 187,500 &37,500 & 4 \\\hline 187,500& 37,500 & 5 \\\hline\end{array}$
The present value index for this investment is:

A) 1.00.
B) 0.95.
C) 1.25.
D) 1.05.

Question 63

The amount of the average investment for a proposed investment of $70,000 in a fixed asset, with a useful life of four years, recognition is given to the effect of straight-line depreciation on the investment, no residual value, and an expected total net income of $21,600 for the 4 years, is:

A) $10,800.
B) $21,600.
C) $35,000.
D) $30,000.

Question 64

The amount of the estimated average income for a proposed investment of $60,000 in a fixed asset, giving effect to depreciation (straight-line method), with a useful life of four years, no residual value, and an expected total income yield of $22,300, is:

A) $10,800.
B) $5,575.
C) $5,400.
D) $15,000.

Question 65

Which method of evaluating capital investment proposals uses present value concepts to compute the rate of return from the net cash flows expected from capital investment proposals?

A) Internal rate of return
B) Cash payback
C) Net present value
D) Average rate of return

Question 66

Assuming that the desired rate of return is 6%, determine the present value of $10,000 to be received in one year, using the following partial table of present value of $1 at compound interest. $$\begin{array} { | l | l| l | l | } \hline 12 \% & 10 \% & 6 \% & \text { Year } \\\hline 0.893 & 0.909 & 0.943 & 1 \\\hline 0.797 & 0.826 &0 .890 & 2 \\\hline 0.712 & 0.751 & 0.840 & 3 \\\hline 0.636 & 0.683 & 0.792 & 4 \\\hline & & &\end{array}$$

A) $9,430
B) $9,000
C) $9,090
D) $8,930

Question 67

The expected average rate of return for a proposed investment of $3,000,000 in a fixed asset giving effect to depreciation (straight-line method) with a useful life of 20 years, no residual value, and an expected total income of $6,000,000 is:

A) 25%.
B) 18%.
C) 40%.
D) 20%.

Question 68

The expected average rate of return for a proposed investment of $540,000 in a fixed asset, with a useful life of four years, recognition is given to the effect of straight-line depreciation on the investment, no residual value, and an expected total net income of $216,000 for the 4 years, is:

A) 18%.
B) 15%.
C) 27%.
D) 20%.

Question 69

Using the following partial table of present value of $1 at compound interest, determine the present value of $20,000 to be received four years hence, with earnings at the rate of 10% a year. $$\begin{array} { | l | l| l | l | } \hline 12 \% & 10 \% & 6 \% & \text { Year } \\\hline 0.893 & 0.909 & 0.943 & 1 \\\hline 0.797 & 0.826 & 0 .890 & 2 \\\hline 0.712 & 0.751 & 0.840 & 3 \\\hline 0.636 & 0.683 & 0.792 & 4 \\\hline & & &\end{array}$$

A) $13,660
B) $12,720
C) $15,840
D) $10,400

Question 70

Which of the following is a present value method of analyzing capital investment proposals?

A) Average rate of return
B) Cash payback method
C) Accounting rate of return
D) Net present value

Question 71

The management of Hence Corporation is considering the purchase of a new machine costing $200,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 90,000 & \$ 50,000 & 1 \\\hline 10,000 & 20,000 & 2 \\\hline 50,000 & 10,000 & 3 \\\hline 45,000 & 5,000 & 4 \\\hline 45,000 & 5,000 & 5 \\\hline\end{array}$
The cash payback period for this investment is:

A) 5 years.
B) 3 years.
C) 2 years.
D) 4 years.

Question 72

The management of Hence Corporation is considering the purchase of a new machine costing $200,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 90,000 & \$ 50,000 & 1 \\\hline 10,000 & 20,000 & 2 \\\hline 50,000 & 10,000 & 3 \\\hline 45,000 & 5,000 & 4 \\\hline 45,000 & 5,000 & 5 \\\hline\end{array}$
The net present value for this investment is:

A) positive $24,960.
B) negative $27,600.
C) positive $27,600.
D) negative $24,960.

Question 73

The management of London Corporation is considering the purchase of a new machine costing $750,000. The company's desired rate of return is 6%. The present value factors for $1 at compound interest of 6% for 1 through 5 years are 0.943, 0.890, 0.840, 0.792, and 0.747, respectively. In addition to this information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 187,500 & \$ 37,500 & 1 \\\hline 187,500& 37,500 & 2 \\\hline187,500& 37,500 & 3 \\\hline 187,500 &37,500 & 4 \\\hline 187,500& 37,500 & 5 \\\hline\end{array}$
The average rate of return for this investment is:

A) 5%.
B) 10%.
C) 25%.
D) 15%.

Question 74

The present value index is computed using which of the following formulas?

A) Amount to be invested/Average rate of return
B) Total present value of net cash flow/Amount to be invested
C) Total present value of net cash flow/Average rate of return
D) Amount to be invested/Total present value of net cash flow

Question 75

Crane Company is considering the acquisition of a machine that costs $60,000. The machine is expected to have a useful life of 5 years, a negligible residual value, an annual cash flow of $15,000, and annual operating income of $15,000. What is the estimated cash payback period for the machine?

A) 1.7 years
B) 3 years
C) 4 years
D) 5 years

Question 76

The management of Hence Corporation is considering the purchase of a new machine costing $200,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 90,000 & \$ 50,000 & 1 \\\hline 60,000 & 20,000 & 2 \\\hline 50,000 & 10,000 & 3 \\\hline 45,000 & 5,000 & 4 \\\hline 45,000 & 5,000 & 5 \\\hline\end{array}$
The present value index for this investment is:

A) 0.88.
B) 1.45.
C) 1.14.
D) 0.70.

Question 77

The management of London Corporation is considering the purchase of a new machine costing $750,000. The company's desired rate of return is 6%. The present value factors for $1 at compound interest of 6% for 1 through 5 years are 0.943, 0.890, 0.840, 0.792, and 0.747, respectively. In addition to this information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 187,500 & \$ 37,500 & 1 \\\hline 187,500& 37,500 & 2 \\\hline187,500& 37,500 & 3 \\\hline 187,500 &37,500 & 4 \\\hline 187,500& 37,500 & 5 \\\hline\end{array}$

The cash payback period for this investment is:

A) 3 years.
B) 5 years.
C) 20 years.
D) 4 years.

Question 78

The management of London Corporation is considering the purchase of a new machine costing $750,000. The company's desired rate of return is 6%. The present value factors for $1 at compound interest of 6% for 1 through 5 years are 0.943, 0.890, 0.840, 0.792, and 0.747, respectively. In addition to this information, use the following data in determining the acceptability in this situation: $\begin{array}{|l|l|l|}\hline\text { Net } & \text { Income from } \\\text { Cash }\\ \hline\text { Flow }& \text {Operations }&\text { Year }\\\hline \$ 187,500 & \$ 37,500 & 1 \\\hline 187,500& 37,500 & 2 \\\hline187,500& 37,500 & 3 \\\hline 187,500 &37,500 & 4 \\\hline 187,500& 37,500 & 5 \\\hline\end{array}$
The net present value for this investment is:

A) positive $39,750.
B) positive $118,145.
C) negative $118,145.
D) negative $39,750.

Question 79

A series of equal cash flows at fixed intervals is termed as a(n):

A) present value index.
B) price-level index.
C) net cash flow.
D) annuity.

Question 80

The payback period is determined using which of the following formulas?

A) Amount to be invested/Annual average net income
B) Annual net cash flow/Amount to be invested
C) Annual average net income/Amount to be invested
D) Amount to be invested/Annual net cash flows