Deck 26: Capital Investment Decisions

Question 1

Which of the following is a capital budgeting method used to screen potential investments?

A) return on assets
B) acid test ratio
C) accounting rate of return
D) debt-to-equity ratio

Answer 1

C

Question 2

Which of the following best describes a capital budgeting post-audit?

A) an audit of an operating unit of a company
B) an audit performed only at the end of the project's life span
C) an analysis of an investment's cash flows prior to committing to the initial investment
D) a comparison of actual results of capital investments with projected results

Answer 2

D

Question 3

The payback and accounting rate of return (ARR)methods are suitable for investments with a relatively short time span.

Answer 3

True

Question 4

The payback and accounting rate of return methods are often used to perform an initial screening of investments.

Question 5

Which of the following best describes the term capital rationing?

A) a method of determining the period within which the cash invested is recouped
B) a process of ranking and choosing among alternative capital investments based on the availability of funds
C) a method which shows the effect of an investment on a company's accrual-based income
D) a process of controlling operating costs when adequate funds are not available

Question 6

The payback method provides management with valuable information about the time period in which the cash invested will be recouped.

Question 7

The last step in the capital budgeting process is control,which compares the actual results with the projected results.These comparisons are known as ________.

A) net cash inflows
B) post-audits
C) rankings
D) variance analysis

Question 8

Which of the following is a capital budgeting method?

A) return on assets
B) net present value
C) inventory turnover
D) return on equity

Question 9

Capital rationing is a process adopted when a company has limited resources,and it must find ways to reduce operating expenses in all of its divisions and units.

Question 10

The acquisition or construction of a capital asset is known as a capital investment.

Question 11

The accounting rate of return shows the effect of the investment on the company's accrual-based income.

Question 12

Which of the following two methods are typically used for initial screening of investments,rather than for detailed,in-depth analysis?

A) payback and accounting rate of return
B) net present value and payback
C) internal rate of return and net present value
D) accounting rate of return and net present value

Question 13

List the steps of the capital budgeting process and identify actions that relate to each step.

Question 14

Two methods of analyzing potential capital investments-payback and accounting rate of return-ignore the time value of money.

Question 15

An operational asset used for a long period of time is known as a capital asset.

Question 16

Capital budgeting is the ________.

A) process of planning for investments in long-term assets
B) preparation of the budget for operating expenses
C) process of evaluating the profitability of a business
D) process of making pricing decisions for products

Question 17

A post-audit in capital budgeting is a comparison of the actual results of capital investments with the projected results.

Question 18

The net present value and internal rate of return methods are appropriate for longer-term investments because they ignore the time value of money.

Question 19

Capital budgeting involves ________.

A) budgeting for yearly operational expenses
B) preparing the sales budget for the coming year
C) deciding among various long-term investments
D) analyzing various alternatives of financing available to a company

Question 20

Which of the following is a capital budgeting method that ignores the time value of money?

A) payback
B) internal rate of return
C) return on assets
D) net present value

Question 21

The payback method is a screening device and is rarely used as the sole method for deciding whether to invest in an asset.

Question 22

Most capital budgeting methods focus on accrual-based income.

Question 23

The payback method is used only when the net cash inflows from a capital investment are the same for each period.

Question 24

Newman Automobiles Manufacturing is considering two alternative investment proposals with the following data: $$\begin{array} { | l | r | r | } \hline & \text { Proposal } \mathbf { X } & \text { Proposal Y } \\\hline \text { Investment } & \$ 11,100,000 & \$ 570,000 \\\hline \text { Useful life } & 5 \text { years } & 5 \text { years } \\\hline \text { Estimated annual net cash inflows for 5 years } & \$ 2,220,000 & \$ 95,000 \\\hline \text { Residual value } & \$ 54,000 & \$ 27,000 \\\hline \text { Depreciation method } & \text { Straight-line } & \text { Straight-line } \\\hline \text { Required rate of return } & 12 \% & 10 \% \\\hline\end{array}$$ Calculate the payback period for Proposal X.

A) 5 years
B) 4 years
C) 9 years
D) 10 years

Question 25

Software Hub is deciding whether to purchase new accounting software.The cost of the software package is $68,000,and its expected life is ten years.The payback for this investment is four years.Assuming equal yearly cash flows,what are the expected annual net cash savings from the new software? (Assume the investment has no residual value.)

A) $6,800
B) $51,000
C) $17,000
D) $272,000

Question 26

Both the payback and the accounting rate of return methods focus on cash flows that an asset generates.

Question 27

Landmark Prints is considering an investment in new equipment costing $520,000.The equipment will be depreciated on a straight-line basis over a five-year life and is expected to generate net cash inflows of $128,000 the first year,$160,000 the second year,and $154,000 every year thereafter until the fifth year.What is the payback period for this investment? The residual value is zero.(Round your answer to two decimal places.)

A) 4.50 years
B) 3.51 years
C) 2.86 years
D) 3.06 years

Question 28

The payback method considers cash flows that occur both during and after the payback period.

Question 29

All else being equal,investments with longer payback periods are preferable.

Question 30

A major criticism of the payback method is that it focuses only on the time to recover the investment and ignores profitability.

Question 31

Managers generally use payback as the sole method for deciding whether to invest in an asset.

Question 32

Logan,Inc.is evaluating two possible investments in depreciable plant assets.The company uses the straight-line method of depreciation.The following information is available: $$\begin{array} { | l | r | r | } \hline & \text { Investment A } & \text { Investment B } \\\hline \text { Initial capital investment } & \$ 102,000 & \$ 150,000 \\\hline \text { Estimated useful life } & 10 \text { years } & 10 \text { years } \\\hline \text { Estimated residual value } & 0 & \$ 23,000 \\\hline \text { Estimated annual net cash inflow for 10 years } & \$ 20,000 & \$ 46,000 \\\hline \text { Required rate of return } & 10 \% & 14 \% \\\hline\end{array}$$ Calculate the payback period for Investment A.(Round your answer to two decimal places.)

A) 3.04 years
B) 3.95 years
C) 1.00 year
D) 5.10 years

Question 33

Cash inflows include future cash revenue generated from an investment and any future residual value of the asset but exclude any future savings in ongoing cash operating costs resulting from the investment.

Question 34

The payback method uses discounted cash flows to make investment decisions.

Question 35

Cortes Cargo,Inc.is considering three investment opportunities with the following payback periods: $$\begin{array} { | l | c | c | c | } \hline & \text { Project } X & \text { Project } Y & \text { Project } Z \\\hline \text { Payback period } & 3 \text { years } & 2.5 \text { years } & 2.8 \text { years } \\\hline\end{array}$$ Use the decision rule for payback to rank the projects from most desirable to least desirable,all else being equal.

A) Y, Z, X
B) X, Y, Z
C) Z, Y, X
D) Y, X, Z

Question 36

Net cash inflows from a capital investment arise from an increase in revenues,a decrease in expenses,or both.

Question 37

The following details are provided by a manufacturing company: $$\begin{array} { | l | r | } \hline & \text { Product line } \\\hline \text { Investment } & \$ 1,190,000 \\\hline \text { Useful life } & 12 \text { years } \\\hline \text { Estimated annual net cash inflows for first year } & \$ 400,000 \\\hline \text { Estimated annual net cash inflows for second year } & \$ 390,000 \\\hline \text { Estimated annual net cash inflows for next ten years } & \$ 490,000 \\\hline \text { Residual value } & \$ 90,000 \\\hline \text { Depreciation method } & \text { Straight-line } \\\hline \text { Required rate of return } & 12 \% \\\hline\end{array}$$ Calculate the payback period for the investment.(Round your answer to two decimal places.)

A) 2.98 years
B) 2.82 years
C) 1.98 years
D) 2.20 years

Question 38

List three cash inflows and three cash outflows for capital investments.
$$\begin{array} { | c | c | } \hline \text { Cash inflows } & \text { Cash outflows } \\\hline & \\\hline & \\\hline & \\\hline\end{array}$$

Question 39

Joanne,Inc.is evaluating two possible investments in depreciable plant assets.The company uses the straight-line method of depreciation.The following information is available: $$\begin{array} { | l | r | r | } \hline & \text { Investment A } & \text { Investment B } \\\hline \text { Initial capital investment } & \$ 110,000 & \$ 153,000 \\\hline \text { Estimated useful life } & 10 \text { years } & 10 \text { years } \\\hline \text { Estimated residual value } & 0 & \$ 30,000 \\\hline \text { Estimated annual net cash inflow for 10 years } & \$ 21,000 & \$ 46,000 \\\hline \text { Required rate of return } & 12 \% & 14 \% \\\hline\end{array}$$ Calculate the payback period for Investment B.(Round your answer to two decimal places.)

A) 3.33 years
B) 1.83 years
C) 3.81 years
D) 5.24 years

Question 40

When projecting future cash flows of an investment ________.

A) cash flows includes depreciation
B) cash inflows and outflows are treated separately, rather than being netted together
C) cash flows are projected by accounting personnel without considering input from other departments
D) the initial investment is a significant cash outflow that is treated separately from all other cash flows

Question 41

A company is evaluating three possible investments.The following information is provided by the company: $$\begin{array} { | l | r | r | r | } \hline & \text { Project A } & \text { Project B } & \text { Project C } \\\hline \text { Investment } & \$ 200,000 & \$ 54,000 & \$ 200,000 \\\hline \text { Residual value } & 0 & 20,000 & 24,000 \\\hline \text { Net cash flows: } & & & \\\hline \text { Year 1 } & 52,000 & 36,000 & 94,000 \\\hline \text { Year 2 } & 52,000 & 27,000 & 64,000 \\\hline \text { Year 3 } & 52,000 & 23,000 & 74,000 \\\hline \text { Year 4 } & 52,000 & 20,000 & 34,000 \\\hline \text { Year 5 } & 52,000 & 0 & 0 \\\hline\end{array}$$ What is the payback period for Project A? (Assume that the company uses the straight-line depreciation method.)(Round your answer to two decimal places.)

A) 2.85 years
B) 1.50 years
C) 3.85 years
D) 5.00 years

Question 42

Safe Driving School is considering purchasing new autos costing $235,000.The company's management has estimated that the autos will generate cash flows as follows:
$$\begin{array} { l l } \text { Year 1 } & \$ 80,000 \\\text { Year 2 } & \$ 85,000 \\\text { Year 3 } & \$ 95,000 \\\text { Year 4 } & \$ 45,000\end{array}$$ Considering the residual value is zero,calculate the payback period.Round to one decimal place

Question 43

McAfee Automobiles Manufacturing is considering two alternative investment proposals with the following data: $$\begin{array} { | l | r | r | } \hline & \text { Proposal } X & \text { Proposal Y } \\\hline \text { Investment } & \$ 11,800,000 & \$ 470,000 \\\hline \text { Useful life } & 5 \text { years } & 5 \text { years } \\\hline \text { Estimated annual net cash inflows for 5 years } & \$ 2,360,000 & \$ 103,000 \\\hline \text { Residual value } & \$ 58,000 & \$ 34,000 \\\hline \text { Depreciation method } & \text { Straight-line } & \text { Straight-line } \\\hline \text { Required rate of return } & 12 \% & 10 \% \\\hline\end{array}$$ Calculate the accounting rate of return for Proposal Y.(Round any intermediate calculations and your final answer to two decimal places.)

A) 16.10%
B) 10.63%
C) 6.27%
D) 10.80%

Question 44

The accounting rate of return method focuses on operating income instead of net cash inflow generated by an asset.

Question 45

If net cash inflows are unequal,how is the payback period (in years)of an investment is calculated?

Question 46

Flint Systems is considering investing in production-management software that costs $640,000,has $67,000 residual value,and leads to cost savings of $1,850,000 per year over its five-year life.Calculate the average amount invested in the asset that should be used for calculating the accounting rate of return.

A) $707,000
B) $640,000
C) $353,500
D) $67,000

Question 47

Under what circumstances is the investment with the shortest payback the best choice? How should managers use the payback method?

Question 48

The Accounting Rate of Return method evaluates the lifetime return of an investment,whereas Return on Investment evaluates the annual return of an investment.

Question 49

Yates,Inc.is evaluating two possible investments in depreciable plant assets.The company uses the straight-line method of depreciation.The following information is available:
$$\begin{array} { l r r } & \text { Investment A } & \text { Investment B } \\\text { Initial capital investment } & \$ 275,000 & \$ 225,000 \\\text { Estimated useful life } & 8 \text { years } & 7 \text { years } \\\text { Estimated residual value } & \$ 15,000 & \$ 20,000 \\\text { Estimated annual net cash inflow for 10 years } & \$ 55,000 & \$ 35,000 \\\text { Required rate of return } & 12 \% & 12 \%\end{array}$$ Compute the payback period for each investment.Show your calculations and round to one decimal place.

Question 50

A company is evaluating three possible investments.Each uses the straight-line method of depreciation.Following information is provided by the company: $$\begin{array} { | l | r | r | r | } \hline & \text { Project A } & \text { Project B } & \text { Project C } \\\hline \text { Investment } & \$ 228,000 & \$ 52,000 & \$ 228,000 \\\hline \text { Residual value } & 0 & 10,000 & 34,000 \\\hline \text { Net cash flows: } & & & \\\hline \text { Year 1 } & 56,000 & 24,000 & 86,000 \\\hline \text { Year 2 } & 56,000 & 15,000 & 56,000 \\\hline \text { Year 3 } & 56,000 & 11,000 & 66,000 \\\hline \text { Year 4 } & 56,000 & 8,000 & 26,000 \\\hline \text { Year 5 } & 56,000 & 0 & 0 \\\hline\end{array}$$ What is the accounting rate of return for Project B? (Round your answer to two decimal places.)

A) 20.84%
B) 9.82%
C) 12.90%
D) 12.22%

Question 51

Paramount Carpets is considering purchasing new equipment costing $736,000.The company's management has estimated that the equipment will generate cash flows as follows: $$\begin{array} { | r | r | } \hline \text { Year } 1 & \$ 218,000 \\\hline 2 & 218,000 \\\hline 3 & 260,000 \\\hline 4 & 260,000 \\\hline 5 & 168,000 \\\hline\end{array}$$ Considering the residual value is zero,calculate the payback period.(Round your answer to two decimal places.)

A) 4.39 years
B) 3.15 years
C) 3.62 years
D) 3.81 years

Question 52

Clapton Corporation is considering an investment in new equipment costing $934,000.The equipment will be depreciated on a straight-line basis over a ten-year life and is expected to have a residual value of $90,000.The equipment is expected to generate net cash flows of $156,000 for each of the first five years and $138,000 for each of the last five years.What is the accounting rate of return associated with the equipment investment? (Round your answer to two decimal places.)

A) 12.86%
B) 13.30%
C) 8.25%
D) 12.23%

Question 53

The accounting rate of return also is known as the average rate of return or annual rate of return.

Question 54

Dartis Tools Co.is considering investing in specialized equipment costing $670,000.The equipment has a useful life of five years and a residual value of $61,000.Depreciation is calculated using the straight-line method.The expected net cash inflows from the investment are given below: $$\begin{array} { | r | r | } \hline \text { Year } 1 & \$ 201,000 \\\hline 2 & 159,000 \\\hline 3 & 163,000 \\\hline 4 & 100,000 \\\hline 5 & \underline { 157,000 } \\\hline & \$ 780,000 \\\hline\end{array}$$ What is the accounting rate of return on the investment? (Round your answer to two decimal places.)

A) 10.21%
B) 11.23%
C) 9.36%
D) 4.68%

Question 55

Which capital budgeting method uses accrual accounting,rather than net cash flows,as a basis for calculations?

A) payback
B) accounting rate of return
C) net present value
D) internal rate of return

Question 56

Caliber Lawnmowers is considering the purchase of a new machine costing $804,000.The company's management is estimating that the new machine will generate additional cash flows of $180,000 a year for ten years and have a residual value of $62,000 at the end of ten years.What is the machine's payback period? (Round your answer to two decimal places.)

A) 4.47 years
B) 7.29 years
C) 3.33 years
D) 4.32 years

Question 57

Nylan Tiles is considering an investment in new equipment costing $850,000.The equipment will be depreciated on a straight-line basis over a five-year life and is expected to have a residual value of $54,000.The equipment is expected to generate net cash inflows of $1,000,000 in total during the five-year life.What is the accounting rate of return associated with the equipment investment? (Round your answer to two decimal places.)

A) 10.79%
B) 9.03%
C) 49.10%
D) 9.33%

Question 58

The accounting rate of return is calculated by dividing the average annual operating income by the average amount invested.

Question 59

The accounting rate of return method considers the time value of money.

Question 60

If the expected accounting rate of return meets or exceeds the required rate of return,the decision rule is to not make the investment.

Question 61

The process for calculating present values is often called discounting future cash flows because future amounts are discounted to their present value.

Question 62

An annuity is a stream of equal cash payments made at equal time intervals.

Question 63

Elsie Moving Company is considering purchasing new equipment that costs $724,000.Its management estimates that the equipment will generate cash flows as follows: $$\begin{array} { | r | c | } \hline \text { Year 1 } & \$ 212,000 \\\hline 2 & 212,000 \\\hline 3 & 260,000 \\\hline 4 & 260,000 \\\hline 5 & 158,000 \\\hline\end{array}$$ The company's required rate of return is 10%.Using the factors in the table below,calculate the present value of the cash inflows.(Round all calculations to the nearest whole dollar.)
Present value of $1:
$$\begin{array} { | l | r | r | r | r | r | } \hline & { 6 \% } & { 7 \% } &{ 8 \% } & { 9 \% } & 10 \% \\\hline 1 & 0.943 & 0.935 & 0.926 & 0.917 & 0.909 \\\hline 2 & 0.890 & 0.873 & 0.857 & 0.842 & 0.826 \\\hline 3 & 0.840 & 0.816 & 0.794 & 0.772 & 0.751 \\\hline 4 & 0.792 & 0.763 & 0.735 & 0.708 & 0.683 \\\hline 5 & 0.747 & 0.713 & 0.681 & 0.650 & 0.621 \\\hline\end{array}$$

A) $791,229
B) $795,284
C) $838,778
D) $806,742

Question 64

Door to Door Moving Company is considering purchasing new equipment that costs $730,000.Its management estimates that the equipment will generate cash flows as follows: $$\begin{array} { | r | c | } \hline \text { Year 1 } & \$ 206,000 \\\hline 2 & 206,000 \\\hline 3 & 262,000 \\\hline 4 & 262,000 \\\hline 5 & 154,000 \\\hline\end{array}$$ Present value of $1:
$$\begin{array} { | l | r | r | r | r | r | } \hline & { 6 \% } & { 7 \% } & { 8 \% } & { 9 \% } & 10 \% \\\hline 1 & 0.943 & 0.935 & 0.926 & 0.917 & 0.909 \\\hline 2 & 0.890 & 0.873 & 0.857 & 0.842 & 0.826 \\\hline 3 & 0.840 & 0.816 & 0.794 & 0.772 & 0.751 \\\hline 4 & 0.792 & 0.763 & 0.735 & 0.708 & 0.683 \\\hline 5 & 0.747 & 0.713 & 0.681 & 0.605 & 0.621 \\\hline\end{array}$$ The company's annual required rate of return is 8%.Using the factors in the table,calculate the present value of the cash inflows.(Round all calculations to the nearest whole dollar.)

A) $36,668
B) $786,000
C) $884,000
D) $872,770

Question 65

A company is evaluating an investment.The company uses the straight-line method of depreciation.Use the following information to compute the accounting rate of return.Show your calculations and round to one decimal place.
$\begin{array}{ll}& \text { Project } \\\text { Investment } & \$ 875,000 \\\text { Residual value } & 0 \\\text { Operating income: } &\\\text { Year 1 } & 120,000 \\\text { Year 2 } & 120,000 \\\text { Year 3 } & 120,000 \\\text { Year 4 } & 120,000 \\\text { Year 5 } & 120,000\end{array}$

Question 66

The only difference between the present value and future value of a lump sum is the amount of interest that is earned in the intervening time span.

Question 67

Which of the following describes the time value of money?

A) The time value of money has no effect on the timing of capital investments.
B) Money loses its purchasing power over time through inflation.
C) The fact that invested cash may not earn interest over time is called the time value of money.
D) A dollar received today is worth more than a dollar to be received in the future.

Question 68

Compound interest assumes that all interest earned will remain invested and earn additional interest at the same interest rate.

Question 69

When using the accounting rate of return,what is the basis for making the decision to make the investment?

Question 70

An investment today of $8,424 at 6% will yield total payments of $10,000 over five years.The reason for this increase is that the interest is being earned on principal that is left invested each year.

Question 71

Martin Production Co.is considering investing in specialized equipment costing $975,000.The equipment has a useful life of five years and a residual value of $75,000.Depreciation is calculated using the straight-line method.The expected net cash inflows from the investment are given below:
$$\begin{array} { r r } \text { Year 1 } & \$ 275,000 \\\text { Year 2 } & 220,000 \\\text { Year 3 } & 200,000 \\\text { Year 4 } & 200,000 \\\text { Year 5 } & \underline { 180,000 } \\& \$ 1,075,000\end{array}$$ Compute the accounting rate of return on the investment,Show your calculations and round to two decimal places.

Question 72

Lora Corporation will receive $10,000 a year at the end of each of the next five years.Using a discount rate of 14%,the present value of the receipts can be stated as ________.

A) PV = $10,000 (Ordinary Annuity FV factor, i = 14%, n = 5)
B) PV = $10,000 (PV factor, i = 14%, n = 5)
C) PV = $10,000 (Ordinary Annuity PV factor, i = 14%, n = 5)
D) PV = $10,000 (FV factor, i = 14%, n = 5)

Question 73

The fact that invested cash earns income over time is called the time value of money.

Question 74

The following formula is used to compute the present value of a lump sum:
Future value = Present value × PV factor for i = X%,n = X periods

Question 75

A company is evaluating three possible investments.Each uses the straight-line method of depreciation.The following information is provided by the company: $$\begin{array} { | l | r | r | r | } \hline & \text { Project A } & \text { Project B } & \text { Project C } \\\hline \text { Investment } & \$ 210,000 & \$ 54,000 & \$ 210,000 \\\hline \text { Residual value } & 0 & 30,000 & 28,000 \\\hline \text { Net cash flows: } & & & \\\hline \text { Year 1 } & 70,000 & 34,000 & 82,000 \\\hline \text { Year 2 } & 70,000 & 25,000 & 52,000 \\\hline \text { Year 3 } & 70,000 & 21,000 & 62,000 \\\hline \text { Year 4 } & 70,000 & 18,000 & 22,000 \\\hline \text { Year 5 } & 70,000 & 0 & 0 \\\hline\end{array}$$ What is the accounting rate of return for Project C? (Round your answer to two decimal places.)

A) 14.29%
B) 7.56%
C) 33.33%
D) 10.48%

Question 76

Compound interest means that interest is calculated only on the principal amount.

Question 77

All else being equal,the shorter the investment period,the higher the total amount of interest earned.

Question 78

Which of the following most accurately describes an annuity?

A) an investment which produces increasing cash flows over time
B) a series of unequal cash payments made at equal time intervals
C) a stream of equal cash payments made at equal time intervals
D) a term that does not apply to mortgage payable or bond payable

Question 79

An annuity is a series of unequal payments over equal intervals.

Question 80

Lloyd's Moving Company is considering purchasing new equipment that costs $728,000.Its management estimates that the equipment will generate cash flows as follows: $$\begin{array} { | r | c | } \hline \text { Year 1 } & \$ 206,000 \\\hline 2 & 206,000 \\\hline 3 & 254,000 \\\hline 4 & 254,000 \\\hline 5 & 156,000 \\\hline\end{array}$$ Present value of $1:
$$\begin{array} { | l | r | r | r | r | r | } \hline & { 6 \% } &{ 7 \% } & { 8 \% } & { 9 \% } & 10 \% \\\hline 1 & 0.943 & 0.935 & 0.926 & 0.917 & 0.909 \\\hline 2 & 0.890 & 0.873 & 0.857 & 0.842 & 0.826 \\\hline 3 & 0.840 & 0.816 & 0.794 & 0.772 & 0.751 \\\hline 4 & 0.792 & 0.763 & 0.735 & 0.708 & 0.683 \\\hline 5 & 0.747 & 0.713 & 0.681 & 0.650 & 0.621 \\\hline\end{array}$$ The company's annual required rate of return is 9%.Using the factors in the table,calculate the present value of the cash flows.(Round all calculations to the nearest whole dollar.)

A) $870,000
B) $839,674
C) $853,320
D) $872,000