Deck 26: Capital Budgeting

Question 1

The payback period analysis fails to consider the cash flows over the entire life of the investment.

Answer 1

True

Question 2

The payback period considers total profitability over the life of an investment and takes into consideration the timing of an investment's future cash flows.

Answer 2

False

Question 3

The residual value of an asset should be subtracted from the cost of the asset when determining the average amount invested.

Answer 3

False

Question 4

The impact of a capital budgeting decision upon the environment is an example of a nonfinancial consideration.

Question 5

The acquiring of a subsidiary company by a publicly traded company would be an example of a capital expenditure.

Question 6

The present value of a future cash flow is the amount you would pay today for the right to receive that future amount.

Question 7

In capital budgeting,one may use estimates in making decisions.

Question 8

Capital budgeting estimates often involve a considerable degree of uncertainty.

Question 9

To determine the average investment over the life of an asset,divide the total depreciation of the investment by two.

Question 10

Perhaps the most important financial considerations in a capital budgeting decision are the decision's effects upon future cash flow and future profitability.

Question 11

Non-financial factors are relevant in capital budgeting.

Question 12

The present value of money is always less than its future value.

Question 13

Most capital budgeting techniques involve analysis of net operating profits.

Question 14

A failure of the return on average investment method is that no consideration is given to the time value of money.

Question 15

The annual net cash flow of an investment refers to the excess revenue it generates over its related expenses.

Question 16

Capital investments are difficult,if not impossible,to reverse once funds have been invested.

Question 17

The difference between the present value and future value depends on the rate of interest and the length of time that interest accumulates.

Question 18

Nonfinancial considerations are not accounted for in capital budgeting decisions.

Question 19

The payback period can be determined by multiplying the amount invested by net cash flows received annually.

Question 20

Capital investment refers to large expenditures to purchase plant assets,develop new products,or sell more company stock.

Question 21

The reliability of estimates is a critical factor in capital budget proposals.

Question 22

Capital budget audits are often undertaken to ensure the accuracy of cash flow estimates.

Question 23

[The following information applies to the questions displayed below.]
The Terme Corporation is contemplating the purchase of new equipment,which may potentially increase revenues by 25%.Currently,sales are $750,000 per year and variable costs are 55% of sales.The equipment is expected to last for 5 years with no residual value.The cash outflow expected at the beginning of the year is $ 357,500.
What is the amount of depreciation deduction the company could expense annually assuming the straight-line depreciation method is used?

A)$75,000
B)$41,250
C)$71,500
D)$30,250

Question 24

When straight-line depreciation is used,the average carrying value of an asset with no salvage value is equal to the asset's original cost divided by its estimated useful life.

Question 25

The discount rate used in discounting cash flows from proposed investments is usually the rate of return required by the investor.

Question 26

The recognition of depreciation expense often causes the annual net income of an investment to be less than the amount of its annual net cash flows.

Question 27

When an investment fails to provide the desired rate of return,the investment should be rejected.

Question 28

Which of the following is not considered a capital investment?

A)The purchase of a large machine.
B)The development of a new product line.
C)The purchase of a large order of raw materials used in the production process.
D)The acquisition of a subsidiary company.

Question 29

A short payback period is preferred so that the investment's costs can be put to other uses.

Question 30

Capital investment proposals may not be evaluated by using:

A)The payback period.
B)The return on investment method.
C)The discounted cash flow method.
D)The income statement method.

Question 31

When the net present value is greater than zero,the investment's rate of return is less than the discount rate.

Question 32

[The following information applies to the questions displayed below.]
The Terme Corporation is contemplating the purchase of new equipment,which may potentially increase revenues by 25%.Currently,sales are $750,000 per year and variable costs are 55% of sales.The equipment is expected to last for 5 years with no residual value.The cash outflow expected at the beginning of the year is $ 357,500.
Ignoring income taxes,what is the estimated annual net operating income increase/decrease?

A)$9,375 decrease
B)$12,875 increase
C)$43,125 decrease
D)$54,125 increase

Question 33

[The following information applies to the questions displayed below.]
The Terme Corporation is contemplating the purchase of new equipment,which may potentially increase revenues by 25%.Currently,sales are $750,000 per year and variable costs are 55% of sales.The equipment is expected to last for 5 years with no residual value.The cash outflow expected at the beginning of the year is $ 357,500.
By how much would Terme's annual gross profit increase if the investment is undertaken?

A)$750,000
B)$84,375
C)$187,500
D)$103,125

Question 34

Results of capital budgeting processes may have serious implications for employees.

Question 35

The return on average investment computation ignores the timing of an investment's future cash flows.

Question 36

The net present value of an investment proposal is the difference between the total present value of future net cash flows and the cost of the investment.

Question 37

Capital investment decisions are not affected by:

A)Income taxes.
B)Nonfinancial considerations.
C)Depreciation methods.
D)Inventory levels.

Question 38

In capital budgeting,the investment proposal with the shortest payback period always has the highest rate of return.

Question 39

In considering investment in new plant assets,the payback period is computed without regard to the total useful life of the investment.

Question 40

The higher the required rate of return of an investment,the less an investor will be willing to pay for the investment.

Question 41

When management considers an investment,they look for the payback period to be:

A)Short.
B)Long.
C)Profitable.
D)Useful.

Question 42

[The following information applies to the questions displayed below.]
Newport Corporation is considering investing $65,000 in equipment to produce a new product.The useful service life of the equipment is estimated to be ten years,with no salvage value.Straight-line depreciation is used.The company estimates that production and sale of the new product will increase net income by $6,500 per year.
The payback period of this investment is:

A)Four years.
B)Five years.
C)Six years.
D)Over six years.

Question 43

The management of Salem Corporation is considering the purchase of equipment costing $109,000,which has an estimated life of 3 years and no salvage value.The net after tax cash flow from the project for each of the three years is expected to be $45,000.The company's cost of capital is 10%.Compute the net present value of the equipment.(Present value of $1 due in three years,discounted at 10%,is 0.751;present value of $1 received annually for three years,discounted at 10% is 2.487. )

A)($3,616)
B)$2,548
C)$2,915
D)($3,213)

Question 44

[The following information applies to the questions displayed below.]
Newport Corporation is considering investing $65,000 in equipment to produce a new product.The useful service life of the equipment is estimated to be ten years,with no salvage value.Straight-line depreciation is used.The company estimates that production and sale of the new product will increase net income by $6,500 per year.
The expected rate of return on average investment in this equipment is:

A)15%.
B)20%.
C)7.5%.
D)Some other percentage.

Question 45

If an investment costs $140,000 with no residual value,an expected increase in net income of $35,000 and a 5-year useful life,the payback period would be:

A)2.2 years.
B)4 years.
C)5 years.
D)2 years.

Question 46

Which of the following factors does the payback method consider?

A)Total profitability of an investment
B)The cash flows over the entire life of an investment
C)The timing of cash flows
D)The initial investment

Question 47

Of the following techniques of capital budgeting,which one explicitly incorporates an estimate of an interest rate into the basic computation?

A)Payback method
B)Average rate of return
C)Discounted cash flows method
D)Accounting book value method

Question 48

Which method of project selection gives consideration to the time value of money in a capital budgeting decision?

A)Payback method
B)Average rate of return
C)Discounted cash flows method
D)Accounting rate of return

Question 49

Kenny Company is considering the possibility of investing $1,500,000 in a special project.This venture will return $375,000 per year for 12 years in after tax cash flows.Depreciation on the project will be $187,500 per year using straight-line depreciation.The payback period for the project is:

A)6 years.
B)12 years.
C)4 years.
D)2 years.

Question 50

The selection of an appropriate discount rate for determining net present value of a particular investment proposal does not depend upon:

A)The present value of the proposal's future cash flows.
B)Alternative investment opportunities available.
C)The nature of the investment proposal.
D)The investor's cost of capital.

Question 51

The payback period:

A)Is the length of time necessary to recover the entire cost of an investment from its resulting annual net cash flow.
B)Is the length of time necessary to recover the entire cost of an investment from its resulting annual net income.
C)Takes into consideration the profitability of an investment over its entire life,but ignores the timing of its future cash flows.
D)Takes into consideration both the profitability of an investment over its entire life and the timing of its future cash flows.

Question 52

[The following information applies to the questions displayed below.]
Neville Company is considering an investment of $380,000 in heavy equipment,which will enable the company to be more competitive in the construction industry.The useful service life of the equipment is estimated to be 10 years,with $30,000 salvage value.Straight-line depreciation is used.The company estimates that net income will increase by $41,000 per year as a result of the company's ability to handle a wider range of projects with the new equipment.
The expected rate of return on average investment will be approximately:

A)20%.
B)43%.
C)23%.
D)37%.

Question 53

Which of the following is generally not considered a capital budgeting technique?

A)Payback period
B)Return on average investment
C)Return on stockholders' equity
D)Discounted future cash flows

Question 54

[The following information applies to the questions displayed below.]
Neville Company is considering an investment of $380,000 in heavy equipment,which will enable the company to be more competitive in the construction industry.The useful service life of the equipment is estimated to be 10 years,with $30,000 salvage value.Straight-line depreciation is used.The company estimates that net income will increase by $41,000 per year as a result of the company's ability to handle a wider range of projects with the new equipment.
The payback period for this investment is approximately:

A)4.7 years.
B)9 years.
C)8.75 years.
D)5 years.

Question 55

The present value of money is always:

A)Less than its future amount.
B)The same as its future amount.
C)More than its future amount.
D)More or less than its future amount depending upon the discount rate.

Question 56

Jericho Corporation is considering the purchase of new equipment costing initially $96,000.The equipment has an estimated life of 6 years with no salvage value.Straight-line depreciation is to be used.Net annual after tax cash flow is estimated to be $31,200 for 6 years.The payback period is:

A)1.2300 years.
B)3.0769 years.
C)5.0799 years.
D)6.0000 years.

Question 57

[The following information applies to the questions displayed below.]
Lazar Corporation is evaluating a proposal to invest in a machine costing $89,000.The machine has an estimated useful life of ten years,and an estimated salvage value of $14,000.The machine will increase the company's net income by approximately $9,600 per year.All revenue and expenses other than depreciation will be received and paid in cash.
The expected rate of return on average investment of the machine is:

A)10.0%.
B)17.0%.
C)18.6%.
D)48.0%.

Question 58

The president of Nash Company is considering a proposal by the factory manager for the purchase of a machine for $72,500.The useful life would be eight years,with no residual scrap value.The use of the machine will produce a positive annual cash flow of $14,000 a year for eight years.An annuity table shows that the present value of $1 received annually for eight years and discounted at 10% is 5.335.The net present value of the proposal,discounted at 10%,is:

A)$2,190.
B)Zero.
C)($3,868).
D)$3,868.

Question 59

[The following information applies to the questions displayed below.]
Lazar Corporation is evaluating a proposal to invest in a machine costing $89,000.The machine has an estimated useful life of ten years,and an estimated salvage value of $14,000.The machine will increase the company's net income by approximately $9,600 per year.All revenue and expenses other than depreciation will be received and paid in cash.
The payback period of the machine is approximately:

A)Four years.
B)Eight years.
C)Five years.
D)Ten years.

Question 60

A cost that has been incurred irrevocably by past actions is a(n):

A)Capital expenditure.
B)Incremental cost.
C)Sunk cost.
D)Fixed cost.

Question 61

[The following information applies to the questions displayed below.]
Helicopter Gear is planning to expand its product line,which requires investment of $475,200 in special-purpose machinery.The machinery has a useful life of six years and no salvage value.The estimated annual results of offering the new products are as follows:
All revenue from the new products and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.
Compute the net present value of this proposed investment,using a discount rate of 12%.(An annuity table shows that the present value of $1 received annually for six years,discounted at 12%,is 4.111. )

A)($105,600)
B)($41,078)
C)$369,600
D)$434,121

Question 62

[The following information applies to the questions displayed below.]
Rooney,Inc.is considering the purchase of a new machine costing $640,000.The machine's useful life is expected to be 8 years with no salvage value.The straight-line depreciation method will be used.The net increase in annual after tax cash flow is expected to be $147,000.Rooney estimates its cost of capital to be 14%.(The present value of a $1 annuity for 8 years at 14% is 4.639,and the present value of $1 to be received in 8 years is 0.351. )
The net present value of the investment in the machine under consideration is:

A)$40,520.
B)$41,933.
C)$60,480.
D)$75,160.

Question 63

[The following information applies to the questions displayed below.]
Newman Labs is considering buying equipment,which would enable the company to obtain a five-year research contract.The specialized equipment costs $650,000 and will have no salvage value when the five-year contract period is over.The estimated annual operating results of the project are as follows:
All revenue from the contract and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.
The payback period for the investment in equipment is closest to:

A)5 years.
B)1 years.
C)2.5 years.
D)2.8 years.

Question 64

[The following information applies to the questions displayed below.]
Newman Labs is considering buying equipment,which would enable the company to obtain a five-year research contract.The specialized equipment costs $650,000 and will have no salvage value when the five-year contract period is over.The estimated annual operating results of the project are as follows:
All revenue from the contract and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.
Compute the net present value of this investment,using a discount rate of 12%.(An annuity table shows that the present value of $1 received annually for five years,discounted at 12%,is 3.605. )

A)$468,650
B)$179,150
C)$289,500
D)$829,150

Question 65

[The following information applies to the questions displayed below.]
Rooney,Inc.is considering the purchase of a new machine costing $640,000.The machine's useful life is expected to be 8 years with no salvage value.The straight-line depreciation method will be used.The net increase in annual after tax cash flow is expected to be $147,000.Rooney estimates its cost of capital to be 14%.(The present value of a $1 annuity for 8 years at 14% is 4.639,and the present value of $1 to be received in 8 years is 0.351. )
Upper level managers at Rooney,Inc.are concerned that employee estimates of future cash flows from the new machine may be overly optimistic.To what dollar amount can the annual after tax cash flow fall before the investment in the new machine should be rejected?

A)$640,000.
B)$224,640.
C)$168,080.
D)$137,961.

Question 66

On the basis of the above data,which of the following is false?

A)Proposal A should be considered unacceptable.
B)Proposal C is the best alternative because it has the shortest payback period,which is the most meaningful of the capital budgeting statistics.
C)Proposal A's negative net present value indicates that this alternative will not generate management's required rate of return.
D)Although proposals B and C are each acceptable,proposal B is a better investment considering the time value of money.

Question 67

Joseph Company is considering replacing an existing piece of machinery with newer technology.In deciding whether to replace the existing machinery,management should consider which costs as relevant?

A)Future costs which will be classified as fixed rather than variable.
B)Future costs which will be different under the two alternatives.
C)Sunk costs associated with the old machine.
D)Historical costs associated with the old machine.

Question 68

The management of Trylon Farms is considering the purchase of equipment costing $320,000.The equipment has a useful life of eight years,with $20,000 residual value.The use of this equipment will produce positive annual cash flow of $60,000 for eight years,as well as $20,000 from sale of the equipment at the end of the eighth year.Compute the net present value of this investment,discounted at an annual rate of 10%.(Present value of $1 due in eight years,discounted at 10%,is 0.467;present value of $1 received annually for eight years,discounted at 10% is 5.335. )

A)$9,340
B)$320,100
C)$9,440
D)$329,440

Question 69

[The following information applies to the questions displayed below.]
Helicopter Gear is planning to expand its product line,which requires investment of $475,200 in special-purpose machinery.The machinery has a useful life of six years and no salvage value.The estimated annual results of offering the new products are as follows:
All revenue from the new products and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.
The payback period for this proposed investment is:

A)4.5 years.
B)12.3 years.
C)6 years.
D)2.8 years.

Question 70

An investment cost $80,000 with no salvage value,a 5-year useful life,and had an expected annual increase in net income of $7,000.Straight-line depreciation is used.What is the expected return on average investment?

A)8.8%
B)20%
C)17.5%
D)10.4%

Question 71

[The following information applies to the questions displayed below.]
Newman Labs is considering buying equipment,which would enable the company to obtain a five-year research contract.The specialized equipment costs $650,000 and will have no salvage value when the five-year contract period is over.The estimated annual operating results of the project are as follows:
All revenue from the contract and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.
The return on average investment for this investment is approximately:

A)10%.
B)20%.
C)31%.
D)50%.

Question 72

[The following information applies to the questions displayed below.]
Helicopter Gear is planning to expand its product line,which requires investment of $475,200 in special-purpose machinery.The machinery has a useful life of six years and no salvage value.The estimated annual results of offering the new products are as follows:
All revenue from the new products and all expenses (except depreciation)will be received or paid in cash in the same period as recognized for accounting purposes.
The return on average investment for this proposed investment is closest to:

A)8.3%.
B)50%.
C)25%.
D)11.1%.

Question 73

In computing the return on average investment of a particular asset,the asset's annual depreciation expense may be viewed as:

A)An increase in the average amount invested over the life of the asset.
B)An increase in the asset's carrying value each year.
C)A recovery of the amount originally invested in the asset.
D)A decrease in the asset's net cash flows.

Question 74

The average carrying value (or average investment)of an asset with no salvage value is equal to:

A)The original cost of the asset divided by its estimated useful life.
B)The original cost of the asset divided by two.
C)The average annual net cash flow of the asset multiplied by the asset's estimated useful life.
D)The average annual net income of the asset multiplied by the asset's estimated useful life.

Question 75

The minimum rate of return used by an investor to bring future cash flows to their present value is called:

A)The investment rate.
B)The prime rate.
C)The discount rate.
D)The present rate.

Question 76

The above data indicate that:

A)After considering the timing of future cash flows,each of the three proposals is expected to provide a rate of return in excess of 15%.
B)Proposal A will generate net losses annually.
C)If the salvage value of proposal A were $52,000 instead of zero,proposal A would have the highest net present value.
D)The present value of proposal B's future cash flows is $2,471,600.

Question 77

To compute a future amount from a present value,we need to know:

A)The future value and length of time.
B)The interest rate and length of time.
C)The future annuity amount.
D)The present annuity amount.

Question 78

[The following information applies to the questions displayed below.]
The management of Ortega Manufacturing has three different proposals under consideration.The Accounting Department has prepared the following information:

Which of the above proposals generates the greatest annual cash flow?

A)Proposal A
B)Proposal B
C)Proposal C
D)Cannot be determined with the given information

Question 79

A machine cost $46,000 and had a useful life of 4 years and a residual value of $7,000.What is the net present value of the machine if the annual cash flow is $16,000 and the company uses a discount rate of 10%? An annuity table shows the present value of $1 at 10% for 4 years to be 0.683.The present value of an ordinary annuity of $1 discounted at 10% for 4 years is 3.170.

A)$16,501
B)$33,118
C)$9,501
D)$13,000

Question 80

Sterling Corporation has borrowed $75,000 that must be repaid in two years.This $75,000 is to be invested in an eight-year project with an estimated annual net cash flow of $15,000.The payback period for this investment is:

A)Two years.
B)Five years.
C)Eight years.
D)Indeterminable with the given information.