Question 1

A company is considering the purchase of a new machine for $48,000. Management expects that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. All revenues and expenses except depreciation are on a cash basis. The payback period for the machine is 12 years.

Accepted Answer

The payback period is actually 3 years ($48,000 initial cost / $16,000 annual cash inflow).

Question 2

For Years 1-5, a proposed expenditure of $500,000 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 5 years.

Accepted Answer

The cash payback period is calculated by summing the net cash flows until the initial investment is recovered. In this case, by the end of Year 4 ($90,000 + $85,000 + $75,000 + $75,000 = $325,000), the initial investment of $500,000 has not been fully recovered. By adding the Year 5 cash flow ($75,000), the total cash flow over the 5 years is $400,000, which still does not recover the initial $500,000 investment, indicating the payback period is longer than 5 years.

Question 3

A company is considering purchasing a machine for $21,000. The machine will generate income from operations of $2,000; annual net cash flows from the machine will be $3,500. The payback period for the new machine is 10.5 years.

Accepted Answer

To calculate payback period, we divide the cost of the investment by the annual net cash flows.
Payback period = $21,000 ÷ $3,500 = 6 years.
Since the payback period is shorter than the stated 10.5 years, the statement is false.

Question 4

If a proposed expenditure of $70,000 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.

Accepted Answer

The cash payback period is the length of time it takes for the cash inflows from an investment to recover the initial cost of the investment.

To calculate the cash payback period, we need to divide the initial cost of the asset ($70,000) by the annual net cash flow ($32,000).

Cash payback period = $70,000 ÷ $32,000 = 2.1875 years

Therefore, the statement in the question is false. The cash payback period is not 2.5 years, but rather 2.1875 years.

Question 5

The average rate of return method of analyzing capital budgeting decisions measures the average rate of return from using the asset over its entire life.

Accepted Answer

This statement is true. The average rate of return method calculates the average annual return over the entire life of an asset and compares it to the initial investment to determine whether the investment is worthwhile.

Question 6

The cash payback method can be used only when net cash inflows are the same for each period.

Accepted Answer

The cash payback method measures the time it takes to recover the initial investment in terms of cash inflows. It does not require net cash inflows to be the same for each period. However, it does assume that cash inflows will occur evenly throughout the payback period.

Question 7

The computations involved in the net present value method of analyzing capital investment proposals are less involved than those for the average rate of return method.

Accepted Answer

The net present value method involves more complex computations, including discounting future cash flows to their present value, which is more involved than the simpler calculations of the average rate of return method that typically uses basic arithmetic to estimate the return as a percentage of the investment.

Question 8

The time expected to pass before the net cash flows from an investment would return its initial cost is called the amortization period.

Accepted Answer

The time expected to pass before the net cash flows from an investment would return its initial cost is called the payback period. The amortization period refers to the gradual reduction of an asset's value over time due to its usage, wear and tear, or obsolescence.

Question 9

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 4 years.

Accepted Answer

The answer of If a proposed expenditure of $80,000 for...

Question 10

A company is considering the purchase of a new machine for $48,000. Management expects that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. All revenues and expenses except depreciation are on a cash basis. The payback period for the machine is 6 years.

Accepted Answer

The answer of A company is considering the purchase of...

Question 11

A company is planning to purchase a machine that will cost $24,000, have a 6-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total income over the life of the machine is estimated to be $12,000. The machine will generate net cash flows per year of $6,000. The average rate of return for the machine is 50%.

Accepted Answer

The average rate of return for the machine cannot be 50% as it is calculated by dividing the average net income by the initial investment. In this case, the average net income over the 6-year life of the machine is $2,000 (total income of $12,000 minus initial cost of $24,000). Dividing this by the initial investment of $24,000 gives a negative average rate of return of -8.33%. Therefore, option B is correct.

Question 12

For Years 1-5, 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 3 years.

Accepted Answer

The cash payback period is calculated by dividing the initial investment ($250,000) by the expected net cash inflows for each year until the investment is paid back. In this case, the sum of the net cash inflows for the first three years is $250,000, which means the investment is paid back within 3 years. Therefore, the statement is true.

Question 13

A company is planning to purchase a machine that will cost $24,000, have a 6-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total income over the life of the machine is estimated to be $12,000. The machine will generate net cash flows per year of $6,000. The payback period for the machine is 4 years.

Accepted Answer

The payback period is calculated by dividing the initial investment ($24,000) by the net cash flow per year ($6,000), which equals 4 years. Therefore, the statement is true.

Question 14

A company is planning to purchase a machine that will cost $24,000, have a 6-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total income over the life of the machine is estimated to be $12,000. The machine will generate net cash flows per year of $6,000. The average rate of return for the machine is 16.7%.

Accepted Answer

The average rate of return is calculated as net cash flows divided by initial investment, multiplied by 100%. In this case, the net cash flows per year are $6,000 and the initial investment is $24,000, resulting in a rate of return of 25%. This is greater than the given 16.7%, indicating that the investment is profitable.

Question 15

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.

Accepted Answer

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 payback period, not the discount period.

Question 16

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.

Accepted Answer

The definition of cash payback period is accurate.

Question 17

A company is considering purchasing a machine for $21,000. The machine will generate income from operations of $2,000; annual net cash flows from the machine will be $3,500. The payback period for the new machine is 6 years.

Accepted Answer

To calculate the payback period, we divide the initial investment by the annual net cash flows:

Payback period = $21,000 / $3,500 = 6 years

Since the payback period is exactly 6 years, the statement is true.

Question 18

The average rate of return is a measure of profitability computed by dividing the average annual cash inflows from an asset by the average amount invested in the asset.

Accepted Answer

The average rate of return is calculated by dividing the average annual profit by the initial investment cost, not by dividing the average annual cash inflows by the average amount invested.

Question 19

A company is considering the purchase of a new piece of equipment for $90,000. Predicted annual net cash inflows from the investment are $36,000 Year 1), $30,000 Year 2), $18,000 Year 3), $12,000 Year 4), and $6,000 Year 5). The average income from operations over the 5-year life is $20,400. The payback period is 3.5 years.

Accepted Answer

The payback period is calculated as follows:
Year 1: $90,000 - $36,000 = $54,000 remaining
Year 2: $54,000 - $30,000 = $24,000 remaining
Year 3: $24,000 - $18,000 = $6,000 remaining
Year 4: $6,000 - $12,000 = -$6,000 (payback period is between Year 3 and Year 4)
Therefore, the payback period is 3.5 years, which is less than the average life of the investment (5 years), indicating it is a good investment.

Question 20

A company is planning to purchase a machine that will cost $24,000, have a 6-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total income over the life of the machine is estimated to be $12,000. The machine will generate net cash flows per year of $6,000. The payback period for the machine is 12 years.

Accepted Answer

The payback period for the machine is actually 4 years. ($24,000 initial cost / $6,000 annual cash flows = 4)

Quiz 25: Capital Investment Analysis